The hotel industry continues to look out the rearview window instead of looking at the road ahead. This has led to a major disconnect from recognizing the risks that lie in the road ahead.
Articles and commentary continue to cite historical STR data instead of looking at the current world situation and U.S. statistics.
The payroll statistics from the first quarter got a lot of people all excited that things were getting much better, and the economy was doing well. We now see that the employment improvement was likely an anomaly due, in part, to a historically warm winter, which made it easier for consumers to travel and get to the mall. In addition, there was catch-up hiring by corporations who were getting staffing levels back to what was needed due to the excessive firing in 2009 and 2010.
If you look at the numbers, the trend since January is a substantial decline. Although the official unemployment rate was down, the reality is labor participation dropped to the worst in 30 years. The real unemployment and underemployment rate is 14.5%. Challenger Grey has said its index of layoffs is again increasing; hourly earnings were unchanged.
In short, the employment picture is terrible.
Housing market in the tank
Housing remains in a severely depressed condition and will remain there for a long time. A recent study revealed that none of the government programs to help distressed homeowners has made a material dent. Now that the $25-billion settlement with the banks has been reached, the foreclosure rate will increase materially. There are possibly another 5 million foreclosures to go. The proposed sales of real-estate-owned houses to private-equity funds to rent will not make any real difference. While prices in many markets appear to be stabilizing, that is far from real improvement or getting mortgages right side up.
I have spoken to the private-equity people who were supposed to be the buyers of all that REO, and they all say they might buy some houses but not the millions that will come available through foreclosure.
Home ownership is now near post-war lows, and that is not likely to change.
Richard Cordray, the new head of the Consumer Finance Protection Bureau, has made it clear to servicers and lenders that unless they do things perfectly, he is coming after them. It is extremely hard for anyone without the strongest credit to get a mortgage. Thirty-eight percent of homebuyers are speculators buying for all cash to rent out. The housing market will not be well for at least another five years.
GDP slowing, too
The nation’s gross domestic product is only growing at a rate of 2.25% to 2.5%, and that might be the high end going forward. Nobody credible is forecasting more than 2.5%. Inflation is between 2.5% and 3%. Therefore there is no real growth.
Historically, revenue per available room tracks GDP over time. As Ross Woods, managing director at Hotel Investment Strategies LLC, has tried to explain, things revert to the mean, and that is what is going to happen to RevPAR.
Don’t get misled to think the first four months of RevPAR increases are indicative of the full year. RevPAR growth of 7% or 6% or even 4% is not sustainable if GDP and unemployment remain bad or get worse, and if the European situation continues to spiral into a new crisis. .
More volatility abroad
Francois Hollande, the next president of France, announced his intention to ignore all the agreements the Europeans have hashed out to try to save the euro. He intends to ramp up spending and to fight the Germans and the European Central Bank on austerity. The Greeks have just renounced the bailout agreements with the ECB and International Monetary Fund. They are daring the rest of Europe to stick with the terms already agreed. Spain is unable to solve its banking crisis without a major bailout form the ECB and the IMF. It has been covered over until now, but it is about to rear its ugly head.
This is going to make the European crisis much worse very fast, and that will negatively impact the debt markets by causing much more uncertainty and volatility. Hollande’s election, and the failed election in Greece, is going to upset all that Europe has worked so hard to achieve.
The defense minister of Israel stated that Iran is very close to being able to build a nuclear bomb. U.S. Secretary of Defense Leon Panetta said an attack by Israel on Iran is possible after April; it’s now May. Israeli Prime Minister Benjamin Netanyahu just stated clearly that unless Iran agrees to stop all nuclear enrichment in two weeks at the next meeting with the West, then the talks will have failed. Iran is not going to agree to that. By August the sanctions will have been shown to have failed. Not to mention, Syria’s situation continues to rapidly worsen. When Syria descends into full-scale civil war, then Lebanon and Iran get pulled in, as do Turkey and Saudi Arabia.
The just foiled bombing of a US bound flight shows that terrorism is very alive and well, and is still aimed at airplanes and the US. Had that bomb succeeded, you could have kissed revpar goodbye. This black swan event is very much a possibility.
The Bo Xilai scandal in China is reported to be having far worse and widespread implications than we know. A credible source of mine said the top levels of provincial governments and business are all very fearful this could lead to arrests or even executions. Corruption is rampant in China, and there is great fear of a major crackdown. There is no way for us to know what is really happening, but the scandal is not a good thing for the Chinese economy. Much more Chinese cash will arrive in the U.S. in the coming months. These guys need to be ready to run at a moment’s notice.
Stock market shaky
The stock market is flat lining or declining. New wealth is normally created through the stock market or increases in housing values. That is not happening.
The end of tax cuts is 31 December. Dividend and interest income taxes increase to 43.4% on 1 January 2013, up from 15%. Sequester kicks in 1 January 2013. That is $1 trillion out of the economy overnight. There likely is going to be a kick-the-can on both in the lame duck session, which solves nothing. If they don’t do something, all hell will break loose. Do you want to bet Obama and the House will agree to all of these massive deals in just six weeks of a lame duck session?
Businesses are so uncertain that expenses still are being reduced. Hiring in large numbers is not happening. Group ADRs are not ramping up as hoped and predicted by many. Travel is one of the first places to keep spending low. With the new, bad employment numbers out, business is not going to ramp up travel or group business. Big ADR increases are not going to occur in most markets going forward. Take out the luxury segment, and it will not be all rosy.
Loan maturities are now ramping up, and only 60% of loans are getting refinanced successfully. While defaults are less for now, the surge of maturities is just starting. Yes, it is better than it was, but living near death with the hope of recovery is barely better than dying. It is all relative.
Impact on the hotel industry
Other than a few locations like New York, which is on its own planet, or San Francisco, where it is nearly impossible to build, there are not many places to develop safely right now. If you are sure the world will be a much better place in three years, go and develop. But you know more than most, if you are sure of that.
If you read the research of financial crashes and near-death experiences for large economies, as I have, you will understand that these massive near depressions take more than a few years to come out of alive. The steps taken by the current administration have exacerbated things substantially, and so the recovery is going to be longer and slower than it should have been, and with Hollande running France and Greece ungoverned it will be even worse.
If you do nothing else, watch the yield on the 10-year Treasury. It is probably the most widely traded security in the world, so it is the best proxy for investor sentiment. When yields go down, investors are pouring money into the U.S. 10-year Treasury because they are scared. The yield on the 10- year is now 45 basis points below where it was just a few weeks ago and is about at an historic low.
My point is not to depress everyone. I simply feel everyone needs to look at the real world far beyond the hotel industry.
Conserve cash. Don’t push hiring yet. Don’t race to develop yet. Continue the cost reduction programs you already implemented. The world is still very uncertain, and nobody can be sure what next week or next month will bring. Eventually things will be very good again, but you want to be alive to be able to take advantage when that happens.
The level of uncertainty is still too great at the moment. The disconnect between the hotel industry optimists and the risks in the world ahead is gaping.
Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that is available through his website, www.citadelrealty.com.
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