I believe we are in the early stages of a modest upturn for hotels, following a soft landing of sorts in 2016.
For most of the last two decades, the economic cycle of the U.S. hotel industry has been all about boom and bust, with two deep downturns and two long recoveries. My view is that we had a mild downturn in 2016 and that we are now on the upswing. The current growth phase looks to be a modest one, lasting only two to three years, much like the upswing in the early 1990s. Occupancy growth will be spotty, with stronger results outside of the largest markets, given substantial supply growth clustered in a few markets.
Driving this recovery are a strong economy, a boost to demand from the hurricanes that devastated large areas of the U.S. in August and September, and a likely slowing of supply as construction labor and materials are diverted toward hurricane recovery. In addition, I expect hotel openings to modestly slow this year and next as construction costs increase and shortages delay projects.
Hurricanes Harvey, Irma and Maria devastated communities in their paths, causing massive damage in a number of areas and substantial loss of life, particularly in Puerto Rico. The recovery efforts are well underway and will likely go on for several years. It is my belief these efforts will affect the hotel industry in the U.S. in significant ways, pushing up demand for hotel rooms and slowing supply growth.
This increased demand began just as the U.S. was starting to see stronger occupancy after a slow 18 months. According to STR, between January of 2016 and July of 2017, monthly occupancy fluctuated between growth and decline; May and June of 2017 were the first two months with consecutive occupancy increases. The 12-month moving average occupancy change for 2016 was just 0.1%, which is arguably a soft landing and frighteningly close to a text-book downturn. In fact, the 12 months ending in October 2016 averaged flat occupancy.
According to FEMA, the agency’s purchases of hotel rooms for families displaced by Hurricane Harvey in Texas and for Irma in Florida under the Transitional Shelter Assistance program totaled more than 1 million room nights in October 2017. Using STR supply data, I calculate that this added approximately 0.7% to occupancy during the month. The FEMA program allows survivors to purchase rooms at qualifying hotels anywhere in the U.S. and it also provides longer-term housing assistance, some of which might include hotel stays. Therefore, the data below represents only part of the demand generated by hurricane survivors during 2017.
FEMA’s hotel room purchases for families displaced by the storms are only one source of incremental demand. FEMA’s program for Harvey has been extended through 16 January 2018 but could be extended further. Demand has also been generated by FEMA employees and contractors, insurance adjusters and construction-related travel. Although likely to continue to taper off, some portion of this demand will likely persist for months.
Another factor, particularly over the next several months, will be leisure and group travel that would have considered Puerto Rico, the U.S. Virgin Islands or other Caribbean destinations that will likely be diverted to other destinations. Many travelers will choose Florida or other mainland destinations, boosting U.S. results, which exclude U.S. territories in Caribbean locations. Before Maria, Puerto Rico’s tourism company attributed 3.4 million room nights per year to tourist stays. If half of this is diverted to the mainland, it could add 0.1% to national occupancy.
On the supply side of the equations, I expect we will see a measurable slowdown in new openings beginning about a year after Harvey hit. This may be slight, but with supply and demand so close to balance, it should be enough for occupancy to remain positive. Shortages and rising costs of skilled construction labor and of construction materials will likely significantly raise construction costs. Labor markets were tight before the storms, with shortages already showing up in some trades. If the economy remains strong, supply growth slowing to 1.8% or 1.7% from late 2018 through 2019 should lead to modest occupancy gains. Comparisons will be tougher between September and December of 2018, barring new severe weather, but continued economic strength should be sufficient to drive demand growth.
The availability of construction financing is always a major driver of supply growth. Debt availability for commercial real estate is very high, but not for new hotel construction. Higher construction costs are likely to reinforce lender conservatism, particularly if there is still high demand for financing of existing real estate.
The tax cuts passed last month might spur substantial economic growth, but any incremental demand it creates, particularly in the second half of 2018 and into 2019, would be upside to the scenario I have outlined.
This new cycle is likely to end with either a recession or a demand shock. Excessive supply growth could be a factor, as it has always been, but accelerated openings do not appear to be on the horizon. The big question is how long this period of economic growth will last. Demand shocks are impossible to predict, but the last two cycles ended abruptly and this one could too. I expect it will end more like the upswing in the early 1990s, with a gentle decline in occupancy as demand slows and supply growth remains steady.
After a 30-year career as a stock research analyst, David Loeb created Dirigo Consulting LLC, which advises on capital markets, strategy and communications issues. Clients have included REITs, brands, and private equity investors. He can be reached at davidloeb@earthlink.net.
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