It is hardly a secret that U.S. hotel industry prospects are less than rosy. The hospitality industry has been inundated with a glut of non-traditional supply, increasing competition, and siphoning travelers away from traditional operators. Despite this, the hotel sector has turned in strong performances throughout the current economic cycle and boasts one of the strongest recoveries of any commercial real estate segment since the recession. While it remains generally healthy for now, a closer look at projected fundamentals may reveal trouble on the horizon.
Overall hotel deal volume downshifted to just above $5.8 billion in the first quarter of 2017, according to Real Capital Analytics, a 6 percent decline year-over-year. This was also the weakest quarter for hotel transaction activity since the start of 2013. According to the Ten-X Commercial Real Estate Nowcast, which combines Google Trends data, Ten-X’s proprietary transaction data, and investor surveys to forecast CRE pricing trends in real time, pricing across the sector has either declined or remained flat in 15 of the last 16 months, and has fallen nearly 11 percent from its peak in the fall of 2015. Significant cooling in pricing and deal volume come amid looming supply additions that are giving investors pause. This torrent of supply will threaten hotel operating conditions and valuations, boosting vacancies and harming investors’ returns.
Despite the sector’s challenges on the horizon, hotel valuations are still close to their peak for the current cycle, due in part to property fundamentals, which remain fairly healthy. Room rates and occupancy rates are both high, with little room for additional run-up given the supply climate, and cap rates across the sector are extremely tight. Ten-X Research projects that valuations will continue to rise in the near-term, reaching their peak during 2017, before falling slightly the following year. A predicted cyclical downturn in 2019 and 2020, however, is expected to inflict significant damage, dropping valuations to a projected 24 percent below the cyclical peak.
Average daily room rates grew 0.8 percent during the first quarter of 2017, a year-over-year increase of just 2.5 percent–the sector’s slowest annual growth since the recovery began in 2010. Revenue per available room experienced similar struggles, climbing just 0.2 percent during the first quarter and 3.5 percent over the last year. That annual rate clocked in among the slowest during the current cycle, and a strong supply pipeline will continue to present a challenge for RevPAR.
The direction of the market varies widely around the country, with each region’s fortunes largely dependent on the amount of new supply set to enter the market over the next four years. National supply is expected to rise by about 7.2 percent by 2020, with much of this volume concentrated in large metro areas. For example, New York City hotel supply is set to rise by 19.7 percent, Washington, D.C., by 17.2 percent, Seattle by 15.5 percent and Houston by 13.8 percent, making those markets risky for investors. Conversely, some non-gateway markets such as Sacramento, Calif., Orlando, Fla., and St. Louis will all see supply increase by less than 4 percent.
The market for hotel properties is also harmed by the U.S. dollar’s continued strength in the wake of Brexit and myriad global economic uncertainty. Combined with the arrival of a new presidential administration promising tax reform, foreign travel to the U.S. is beginning to trend downward, according to ITA data, harming hotel spending and the hospitality industry at large.
The hotel sector has largely managed to endure despite a massive sea change in consumer behavior that has inflicted damage upon its traditional business model. Much of that resiliency has been a result of the strong economy that continues to rebound and attract investment dollars from around the world. As crucial tourism slows and a massive infusion of supply hits the market, however, the sector faces an increasingly uncertain future.
About the Contributor
Peter Muoio is chief economist at Ten-X Research.