In 2020, as the pandemic swept through the United States, many of its nearly 58,000 hotels remained solvent in part by deferring planned capital expenditure (CapEx) spending wherever possible, transferring allocated resources to operations and/or debt payments.
A CapEx study released in December 2020 by Bjorn Hanson of the NYU School of Professional Studies Jonathan M. Tisch Center of Hospitality bears this out. According to Hanson, capital expenditure spending dropped from almost $7.3 billion in 2019 to about $2 billion in 2020, just over a quarter of what hotels spent the year prior. This is the lowest reported annual CapEx total since Hanson began these studies in 2005. The earliest previous low was $2.7 billion in 2010. From 2012 to 2019, CapEx had been steadily rising, reflecting a robust new-build pipeline and a buoyant industry.
The CapEx spending that did occur last year was focused on pandemic-related expenses like improved air filtration, cleaning and sanitation equipment, necessary technology to support guest communications and contactless services, or emergency repairs in key areas like HVAC or roofing. Moreover, part of this survival strategy further relied on “raiding” FF&E budgets, especially as major brands relaxed demands for PIPs and remodel cycles.
The CapEx and FF&E Balancing Act Continues
The industry is now presented with important practical and strategic considerations, as COVID-19 is still very much a threat, even with vaccine distribution. Hoteliers are moving into another year that will again be extremely challenging for the hospitality industry as it relates to both occupancy and ADR, especially for larger, convention- and group-sale driven properties in mature, urban markets. Moreover, although many drive-to markets are faring relatively well, how quickly will organized business travel ramp back up?
Certainly, many new builds that were already underway pre-COVID-19 have opened or are continuing through development; and other property owners are taking advantage of reduced occupancies to conduct already scheduled and funded PIPs.
While one might think that reduced occupancies would result in less wear and tear and, accordingly, less need for capital expenditures, early reports from the field are not encouraging. Many chemicals used for the new sanitation and cleaning protocols, including by guests, are causing deterioration of furniture and furnishings, reducing their “curb appeal” and useful life. Also, as Hanson noted in his report, funds will be needed to support the move to less carpeting, more hard surfaces for the floors of rooms, as well as conversions to walk-in showers, in the name of longevity and ease of cleaning.
Lastly, property owners who peg CapEx spending as a percentage of operating revenues will have less CapEx funds available should occupancies remain depressed. As a result of these COVID-19 factors, hotel CapEx and FF&E larders are likely to remain skimpy for many, but not all, hospitality entities. According to a CapEx study from the International Society of Hospitality Consultants (ISHC), capital expenses each year average over 7 percent of a hotel’s gross revenue, a mark that may be extremely hard to maintain. Potential alternate financing mechanisms for CapEx and FF&E are worth considering.
PIP Dance: Slow Waltz or Jitterbug?
Will hotel entities have enough financial resources to cover CapEx and FF&E allocations for the next year or two? Will brands continue to relax or lengthen remodel/property improvement cycles, or possibly rethink, in concert with franchisees and their property and asset managers, the way hoteliers go about PIPs for remodels and conversions?
Realistically, there are several paths forward.
In some cases, hotel portfolios will remain financially constrained and ownership will find it difficult to make debt service and, thus, fund planned CapEx and FF&E projects. In other cases, well-financed entities may display confidence in the long-term appeal of hotel investments and proceed with PIPs to enhance their competitive posture. This approach would particularly apply to already attractive properties in favorable resort and recreational destinations. It remains to be seen if major brands will work to resume customary PIP cycles and ask previously deferred ones to now be executed.
Another attractive possibility is that the hotel industry would advocate with Congress for more favorable tax treatments, including for capital investments and other segments of the investment stack.
Purchase price and CapEx (along with FF&E) are the only revenue flows directly controlled by the owner, making it imperative at the present time for many owners to carefully marshal those CapEx expenses. Regardless, the name of the game in CapEx and FF&E is always to get the most results for the buck in an area that is critical to product differentiation, even within a given brand.
While searching for such value, many owners will go above formula, or even brand standards, to gain an improved competitive position in a given market. Historically, such entrepreneurship has propelled the industry forward—enhancing the look and feel, the guest appeal, and the possibilities of a hotel experience.
It will be interesting to see how these dynamics play out and what they reveal about the strategies employed by creative owners in this challenging era for hospitality.