Profits Rise Despite Initial Signs of Expense Growth

hotel industry future

Results from the latest edition of Trends in the Hotel Industry reveal that U.S. hotels achieved a 12.3 percent increase in net operating income (NOI) during 2014. This marks the fourth consecutive year of profit growth in excess of 10 percent, a trend PKF Hospitality Research (PKF-HR) forecasts to continue through 2016. The current six-year period (2011-2016) of continuous double-digit gains on the bottom line will be the longest such streak for the nation’s hotels since PKF-HR began tracking industry data in 1937.
In 2014, the average hotel in the Trends sample achieved a bottom-line profit of $17,849 per available room. Of course, the strong increase in unit-level profits wasn’t unexpected. In April 2014, PKF-HR forecast a 12.4 percent increase in NOI for the year and is projecting NOI increases of 13.4 percent in 2015 and another 12.2 percent in 2016.

The 2014 Trends results are based on a sample of operating statements from approximately 7,000 properties in the United States that voluntarily participated in the survey. Over three quarters (78.2 percent) of these hotels reported an increase in profits during 2014.

On average, rooms revenue (RevPAR) composed 69.5 percent of the total revenue at the typical hotel in the survey, and a 7.3 percent RevPAR increase was the main driver of the growth in total hotel revenue. Strong gains in lodging demand, combined with relatively low levels of new supply in most markets, have put the U.S. lodging industry on a trajectory toward all-time record levels of occupancy, providing hotel operators with the opportunity to become more aggressive with pricing.

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While growth of other hotel revenues besides RevPAR continue to lag, U.S. hoteliers continue to turn the corner. During 2014, food and beverage sales, along with revenue from other operated departments, increased at a very healthy 6.2 percent pace. Yet, one of the most significant findings of the Trends survey was the 4.9 percent rise in operating expenses (ExPAR) during 2014 (3.2 percent adjusted for inflation). The 3.2 percent increase is more than double the pace of real ExPAR growth observed from 2009-2013.

Controlling the Controllables
Until now, U.S. hotel managers have done a great job controlling expenses compared to historical recovery periods. The cost control measures instituted during the depths of the great recession in 2009 were carried forward through 2013. The sharp uptick in expense growth in 2014 initially stood out as a potential threat to profit growth in the future.

However, closer investigation of the expense data revealed that U.S. hotel operators were able to effectively manage those cost items for which they have the most control. Measured on a dollar-per-occupied room basis, real ExPAR growth was just 0.2 percent in 2014. This indicates that the main drivers of expense growth were items associated with the increase in business volume or occupied rooms. U.S. hotels are achieving such high occupancy levels that all their fixed costs are covered.

At 44.2 percent of expenses, labor is the single largest cost that hotel managers need to control. According to the Bureau of Labor Statistics, the national unemployment rate dropped to 6.2 percent in 2014, which contributed to the 3.6 percent increase in the average hourly compensation rate for workers in the U.S. hospitality industry.

Labor costs for the hotels in the Trends sample increased by 3.7 percent in 2014, the result of a 3.7 percent rise in salaries, wages, and bonuses, along with a 3.8 percent jump in payroll-related expenses such as benefits. During the past 15 years, the benefits component has been the dominant driver of labor costs at U.S. hotels. Now, it appears that the recent decline in the unemployment rate has had the greatest impact on the salaries and wages paid to hotel employees.

When we take the BLS data into consideration, it appears that hotel managers responded to the rise in labor costs by controlling staffing levels. In 2014, PKF-HR estimates that the total hours worked by employees at the hotels in the Trends survey grew by a mere 0.6 percent. Considering that the number of occupied rooms in the sample increased by 3.0 percent, it is clear that operators were able to achieve significant increases in employee productivity during the year.

But there are some hotel expenses that hotel managers have less control over, and it appears that these costs dominated the 4.9 percent increase in ExPAR observed during 2014. The fees a hotel pays to credit card, franchise, and management companies are typically based on a percentage of revenues and/or profits. Therefore, since we are in a period of significant revenue and profit growth, it is not surprising that we are seeing a surge in these costs. In 2014, the combined cost of credit card commissions, franchise fees, and management fees increased by 6.5 percent. Other expenses that influenced the 4.9 percent rise in ExPAR are non-labor maintenance expenses (5.0 percent increase), the cost of goods sold (5.3 percent), and utilities (4.8 percent).

Mixed Pressures in the Future
The outlook for hotel revenue growth is extremely bright for the next few years. However, hotel operators will face a variety of tailwinds and headwinds when it comes to controlling their expenses.

Factors that will curb expense growth in the next few years include low levels of inflation, as well as a slowdown in the pace of occupancy growth. With fewer additional rooms being occupied, the increase in the variable expenses needed to serve the new guests will be limited.

On the other hand, growth in employment levels will continue to put upward pressure on salaries and wages. In addition, revenue and profit growth will cause increases in credit card commissions, franchise fees, and management fees.

PKF-HR believes that hotel operators will continue to adapt to the operating environment as they have in the past. Fortunately, our forecasts of revenue growth exceed our projections of expense growth for the foreseeable future. It continues to be one of the most prosperous periods for all participants in the U.S. lodging industry.

Robert Mandelbaum is director of research information services for PKF-HR, a CBRE Company (www.pkfc.com). To purchase the 2015 Trends in the Hotel Industry report, please visit store.pkfc.com.