Adapted from a 5-20-13 article on GlobeSt.com by Rayna Katz
The hotel sector is having a golden moment.
“It’s a good time to invest in the industry,” says Robert Mandelbaum, director of research information services at PKF Consulting. “In fact, it’s one of the better times. There’s not a lot of new competition in 2013 and 2014, which will perpetuate the growth in occupancy. That allows hotels to drive prices, and they are benefiting from the ADR.”
Benefitting indeed. In a March report, PKF Hospitality Research predicts domestic hotels will experience a 6.1% increase in RevPAR for the year, prompting a staggering 10.2% rise of NOI.
An owner’s first-hand experience supports these claims. “Since the start of the year we’ve seen fairly strong operating performance in all segments of hotels across our portfolio,” says Tyler Henritze, a senior managing director in Blackstone’s real estate group. “Q1 has met or exceeded expectations.”
These positive forecasts, and first-hand experience, stem from astounding occupancy levels as well as a dearth of new supply, according to several industry analysts.
“We’re seeing some of the most favorable operational metrics today than we have in a long time,” says Gregory LaBerge, national director of Marcus & Millichap’s national hospitality group, as previously reported in Real Estate Forum’s sister publication, GlobeSt.com. Further, “This will go on for the next several years. Over the past few years, we’ve seen some of the lowest numbers of new hotels coming on line.”
Supply was muted, LaBerge explains, but demand soared, with 2012 posting record room sales of nearly 1.1 billion nights. “And we’re supposed to blow through that again this year.”
Agrees Jan Freitag, SVP at Smith Travel Research, “In the first three months of this year, the industry made more room revenue, at $27 billion, than in any other first quarter.” This positive moment will likely continue for some time, he adds.
“Our pipeline looks fantastic,” says Bill Fortier, SVP of Americas development at Hilton Worldwide. “We added more than 500 properties last year, we could add 600 this year and possibly 700 in 2014.”
It’s not a bad time for those looking to break into hotels to consider building, he suggests. “It’s cheaper right now to build than to buy.”
Still, the pace of supply growth is far from rapid, Freitag notes. “The long term average is 2.1% and we’re at 0.6% for 2013. This is the lowest level of construction we’ve ever seen.” The pace is lending an assist to pricing, he adds. The slow growth “means occupancy has to go up, and that gives you pricing power. For the first quarter, occupancy was 57.7% and ADR was $108.” By contrast, according to PKF data, occupancy was 56.7% for Q1 2012, and ADR was $103.
But if an asset class is so popular, can a buyer get in? “That’s the problem,” admits Freitag. “We’re expecting room rate and RevPAR growth in the next 24 to 36 months to be rate-growth driven and that’ll drive NOI, which should then drive real estate values.”
Players in the market and analysts alike feel the best bang for a buck in the hotel sector right now is select-service hotels.
“Select service is the darling of the industry right now,” declares Fortier. “Big private equity funds finally figured out that there’s more to be made in focused service than full service,” he asserts. “There’s better long-term return and less risk because there aren’t costs for food and beverage service and the like, which can be expensive to maintain.”
At least one such brand from Hilton’s portfolio, Hampton Hotels, is a good example of the success of this hotel segment. The chain opened 22 new properties—adding 2,134 guestrooms—in the first quarter, kicking off an expected 90 openings this year. In 2012, 70 Hampton Hotels made their debut.
“We target select-service hotels because they are a more efficient and less-complex operating model with stronger margins,” adds Greg Merage, CEO of MIG Real Estate, which recently purchased its fourth such property in the Tampa, FL area, “and they offer a much lower investment cost per room compared to their full-service counterparts. Within this category, we like the ‘power brands’—such as Marriott, Hilton, IHG, Hyatt—because of their robust marketing engines and successful loyalty programs.”
And limited-service hotels still pack plenty of value, Mandelbaum says. “There’s a lack of availability at full-service hotels with the high occupancy levels, so people have to seek rooms in lower priced properties.” Also, he noted, “as the top-tier hotels drive rates up, people will trade down because of price, so lower-priced properties will do better, too.”
It’s tough to make a bad choice in the current market, notes Mandelbaum. “We don’t think there are bad segments to invest in, some just are better than others.” Agrees Merage, “The basis and cap rates for hotels, relative to other property types, remain very attractive. Financing for hotels also has become very competitive; we’re seeing terms that rival what was being done before the recession.”
Hotel investors nationwide can expect healthy profit growth for the foreseeable future, says Mandelbaum. “The outlook is positive. Not only is revenue growth being driven by ADR at this point in the cycle, which is very profitable for investors,” he notes, “but after previous recessions we’ve seen surges in expense growth during the first few years of recovery as managers replace the services and amenities cut during recessions and bring back employees who were cut or had their wages and/or hours reduced.”
During this recovery though, Mandelbaum contends, “We actually have seen a continuation of the austerity practices of 2008 and 2009, and expense growth has been fairly modest. It’s not surging like after past recessions, so there’s growth at the bottom line,” he says. “I think technology and efficient staffing are helping to perpetuate the limited cost spike.”
Overall, Mandelbaum predicts, the trajectory for hotels is good on a number of fronts. “We’re expecting both rate and revenue growth in 2015 and 2016. We will see a slight decline in the pace of growth in 2017, but that’s mostly due to the cyclical nature of the industry,” he contends. “The prospects are good for hotels.”
Adapted by David H. Hogg