Select Your Profits

The definition of select service within the lodging industry may vary from person to person, but there is no doubt that properties in this segment are the most popular among developers. Using the broadest definition of select service, this category comprised an estimated 85 percent of the total projects in the development pipeline according to the October 2012 U.S. Hotel Pipeline Outlook report from Smith Travel Research.

While developers may be influenced by emotional and other non-economic factors, financial return is typically the main criteria considered when choosing to develop one type of hotel versus another. To gain a better understanding of the financial performance of select-service hotels, we compared them to full-service properties.

From the PKF Trends in the Hotel Industry database we pulled a sample of 319 select-service properties for which we had data each year from 2005 through 2011. For comparison, we identified a same-store sample of 79 traditional full-service hotels that operate under a brand within the same parent companies represented in the select-service sample. Resort and large convention hotels were excluded from this comparison.

In general, select-service properties offer a limited degree of food and beverage alternatives compared to traditional full-service hotels. In some circumstances, this definition will include limited-service, extended-stay, and all-suite hotels that offer only complimentary food and beverage service. However, for the purpose of our analysis, the select-service sample consisted solely of hotels that offer some, albeit limited, amount of regular non-complimentary food and beverage service.

On average, the select-service sample averaged 154 rooms in size, with an average occupancy of 67.5 percent and an average daily rate (ADR) of $111.11 in 2011. For these properties, food and beverage revenue comprised 7.4 percent of total revenue for the year. The full-service sample averaged 334 rooms, 69.1 percent occupancy, and an ADR of $142.15. Food and beverage sales at these hotels made up 28.8 percent of total hotel revenue.

Profit Efficiency
As expected, the select-service sample consistently achieved higher profit margins compared to the full-service hotels. From 2005 through 2011, net operating income (NOI) measured as a percent of total revenue averaged 36.4 percent at the select-service hotels and 25.7 percent at the full-service properties. NOI (profit) is defined as income before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization.

The mathematical influence of the low contribution margins achieved in hotel food and beverage departments is the primary reason for the lower overall profit margins experienced at full-service properties. However, it should be noted that the full-service hotels in our study sample were able to achieve a higher food and beverage department profit margin (26.5 percent) compared to the select-service properties (12.1 percent). The greater volumes of more profitable banquet and beverage sales at the full-service hotels explain this difference.

Labor costs are the largest expense at hotels and an area that requires significant attention from management. For hotel owners and operators seeking less stress, the reduced levels of staffing at select-service hotels are attractive. In 2011, the combined cost of salaries, wages, and benefits at the select-service hotels averaged 43.4 percent of revenue, or $13,112 per available room (PAR). On the other hand, full-service labor costs were $26,034, or 50.9 percent of total revenue. The lower levels of labor also contribute to the higher profit margins at select-service hotels.

Over the seven-year period studied, the select-service and full-service hotels performed comparably. As of year-end 2011, the NOIs for both categories were down approximately 3.3 percent from the profit levels they achieved in 2005. However, when analyzing the year-by-year changes in NOI, we find slightly more volatility in the performance of the select-service sample.

The period 2005 through 2007 was a prosperous one for the U.S. lodging industry. During this time, profits for the select-service sample increased by 29.2 percent, while the full-service hotels achieved an NOI gain of 20.4 percent. On the other side of the business cycle, NOI levels declined by 42.3 percent at select-service hotels and 39.1 percent at full-service properties from peak (2007) to trough (2009). Then, during the early stages of the recovery, profits at full-service hotels were greater during the first year of the upturn (2010), but lagged behind the NOI increase of select-service hotels in 2011. It should be noted that the annual changes in revenue per available room (RevPAR) for both samples were fairly consistent with their respective changes in NOI during the study period.

This year-by-year analysis of changes in NOI indicates that select-service hotels have been better equipped to capitalize on favorable market conditions, but suffer more during depressed periods of performance.

The Dollar Difference
Select-service NOI margins are greater than those at full-service hotels, but the average full-service property achieves greater levels of profit. In 2011 the average select-service hotel in our sample averaged an NOI of $9,561 PAR. This compares to $12,525 PAR in profits at the full-service hotels.

Because of the lower levels of amenities and services offered at select-service hotels, the development costs for these properties are lower when compared to traditional full-service lodgings on a dollar per available room basis. While the profits of the select-service sample averaged 24 percent less than the full-service properties, a similar comparison needs to be made of the relative development costs for an owner to properly determine the viability of a select-service investment.

Select-service hotels have proven to be very profitable. During prosperous times these properties are very efficient at transforming top-line dollars to bottom-line profits. That being said, select-service feasibility is not always guaranteed. During the recession select-service hotels showed they are a bit more vulnerable to declines in profits. PKF advises its clients to examine all the local market and financial factors that impact the property type selection process.

Robert Mandelbaum is director of Research Information Services for PKF Hospitality Research LLC.