Looking toward 2023, Perry Group International President and Founder Dennis Gemberling said the hotel climate resembles balanced scales. On one side is the steady leisure market and the resurgence of business and group travel, and on the other side is higher interest rates, the high cost of money, and higher pricing.
“We’re all trying to figure out which side of the scales is going to rise and which one is going to drop,” he said.
THE STATE OF THE MARKET
According to many reports, RevPAR for the U.S. lodging industry has returned to pre-COVID performance in the aggregate, but the recovery has varied widely on an individual market and property basis. This means national performance statistics can be misleading, according to Maxine Taylor, executive vice president, asset management, with CHMWarnick.
“Some hotels are well exceeding 2019 levels, and others, especially those in key urban markets, are still operating 25-30% below pre-COVID RevPAR levels,” Taylor said. “Generally, ADR has made a nice recovery driven by pentup demand and inflation – in many cases surpassing 2019 levels. Leisure destination markets such as the Hawaiian Islands and areas of the Sun Belt (pre-hurricane Ian) have far exceeded pre-COVID levels, while other gateway cities like San Francisco, New York, and Chicago still have a long way to go both in terms of occupancy and ADR recovery, as group and business travel continue to lag.”
Going into 2023, Taylor said CHMWarnick expects a deceleration in leisure demand and growth in the group and corporate segments. Jan Freitag, national director of hospitality analytics, U.S., for CoStar, said he expects the leisure travel segment to remain strong even with a possible recession looming. On the lower end, he said, the economy could impact some leisure travelers on the margin, but the U.S. leisure traveler has always surprised “on the upside,” he said.
“There’s this sense for some higher-end leisure resorts that the leisure traveler has sort of disassociated from Earth – they’ve sort of left gravity,” Freitag said. “Rates are continuing to increase at a level or to a level that has been unfathomable before. So, on the leisure side, things are good.”
Gemberling said business travel also is showing promising signs for 2023.
“The meeting, convention, group business market is starting to bounce back, although not at the same levels we had pre-2020,” Gemberling said. “I think some of that is driven by the fact that the business world just wants to get back out there and do things face to face. However, I think there’s going to be an impact and pressure on company travel budgets, given the cost increases and the rising inflationary elements to that. So, I’m not quite sure it’s going to bounce back as strongly, but I certainly am seeing it bounce back.”
Freitag said he’s bullish on the group sector, in part because he sees more businesses turning to corporate getaways meant to help build culture and strengthen teams that are not meeting daily in the office anymore. In addition, conventions and trade association events are coming back and appear particularly appealing to businesspeople looking to meet clients, partners, and even competitors in person, all on one trip, he said.
Taylor said managers have optimized ADR during the recovery, but she believes they’ll need to continue to hold or increase rates going forward, even if leisure demand slows.
“As an industry, we simply can’t afford to revert back to previous bad habits of heavily discounting rates if corporate and group demand do not return as expected,” Taylor said. “It’s been key to our recovery.”
Taylor believes 2023 will bring continued increases in ADR and RevPAR but net operating income will be limited by increased labor costs, gas rates, and high inflation impacting operating costs.
“Some hotels will need to increase rates and be more selective in the group and corporate accounts they accept, which will be difficult in markets where hotels are still competing for very low demand,” Taylor said. “Hotels will need to remain diligent with costs on all levels, get creative with staffing, and work with technology to boost flow through.”
Freitag said the lodging industry continues to be short of workers, but hotels are adjusting and finding new ways of working to accommodate the shortage. For instance, many hotels during the pandemic decreased regular housekeeping service, limiting it to removing trash and bringing fresh towels – requiring fewer housekeepers to serve an operation.
Gemberling said the industry’s reduction of services without a reduction of price might not be free of consequences.
“You’ve got hotels bragging about the fact that they can make debt service with 35% occupancy,” Gemberling said. “But who’s paying for that? The guests have been paying for it, but I don’t know that they’re going to continue to do so. You’re already starting to see blowback on that from them.”
Gemberling said the consolidation of management accelerated during the pandemic by necessity as brands were forced to manage more with less.
“Where there are brands with multiple properties in a certain location or market, instead of having two or three key people at each property to manage them, there are two or three key people managing multiple properties,” Gemberling said. “The consolidation of that management staff is shaving labor costs off the individual properties, and I don’t see that going away. We’ve gotten used to running three small hotels with one general manager and one salesperson.”
Taylor said the industry needs to be more conscious of sustainability efforts, pointing to California’s mandate starting in 2023 to use in-room amenity dispensers to mitigate the impact of single-use plastic containers. “I imagine this, as well as other green initiatives, will make its way across the nation,” she said.
Similarly, Taylor said operators should consider reduced energy consumption whenever possible, “dusting off old energy-management projects that might now prove more likely to generate a return on investment with the increase in utility costs.”
DEBT AND INTEREST RATE PRESSURES
A variety of challenges await in 2023, and some have already reared their heads. “Many hotels aren’t back to the financial performance of pre-COVID levels and have been hit with astronomical inflation, staffing challenges, increases in utility charges, among other expense increases,” Taylor said. “Owners are likely facing refinancing, which will require infusing equity into the deal at a time when some investors are barely covering existing debt service and failing debt-service-coverage-ratio targets.”
Gemberling agreed many hoteliers face difficult debt-related circumstances.
“The underperforming loans coming due are going to be faced with foreclosure,” Gemberling said. “The underlying question is whether the lender is going to see that as a viable option, or whether they’re going to see if trying to work out something with the borrower is going to maybe be the next best step. But, the lenders are less patient than they were two years ago because they see that things are starting to improve. It’s kind of a catch-22. The economics are improving, but the defaults never really in some cases went away. They just got extended.”
Noting that the Federal Reserve has signaled to expect at least two more interest rate increases during the next several months, Taylor said rate increases are leading to “skyrocketing loan costs and could have detrimental consequences on the availability of excess cash.” As an example, she said that a variable rate loan for $100 million with a cap rate of 4% would have cost the client $75,000 last year – “that same coverage now is costing over $1.25 million and again further eroding available cash moving into 2023.”
“The wave of anticipated foreclosures did not play out during COVID, with many lenders hesitant to take back negatively cash flowing assets,” Taylor said. “That may not be the case now, and it will be interesting to see if lenders are more inclined to foreclose given improved market fundamentals, where borrowers may be challenged to meet debt coverage requirements or are no longer able to reinvest.”
Freitag said the hotel industry “has always suffered from this sort of self-inflicted gunshot wound of oversupply.” However, he said the pipeline of hotels under construction is expected to decelerate due to economic conditions. Facilities under construction will open, but he expects many sites in final planning not to break ground because construction has gotten so much more expensive due to the rising interest rates. Similarly, he expects transactions to slow because “debt is just so expensive right now.”
“There’s still a lot of money out there and people are willing to lend, but they’re willing to lend at numbers that were unfathomable a year ago, even six months ago,” Freitag said. “It’s hard to make it work.”