2020 industry forecast: steady with a little growth
by Gregg Wallis (Hotel Business)
Lou Plasencia was quoted in this article posted on January 15, 2020. The full article is available on the Hotel Business website.
After years of wondering if and when the current hospitality bubble might burst—or what inning we are in in the economic cycle—it looks like 2020 will not be the year we finally find out. Many experts are predicting that the year will be very similar to 2019, and that growth will be minor or flat.
“It wasn’t long ago when you had some economic forecasters saying recession probability was anywhere between 30% and 50% for 2020,” said Mark Woodworth, senior managing director, CBRE Hotels Americas Research. “It seems like that probability has dropped significantly. If our forecasts are not right on for 2020, the reality could be a little bit better than what we are estimating.”
CBRE’s forecasts for revenue growth continue to diminish, but the health of the U.S. lodging industry remains strong. Beyond 2019, occupancy levels are forecast to decrease in 2020 and 2021.
“We believe that elevated levels of uncertainty, tighter lending requirements and escalating construction costs will impair the expected growth in new supply,” he said. “Concurrently, the economy continues to support the demand for lodging accommodations. Despite the declines forecast over the next two years, occupancy levels should remain above 65% for the foreseeable future.”
While supply and demand appear to be in balance, the prospects for growth in room rates remain limited. CBRE’s forecasts for ADR change have been reduced to below 1.5% through 2022. “Not only does this result in a lack of real ADR growth, but the low ADR gains limit RevPAR growth to under 1% through 2021,” said Woodworth. “With revenues growing less than 1%, the ability to grow profits will remain very challenging for the average U.S. hotel.”
Like many others in the industry, Robert Habeeb, CEO of Maverick Hotels & Restaurants, is being cautious when it comes to prospects for the new year. “The tricky thing about forecasting for 2020 and beyond is that so many of the important factors that may influence the market remain unclear. So, we are approaching the coming year with a little bit of trepidation, but a healthy amount of optimism as well,” he said. “We anticipate 2020 to be analogous to 2019, with the industry seeing a nominal RevPAR bump at best. Many experts are predicting a decline in RevPAR, but we are taking a contrarian stance since we don’t see any evidence of this behavior in the short term.”
While most factors will remain the same for 2020, Lou Plasencia, CEO, The Plasencia Group, predicts that hotels will be less profitable in the coming year. “In other words, there is a continued increase in average daily rate, and occupancy is pretty much maxed out, so you are not seeing a tremendous amount of revenue generation—somewhere between 1.5% and 2.5%, depending on the market,” he said.
“The occupancy levels are three to four points above long-run average; it’s the same with profit margins,” said Robert Mandelbaum, director of research information services, CBRE Hotels Americas Research. “Hotels are operating extremely efficiently. Their dollars are flowing from the top line down to the bottom line as well as they ever have going back as far as the 1960s. But, because revenue growth is slow and expenses are on the rise, our projections for absolute profits on the bottom line from the dollars are expected to be flat or a slight decline in the next two to three years. But hotels are still operating as efficiently as they ever have.”
A main reason for this, according to Plasencia, is the growing cost of expenses. “The biggest challenge is really on the expense side, where expenses are growing at a pace faster than RevPAR,” he said. “It is labor, it is insurance, it is property taxes—those are the three main areas. Then you have the challenge of new supply and operators’ ability to raise rates because the new properties are typically offering introductory rates. It is hard to move rates up when there is so much new supply coming into a variety of different markets.”
Mark Ricketts, president/COO, McNeill Hotel Company, agreed that profitability will be a challenge. “With flat occupancy, the real challenge is how to maintain rates,” he said. “Dropping rates doesn’t really induce demand. No one wants to witness a repeat of 2009 when operators got frantic with dramatic rate cutting. Regardless of market conditions, we must exercise discipline and maintain reasonable, profitable levels of rates by offering a compelling value and experience to guests. No one wins a race to the bottom.”
Managing operating expenses is a key to a successful year for any operation, according to Ian McClure, CEO, Gulf Coast Hotel Management Inc. “With increased overall hotel unit supply, we believe the hospitality industry will experience slight RevPAR increases with a possibly challenging year with regard to managing operating expenses, which have outpaced RevPAR growth,” he said. “Hotel operators and management companies that are able to manage those costs will continue to be successful in 2020, while marginal to poor operators could have a difficult year.”
The issue of labor will remain a major factor is 2020. “While owners and managers will continue their 2019 focus on operational efficiencies to maintain margins, growing labor costs will likely continue to outpace bottom-line growth,” said Mitchell Hochberg, president, Lightstone. “On the expense side of the equation, low unemployment is making retention of top property talent difficult, which can lead to operating inefficiencies and increased costs of acquisition, training and retaining employees. Additionally, state-mandated living wage laws will continue to erode profitability.”
“It’s no industry secret that the biggest factor affecting most all segments of hospitality is the availability and cost of labor,” added Ricketts. “Many of our competitors for frontline staff, like big-box retailers or fast-food restaurants, are offering compelling hourly wage rates right now.”
Steps can be taken to combat the labor shortage and its effects on the bottom line. “There are several ways to ameliorate this situation, including new uses of technology and astute allocation of human resources,” he said. “For example, as encouraged by the brands, we are witnessing expanded use of the digital key, which may help relieve staffing levels. Guests also welcome being able to control the room heating and cooling and importing television shows, movies or sporting events to the in-room television through the same phone used for the digital key. We are also seeing some early attempts to use automation in new ways, such as for a self-cleaning bathroom.”
The labor shortage is not an area that is going away any time soon, according to Plasencia. “That is going to be an issue that is going to plague this industry for the next five to 10 years,” he said. “There are jobs at hotels that are going unfilled today because people simply don’t want those jobs. They are too menial—it is not that they don’t pay enough—those jobs are paying good wages—but people just don’t want to wash dishes or clean rooms. I get it. I was speaking with the GM of a major hotel in Las Vegas. He said, ‘I wake every morning knowing that I am going to be 400 employees short.’ How do you operate a hotel when you are short 400 employees? It is remarkable. You are putting a tremendous strain on everybody else. But he just can’t get the labor.”
One area of hospitality that is greatly affected by the labor shortage is construction, which, despite this, is forecast to have growth in new hotels in 2020, with Lodging Econometrics forecasting a 2.2% growth rate for the year.
“I think we are going to see more of the same from a pipeline perspective,” said J.P. Ford, SVP and director of business development, Lodging Econometrics. “We are getting close to a topping-out formation. There are a lot of projects in the pipeline. There are a lot of rooms in the pipeline. We aren’t quite at the peak of where we were in the last cycle, but we are inching up there. The economic environment is favorable. The economy is doing well.”
He continued, “Some of the projects are delayed a little bit, really because of the labor shortage. We are at historic unemployment rates. Pretty much anyone who wants to work is working. There is just a little bit of a shortage in some of the construction trades.”
What drives construction is lending, and Ford said that it remains strong. “You need the capital and the dollars circulating into hospitality, and you need the lending community participating,” he said. “I always keep my eye on that. So far, so good. That could slow things down if lending dried up, but I think we are in pretty good shape.”
Investment remains strong in hospitality, according to Plasencia. “There is no shortage of capital going into lodging right now,” he said. “Underwriting criteria has definitely tightened. They need to get money out. Some companies are hitting record numbers of debt going into the lodging sector and very little on the problem-load side. They have very few defaults, if any, to contend with. That means they are doing a good job of underwriting. They’ve got good sponsorship.”
He continued, “Acquisition financing is fairly easy to get. Construction financing is more difficult. A lot of it depends on sponsorship. There are some guarantees that typically get put in place. But I would say, for the most part, we are not seeing any constraints on the debt part of the deal. Interest rates remain very low and I don’t think you are going to see any major increases. The availability of capital—there is an open faucet at this point.”
One thing that has changed, said Plasencia, is who exactly is doing the investing. “We have seen the entry of a lot of nontraditional investors coming into the business,” he said. “I would say roughly 50-60% of the transactions that we have completed in the last year have been to family offices or high-net-worth individuals who are entering the business for the first time or have only recently entered the business.”
They are entering the sector for a number of reasons. “One, the hotels are generating returns they are not able to get in other investment vehicles, especially other real estate asset classes like industrial, multifamily or office,” he said. “Hotels are providing a good cash-on-cash return that they are not able to get elsewhere.”
Beyond the economic benefits of the hospitality sector, Plasencia said that there is another reason that makes it attractive—literally. “Frankly, it is a lot sexier than any other asset class,” he said. “You can go have lunch and drinks at your hotel, but you can’t do the same in your industrial building. You can stay for a weekend at your resort, but you can’t stay for a weekend at your office building. It is a little bit more attractive in several ways. The hotels that are being acquired by these new investors are typically in resort or urban areas, so they are much more attractive to those investors.”
The number of sellers has also increased. “We have seen a 25-30% increase in companies selling assets this year over the last six months,” he said. “We see that growing into 2020. I do think people are definitely of the opinion that we are very late in the economic cycle, and there is a greater possibility of a recession now than there was a year or two ago. The ability to generate higher profits has also been challenged. As a result of that, a lot of owners who have held assets for eight to 10 years are recycling that capital. They are exiting because of where we are in the economic cycle.”
Plasencia does see an uptick in investment in existing properties instead of new-builds. “The cost to build new assets has increased dramatically, so it is cheaper to buy an existing property today than it is to build a new property,” he said. “Those existing properties are generating cashflows much more quickly than something that you have to spend two years to plan and title, and a year and a half to build, and then two years to build up. I can go buy an existing property right now and be cash-flowing within a year.”
According to CBRE’s Woodworth, especially related to RevPAR, some chain scales are predicted to do better than others in 2020, “but there is not a whole lot of difference. It is pretty much uniformity in how they will react.”
The luxury hotel segment is forecast to have a slightly up year for 2020, with small increases in the major measurement categories, and only a 0.2% decline in occupancy.
But, according to Woodworth, there is uncertainty, especially in relation to tariffs. “When it comes to luxury, part of the concern is about the level of capital investment that has been made on the part of businesses particularly,” he said. “You have a lot of it stemming off of the uncertainty around tariffs and how long the tariffs are going to persist—if they are going to get better before they get worse or if they are going to get worse before they get better. Part of that too—certainly involving China—is lots of focus on supply chain changes, moving out of China and into other countries from a production perspective. Until that gets figured out, it is a real headwind on capital investment. All segments of the industry feel that, to some degree, and I would argue that luxury and upper-upscale feel that a little more than most.”
Richard J. Stockton, president/CEO, Braemar Hotels and Resorts, believes that the segment will continue at the same pace as previous years. “The luxury segment has had the greatest compounded annual RevPAR growth of any chain-scale segment over the last 30 years,” he said. “This trend has remained consistent over the last few years and is expected to continue into 2020.”
He also thinks that the segment will see RevPAR growth for the year. “Although somewhat underwhelming compared to historical performance, next year’s forecast calls for twice the RevPAR growth of the industry average,” he said. “This forecast is not surprising given that barriers to new supply for luxury properties tend to be higher than other segments due to unique location requirements, complex planning approval processes, and the significant amount of time and capital required to bring new luxury projects to fruition.”
Like many of the other segments, upper-upscale is forecast by CBRE to see negligible growth in several categories, with a 0.3% decline in occupancy.
Chris Diffley, managing director, investment group, Rockbridge, said that asset performance in the segment will vary based on local competitive positioning. ”Hotels that successfully meet guests’ expectations and preferences will perform better in this slow-growth market or a declining market,” he said. “Guest preferences continually evolve and change. Guests today are seeking an authentic experience. The market has reacted to that desire with a proliferation of soft brands trying to fill the gaps not met by hard brands. Additionally, there has also been a strengthening of competitive positioning of independent hotels in certain markets.”
The upscale segment will see an increase in supply, with both Lodging Econometrics and CBRE forecasting 4.4% in supply for the year.
Maverick’s Habeeb sees more of the same results for 2020—and matching the forecasts, will be increasing the company’s supply. “Our segment is on track to follow the same trends we saw in 2019, starting with plans to open three new hotels in 2020,” he said. “This opening pace is noteworthy for us in light of reports of slowing supply growth across the industry, which we expect is driven by equal concerns of oversupply and fears of a potential economic slowdown.”
He continued, “We still see a healthy amount of construction taking place in underserved markets, where supply is still available to be absorbed. To that end, we currently have four projects in the pre-development stage, which we believe will solidify in 2020 in time to commence construction in 2021. There are still many underserved markets ideal for new hotel development, and others that have yet to reach their untapped potential.”
Lodging Econometrics predicts a 4.1% growth rate for the upper-midscale construction pipeline for 2020, which, along with upscale, is the highest for the year.
This is nothing new according to Ford. “It has been that way throughout this lodging development cycle that we have been in coming out of the bottom in 2009,” he said. “The upscale and upper-midscale segments have dominated the pipeline, and those are a lot of brands that you know like the Courtyards, Residence Inns, Hilton Garden Inns, Hampton Inns and Holiday Inn Expresses. Those types of brands have wide consumer acceptance and great 800-reservation systems. They can be built less expensively than trying to do a luxury or full-service, upper-upscale property. They work for the business traveler. They work for the leisure traveler. The lending community loves those brands. They have just dominated the pipeline for the past 10 years.”
Ricketts, of McNeill Hotel Company, which owns 15 hotels in upper-midscale, expects a steady year for the segment, but is prepared if things take a downturn. “Should the economy weaken, we do feel that companies, as well as individual leisure guests, will trade down in property type; for example, from a full-service hotel to a Courtyard by Marriott, Hilton Garden Inn or Hampton Inn,” he said. “This behavior is one of the factors that make the select-service model attractive to us.”
The company will be focusing on a few areas to make sure it is maximizing its business. “We will work hard to grow our group business with corporate, organizational and family accounts,” said Ricketts. “This is the time to mine local festivals, sporting events, even family reunions that draw guests to your area. We also see potential in the trend for business travelers wanting to stay on another day or two, giving us valuable bridge nights. It’s not uncommon for a business traveler to extend a stay and be joined later by a spouse and family to enjoy a mini-vacation.”
For the midscale segment, Lodging Econometrics forecasts a 2.9% growth in the construction pipeline, while CBRE predicts less than 1% growth in RevPAR, demand and ADR, with a 1.5% increase in supply, and a 0.7% decrease in occupancy.
Kerry Ranson, chief development officer, HP Hotels, which owns properties in the segment from Wyndham and Choice, is optimistic about the sector for the coming year. “This is the road-warrior segment that traditionally displays resiliency in weaker markets,” he said. “It is helped by the likelihood that people will tend to buy down a segment or two should the economy slow. No segment is completely recession-proof, but the midscale segment is probably as close to it as you can get.”
The segment also benefits from its simpler operating model, which helps with the labor crunch. “You don’t have a staff member overseeing food and beverage or a large meeting space, and many of the properties have a physical design that makes it convenient for a front-desk person to pitch in, when necessary, with other tasks like laundry distribution,” he said.
That simpler operating model doesn’t make the segment completely immune to labor problems. “This factor affects midscale in unique ways, as this segment has always been an entry point and learning ground for our industry,” said Ranson. “However, as managers gain experience, get promoted and move on to new responsibilities at higher segments, we can be left at these properties with a double whammy of an entry-level workforce being led by a manager who is still in training.”
CBRE predicts a 0.8% increase in RevPAR for the economy sector in 2020, with decreases of less than 1% in supply and demand. Lodging Econometrics forecasts a 0.4% growth in the construction pipeline.
The current high level of employment has an effect on RevPAR for the segment, according to Woodworth. “We have done research in the past where we have found that changes in income have a greater impact on the change of performance in demand for upper-priced hotels, whereas changes in employment have the greatest impact on the lower-priced hotels,” he said. “One of the reasons why we are projecting a slowdown in the increase in RevPAR over the next few years is because there is going to be less employment growth. While the growth story is not that great, employment levels are at such a high peak and unemployment is very low; there is just not that much more room for employment growth. We are not going to see that boom in new employment that tends to influence the lower-priced segments more so than the upper-priced.”
Gulf Coast’s McClure, which owns 23 WoodSpring Suites hotels across Colorado, Louisiana and Texas, has a positive outlook for the segment. “The unit supply growth in the economy segment has not yet outpaced demand and, therefore, we believe 2020 will ultimately be a positive RevPAR year for the segment,” he said. “This is especially true for economy, extended-stay brand-wide; WoodSpring Suites’ RevPAR performance was strong in 2019 as of the latest data (through the third quarter of 2019).”
As with other segments, he sees the biggest challenge for the economy segment to be balancing operating expenses with revenue. “The economy sector has a price-sensitive guest mix and does not have strong pricing ability to push ADR, so it’s important to closely manage expenses, such as property-level labor, OTA commissions and property taxes, in order to maintain optimal net operating margins—all of which Choice Hotels assists with as a franchisor,” he said.
Move away from segmentation?
Of course, there are some hotels that defy traditional labels and segmentation. Hochberg suggested that the market has changed in the last few years and requires a new way to look at how hotels are classified.
“The traditional segmentation model is becoming increasingly irrelevant as new hybrid models gain traction,” he said. “Namely, a new breed of lifestyle hotel has emerged that is built upon a select-service hotel operational backbone. For the consumer, this is a much-needed alternative that combines convenience and memorable experiences at an affordable price point.”
He continued, “For the various tranches of ownership, franchise, management, etc., this is a ‘win-win’ outcome, as these experiential offerings can outperform the traditional select-service comp set, while driving accretive bottom-line margins. With the U.S. economy closing in on full employment, this operating model will cater to increased demand in the leisure segment in 2020.”
2020 presidential election
On the minds of many in the hospitality industry is the upcoming presidential election—and the general political climate—the results of which will most likely have an effect on the economy and other issues.
“History has shown that our industry tends to experience ups and downs during an election cycle,” said Ranson. “This next one will also certainly be affected by the current tenor of political discourse, plus remaining trade issues with China and, domestically, by Boeing’s continued struggles in getting its 737 Max planes recertified for flight.”
He continued, “As we know, any uncertainties—political or economic—can translate into companies and groups holding back on travel. But, overall, we should be prepared for the demand and profitability oscillations typical of an election cycle, prompting us to make quick, appropriate shifts in areas like resource allocation or revenue management strategies.”
Stockton sees positives for the industry no matter which way the electorate swings. “Assuming an incumbent victory, the capital markets, business activity and consumer spending should remain stable,” he said. “If there is a change in the presidency to a leader with significantly differing political views, new tax and other policies could introduce unexpected risks to the economy that could have a negative impact on lodging demand. On the upside, however, loosening of immigration controls and further productivity gains could relieve pressure on the labor markets, enhancing overall hotel profitability. We will have to see what challenges and opportunities 2020 brings.”