Although 2015 marked the top of the business cycle for hotels, it doesn’t necessarily mean the start of a downhill slide.
ATLANTA—Enrollment spiked at the School of Hotel Market Doom and Gloom as public sentiment about the U.S. hotel industry’s financial performance turned from positive to negative.
The first quarter of 2016 was less than stellar: U.S. gross-domestic-product growth was less than 1%; concern about international economic strength grew; and public markets fell due to a continuing flow of bad news (the exception being employment growth). Occupancy during the first quarter declined 0.5%, causing concern despite the prior year’s solid results. Demand grew nearly 3% in 2015, while supply increased by just over 1% and revenue per available room jumped 6.2%, according to STR data. (STR is the parent company of Hotel News Now.)
We believe that 2015 marked the top of the business cycle for hotels, but this observation doesn’t imply the start of a downhill slide. CBRE’s forecast calls for a reduction in the national RevPAR growth rate from 5.5% to 4.2%. Financial performance among many U.S. hotels is slowing, not shutting down.
Why the slowdown?
At the School of Hotel Hope and Promise, courses on rational economic thought reinforce ideas about income and consumption, along with the basics of demand, supply and cyclical patterns of real asset markets. The list of potential explanations for a hotel slowdown begins with a simple comparison of demand and supply. Demand grew at a paltry 1% in the first quarter of 2016, while supply grew 1.5%. This supply growth rate was anticipated; the slower demand growth rate was not.
The underlying economic numbers do not provide much guidance for the first quarter’s weak hotel demand growth. Revised GDP growth came in at 0.8%, and among the culprits was a negative 0.45% in business investment. Personal consumption grew faster in the first quarter of 2016 than a year earlier and in the first quarter of 2014. Piling on, real personal income grew a healthy 3.3% during the quarter.
In the absence of a rational economic explanation for the industry’s weak first-quarter performance, only behavioral explanations remain. Uncertainty was rampant in the first quarter as the CBOE Volatility Index (VIX) exceeded 30 twice during the quarter before settling into the midteens in late March. Business and leisure travelers apparently decided to stay home rather than venture out into uncertain territory. The slowdown should ease in the second quarter of 2016 as the uncertainty boogeyman appears to have retreated to his cave.
Why not a shutdown?
Hotel financial performance can be evaluated in levels (i.e., dollars) and in changes (i.e., growth). For some public market investors in hotels, the slowdown in RevPAR growth represents a signal to rotate out of lodging and into other sectors with higher expected growth rates. Among its other characteristics, Wall Street has a fixation for growth. The Baird/STR Hotel Stock Index reveals that public market investors fear a hotel market downturn is imminent.
Since 2010, real personal income has been the single most important determinant of the number of hotel rooms sold in the United States. U.S. hotel demand sustains as long as more educated, upper-income workers do not suffer the ill effects of an economic downturn. Real personal incomes and employment conditions among skilled workers continue to provide solid foundations for hotel demand at the property level.
We predict that supply will more closely align with demand in the coming years; however, in our view, demand and supply will not become so unbalanced in favor of supply to foster much reduction in dollar flows. Hotels are making money with a cushion against disturbances. The attached chart (Exhibit 1) shows gross-operating-profit margins reached near record highs in 2015 and are forecast to exceed previous high-water marks in 2016.
If not a shutdown, then what?
I offer a scenario in which hotel markets at their peak operate similar to engines operating at high revolutions per minute—they both oscillate. The behavioral interpretation of this seemingly mechanical process is that at cyclical peaks market participants have greater difficulty than during up-and-down cyclical phases determining whether the market is headed upward to a new peak or downward into a potential trough. Thus, reactions to news, either positive or negative, elicit modest yet visible economic responses.
The previous two shutdowns were quite severe and precipitated by extraordinarily painful events. Exhibit 2 presents an alternative scenario in which neither a severe shock nor overbuilding occurs, but instead the hotel market mean reverts (i.e., oscillates) with a slight upward trend.
Corgel, J., and B. Edgerton. "Hotel Demand and Real Personal Income: Inextricably Linked!" CBRE Knowledge Center. CBRE Hotels, 8 Apr. 2016.
Corgel, J., and M. Woodworth. "Why Hotels? Economy Weakens but Hotels Remain Relatively Strong-- What Gives? And What Might Give?" Cornell Hospitality Quarterly 53.4 (2012): 270-73.
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