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Labor cost increases have eclipsed hotel revenues for the last three years, yet hotel analysts say the industry prepares to weather future economic hits.

Two recent U.S. hotel reports paint an industry picture of slowing growth. Revenue per available room, or RevPAR, the industry’s key performance indicator, grew by 1.2% the first half of 2019, according to hospitality consulting firm HVS.

RevPAR expects to end the year at 1% and continue at around that slower rate of growth through 2021, down from the last three years of roughly 3% growth, according to CBRE. CBRE this month revised its RevPAR forecast up after predicting in June that 2021 would see a 0.5% decrease.

Profits have been hindered by labor costs growing by between 3% and 4% over the last three years. But even with such headwinds, industry analysts predict the hotel industry will be able to sustain any potential market correction on the horizon — largely due to an economic cycle in which lenders and developers have primarily played it safe.

“Our outlook is slowdown, not recession, both in the economy and with hotel performance,” said Robert Mandelbaum, CBRE Hotels’ Americas Research director of research information services. “Because there’s so much cushion now, even in a slowdown the U.S. lodging industry will be performing above the long-run average, and hoteliers will be able to meet their debt obligations.”

Hotel Room

Unsplash/Nik Lanus

The economic optimism stems from general sentiment any perceived downturn will be a blip compared to the last cycle. Hotels’ recent performance above long-term averages also helps.

Gross operating profit margins are at 38%, while the long-run average tracked by CBRE between 1950 and 2018 is 34%. U.S. hotels’ occupancy rate is at 66% compared to the long-run average of 62.5%.

Many hotel operators have been more efficient with operating costs this cycle and didn’t restore unnecessary amenities like 24-hour room service or all-day seated meal service, Mandelbaum said, which many hotels did before the downturn before cutting them to save money.

While RevPAR growth has declined nationally, there are still plenty of U.S. markets that performed well the first half of 2019. San Francisco led the pack with an 8.1% RevPAR increase followed by Atlanta (7.8%), Phoenix (4.6%), Tampa (4.1%) and Nashville (3.6%), according to HVS.

“If you’re smart on location and conservative on your capital stack, you’ll still do very well,” said Marc Magazine, an executive managing director of Savills’ hospitality group in Washington, D.C. “As long as there’s not a major calamity, we can weather recessions much better than we used to.”

The over-leveraging era of 90% and higher loan-to-value ratios appears to be over with 65% debt/35% equity being the new norm for capital stacks. Developers also usually err on the side of caution and don’t refinance the complete value of a hotel, Magazine said.

“I do think [the] whole dynamic of how to recover from a recession has changed,” he added. “Now, you really are using low-interest rates to get yourself out of a recession whereas, before, you were using high-interest rates to stop inflation.”

But it is still hard to ignore how much of an expense labor has become to hotel owners and operators. Labor costs make up 50% of a hotel’s operating costs, Mandelbaum said.

A national push for a $15/hour minimum wage has hit the hotel industry hard, especially budget hotels that rely more on hourly employees. Low unemployment rates also makes finding and retaining employees difficult without paying them higher wages than a competitor.

Labor costs have exceeded revenue growth for the last three years, according to STR.

“The biggest concern is the labor, but the construction cost piece is a close second,” said Jerod Boyd, HVS’ managing director and senior partner. “It’s inevitable when the economy strengthens, these construction guys are able to charge a lot more beyond the growth of how the hotel industry performs from a RevPAR perspective.”

Savills Executive Managing Director Marc Magazine speaking at Bisnow's Lodging Investment Series

Bisnow/Ethan Rothstein Savills Executive Managing Director Marc Magazine speaking at a Bisnow event

Construction costs haven’t necessarily caused a hotel downturn, but they have limited the pace of construction. Given how hotel occupancy and revenue levels have continued to climb during the prolonged economic cycle (now the longest period of growth in U.S. history), it would make sense for developers to pursue more projects.

U.S. hotel occupancy rates are above historical averages. RevPAR, while certainly slower than the 8.2% national growth rate of 2014, expects to continue at a tepid pace through 2021 before growing by nearly 2% the following year and up to more than 3% in 2023.

There were nearly 670,000 hotel rooms in the U.S. hotel construction pipeline at the end of 2018, according to Lodging Econometrics. While up 7% from the prior year, that number is still down from the industry historic high of more than 750,000 hotel rooms in the pipeline during Q2 2008.

“Given the high levels of occupancy the past few years, we would expect even more construction than what we are seeing,” Mandelbaum said.

Cameron Sperance, Bisnow Boston on bisnow.com