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The current state of the U.S. lodging industry
November 14 2011

While there continue to be enough potholes ahead to proceed with considerable caution, there are plenty of reasons to enjoy the current state of the industry while it lasts.

The lodging industry is in the midst of a solid rebound in virtually all performance measures. While there continue to be enough potholes ahead to proceed with considerable caution, there are plenty of reasons to enjoy the current state of the industry while it lasts.

One of the most optimistic aspects of where we are today is the gradual slowdown in room supply growth. When the industry entered the recession in 2008, room supply was growing very rapidly and industry management was not prepared for a sharp downturn in demand. By late 2008 and early 2009, room supply was growing around 3% over the prior period, greatly compounding the typical difficulties associated with a slump in demand. Following that surge in supply growth, construction activity began to slow down and by mid-2010 room supply was growing by less than 2%. It has continued to decline steadily and for most of 2011 room supply growth has averaged less than 1% from year-earlier levels. As of September 2011, room supply growth had sunk to only 0.6% over September 2010.

While reviewing the pipeline of new rooms coming into the market, it appears that room supply growth will remain low for the foreseeable future. With only 54,000 rooms currently under construction, the industry is in a much better position to withstand potential declines in room demand. While the number of rooms in final planning is just short of 100,000 and the number of rooms in the planning stages totals around 165,000—which could be causes for concern—the number of rooms in these two stages combined is nearly 40,000 less than at this time last year.

The bright spot of what is under construction is that, other than New York City, it appears to be fairly dispersed and should not be a big drag on occupancies going forward. New York is in the midst of a construction boom with more than 7,000 rooms currently under construction in the city. That represents about 7% to the existing supply base. Fortunately, it appears at this time that the city could use additional rooms so we do not expect any major distortions in that market over the short term.

Across the rest of the country, most of the properties under construction are in the upscale and upper-midscale segments, which tend to be smaller and have a less-immediate impact on overall supply growth issues. As a result, we do not expect room supply growth to be a significant problem for the industry as we wrap up 2011 and enter 2012. We will continue to pay close attention to construction activity with a focus on the end of 2012.

Demand growth
Another bright spot for the industry is the nearly stunning rebound in room demand over the past several months. On a seasonally adjusted basis, room demand has been setting records. Prior to the current downturn, the highest number of room nights sold on a seasonally adjusted basis was 87.2 million in November 2005. Following that peak, room demand stabilized around 85 million room nights a month for the next several years. As the recession set in, monthly room demand began to fall fairly dramatically, finally reaching the bottom at around 75 million a month in early 2009. Since then, the number of room nights sold has been climbing steadily. It reached the 85 million room night level in late 2010 and stabilized again at that level. But after nearly nine months stuck at that level, in early 2011 room demand began to grow again. And in March of this year, the industry finally set a new record of room nights sold reaching 87.5 million room nights. Since then demand has continued to set new records. While there was a brief drop in August, September rebounded to fall just short of 90 million room nights sold.

Clearly, this is the one variable where the industry is most vulnerable. The relationship between overall industry demand and economic activity continues to evolve. As shown in the accompanying chart, historically, changes in room demand have been highly correlated to changes in GDP. Over the past several years however, the changes in lodging demand have become more dramatic. When the recession hit, demand for rooms declined much greater than the overall economy and as the economy began to stabilize, lodging demand has improved much more rapidly than the overall economy.

For the third quarter of 2011, room demand was 4.7% greater than the same period last year while GDP growth is expected to be less than 1.6% for the quarter. While STR does not believe that the relationship between demand and the economy has been changed forever, we do believe that demand could remain strong for the remainder of the year and begin to stabilize at current levels as we enter 2012.

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Occupancy rises
The combination of lower supply growth and a solid rebound in demand has led to steadily rising room occupancy rates. In general, occupancy has been drifting downward for the past 20 years. In the late 1980s when STR first began tracking the industry, occupancy regularly exceeded 65%. The industry has not been back to those levels since the mid-1990s. Even during the good years between 2004 and 2008, occupancy only climbed back to a high of 63.5% in June 2006. When the recession hit, occupancy began to decline sharply finally reaching a bottom in January 2010 of 54.5%. While it has rebounded nicely since then, it is still around 60%. Interestingly, while occupancy is generally lower than historical norms, the industry has been able to lower the break-even occupancy to such a point that overall profitability continues to remain solid with considerable upside potential.

The one area that continues to be underperforming given the other industry metrics is room rates. With higher occupancy, room rates should begin to strengthen. However we are less optimistic about this variable than we have been in the past. With this recent downturn, the decline in room rates was unprecedented. After reaching a peak in late 2008 of nearly US$108, room rates declined sharply and bottomed out in early 2009 at around US$95. It has taken nearly two years to get rates back above the US$100 level and it will probably take at least another two years to get back to pre-recession levels. (And that’s not even factoring in inflation.) There has clearly been a hesitancy to push room rate increases at a time when the overall economy continues to struggle and unemployment remains very high. However, if room demand does begin to stabilize or even drifts downward, there is the real possibility that the industry missed an opportunity to be more aggressive on pricing as room demand soared to record levels.

In STR’s opinion, transparency in pricing has completely altered existing revenue management models. The complexity of pricing today with all of the various channel distribution possibilities has forever changed the role of the revenue manager in today’s lodging industry. To help meet these challenges, STR has undertaken a massive study of channel distribution data to provide revenue managers with solid benchmarks of actual performance results. Within a very short time frame, STR has been able to collect and process booking data for nearly 26,000 properties in the US. STR will be introducing a variety of new reports over the coming months primarily geared to helping revenue managers sort through the vast quantity of data available and hopefully provide them with the tools necessary to make intelligent and profitable decisions about pricing. I will discuss some of the findings of this study and how it can be applied in my future articles.

STR forecast
In summary, with room supply growth slowing and room demand growth steadily improving, our forecasts for 2011 and 2012 are fairly conservative given the continued problems with the overall economy. As of now, we expect room supply for 2011 to increase about 0.7% and for 2012 to grow another 0.9%. We expect room demand growth to be about 4.7% for 2011 and about 1.1% in 2012. As a result, we expect occupancy to improve by about 4% this year and only about 0.2% next year. With slightly higher occupancy we expect room rates to increase about 3.6% during 2011 and add another 3.7% in 2012. Showing strong percentage increases next year will be extremely difficult since we will be comparing the 2012 results with a fairly strong 2011.

Obviously these forecasts are based on economic conditions as they exist today. There are a wide variety of concerns that could cause these forecasts to be wide of the actual mark. Perhaps the two biggest problems confronting the global economy today is the credit crisis that is looming in Europe and the overall vulnerability to global shocks that can come from terrorism or upheaval in the Middle East. Add to that the usual cautionary note about natural disasters (Japan) and man-made disasters (reckless government spending) and there are plenty of areas that could affect lodging negatively. The most nagging problem in the U.S. is the prolonged level of high unemployment. While this should not cause any dramatic slowdown in lodging demand, it has removed a significant number of guests from our customer base that will be a drag on future growth in demand. The crisis in the housing market will also be with us for several more years and that will continue to hold down consumer sentiment and suppress overall spending. But for now, the lodging industry is doing much better than a year ago and the outlook is, as usual, cautiously optimistic.

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