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Hotel forecast: overbuilding is not a concern

Mar 19, 2014  By 

According to the recently released March 2014 edition of PKF Hospitality Research, LLC’s (PKF-HR) Hotel Horizons forecast report, the U.S. hotel occupancy rate will finally recover to pre-recession levels in 2014.

Given this lofty level of performance, many industry participants are starting to worry about that an oversupply of new lodging units may be in the future. The demand for lodging accommodations has been at an all-time high for the past two years, so could elevated construction levels be far behind?

“Anyone that was around in the 1980s and 1990s remembers the dramatic negative impact overdevelopment can have on the lodging industry,” said R. Mark Woodworth, president of PKF-HR. “Fortunately, we see a different scenario evolving during the current property cycle. According to Smith Travel Research, the long-run average annual change in supply has been 2.0 percent. We do not see the national annual supply growth exceeding that level until 2017.”

Not only are the forecast percent changes in supply lower than historical averages, but so are the actual counts of new rooms entering the market. “During past expansions, we have seen three to five consecutive years of 100,000 or more net new hotel rooms entering the market. Our current supply forecasts for the next three years are well below that threshold,” Woodworth said.

The economics are not there

“The model we have developed to forecast supply incorporates several industry performance and economic variables,” said John B. (Jack) Corgel, PhD., the Robert C. Baker professor of real estate at the Cornell University School of Hotel Administration and senior advisor to PKF-HR. “One of the key inputs is inflation adjusted pricing, or real average daily rates (ADR) in lodging parlance. Because of the discounting that occurred during recession, real ADR is not projected to reach pre-recession levels until beyond 2015, thus suppressing the financial feasibility of new development projects in the near term.”

“We hear a lot of people complaining that room rates have not risen fast enough. While this may have muted the profitability of lodging assets the past few years, the resulting lack of new supply allows for some very favorable forecasts of future performance,” Woodworth noted. Based on the March 2014 Hotel Horizons market forecast, PKF-HR is projecting 12.7 percent increase in unit-level hotel profits (NOI) in 2014 and another 14.5 percent in 2015. This will cap a five year run of double-digit gains on the bottom-line, a span not seen since the 1970s.

Construction activity

While supply growth is limited on a national level, it should be noted that some markets across the U.S. are seeing meaningful increases in new competition. Over the next two years, the inventory of hotel rooms in New York, Austin, Nashville, Pittsburgh, West Palm Beach, and Miami are all projected to increase in excess of four percent.

“The relatively high construction activity in these locales might concern the hotel owners in these markets. However, despite all the new rooms entering their cities, occupancy levels in New York, Austin, Nashville, Pittsburgh, West Palm Beach, and Miami are forecast to remain above their long-run average through 2018. This is an indication that current hotel development activity is being driven by market demand, not the artificial tax and financing incentives or excess liquidity that caused overbuilding during past recovery periods,” Woodworth stated.

The popular remain popular

Among the chain-scales, the greatest development activity is occurring in the upscale, upper-upscale, and upper-midscale segments. The upscale and upper-midscale categories contain most of the select-service, boutique, and extended-stay brands that are not only popular with developers and lenders, but consumers as well.

“Yet another difference between the current cycle and historical patterns are the types of hotels being built during this recovery. In the past, lower-priced, limited-service hotels were typically the first properties to be built following a recession, simply because they were the most affordable to construct. This time around we are seeing the greatest development activity in the upper-priced segments,” said Woodworth.

Strong fundamentals continue

Strong increases in lodging demand continue to support the supply growth that is occurring. PKF-HR is forecasting the number of accommodated room nights in the U.S. to increase by 2.6 percent in both 2014 and 2015. With demand growth outpacing supply, the national occupancy level will continue to increase through 2015, resulting in six, consecutive years of gains in this metric. “According to Moody’s Analytics, our macroeconomic forecasting agent, real personal income will continue to rise in 2014, while employment will finally return to pre-recession levels by the end of the year. Add in continued growth in business and consumer expenditures, and you have a good tasting recipe for generating lodging demand,” Corgel commented.

With occupancy levels rising, hotel managers should be able to become more aggressive with their pricing. PKF-HR is forecasting ADR to increase by 4.9 percent in 2014 and another 5.7 percent in 2015. “As we know, ADR has a 20 percent greater effect on NOI change than occupancy. Therefore, with ADR driving revenue per available room (RevPAR) growth the next few years, we continue to view the current time period as one of the most profitable in the history of the U.S. lodging industry,” Woodworth concluded.

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