In commercial real estate, hotels are an anomaly since owners and operators can re-price rents for their inventory each night and are not bound by long-term leases. That affords the flexibility to quickly drop or increase rates based on demand or unexpected costs.
In an environment where costs are increasing, it stands to reason that hoteliers should be able to cover any cost increase simply by increasing their average daily rate, or ADR. And as we wrote eight years ago, hoteliers used to be able to do so, resulting in the U.S. hotel industry enjoying a good run of outpacing inflation as measured by the consumer price index, or CPI.
That is how it is supposed to work in theory. In practice, we often compare ADR to CPI to evaluate what is sometimes referred to as “real ADR,” which is intended to assess a hotel's true pricing power, calculated as ADR minus CPI.
In general, the thought is that the higher the real ADR, the higher the amount that drops to the hotel's bottom line. Expenses are going up, presumably at the same rate as CPI, and if the real ADR increases at a faster clip than CPI, then profits increase.
According to data from STR, CoStar's hospitality analytics firm, between 1990 and 2017, real ADR was positive outside of recessionary periods, confirming that hoteliers were able to buffer cost increases with higher room rates. During some quarters, real ADR growth even topped 3%.
However, after 2017, real ADR growth slowed, and for the past six quarters ending in 2019, it has decreased.
That is unexpected given that 2019 was the single strongest year the U.S. hotel industry ever experienced, with room demand, ADR and revenue per available room, or RevPAR, all at record levels. Despite this record-breaking performance, real ADR growth was negative for the year.
What changed in 2017 to undercut the ability of hoteliers to increase prices to cover higher costs? In general, one-word answers to complex questions — “Airbnb” or “online travel agencies” — aren’t sufficient. New supply likely played a role as new hotels opened with rooms priced to build occupancy. Also, at the time, the industry was opening many more limited-service hotels, which changed the makeup of industrywide room revenue.
Another factor may be the much better price transparency and access to lodging alternatives that consumers have had over the past five years. This may especially be the case during compression nights — defined as hotels with occupancy levels at 95% or higher — when potential guests had the option to choose other lodging alternatives, which ultimately led to disappointing hotel industry room rate increases.
In STR's latest forecast, ADR is expected to increase by over 6% and over 7% in 2021 and 2022, respectively, which should easily outpace CPI in those years. The main question that remains unanswered is how will hoteliers make up for higher labor and other costs in the years after demand has returned to more normal levels?