According to my favorite economist Bernie Baumohl, who spoke recently at a private hotel industry event, "inflation has decreased toward the target of 2%, but stress cracks are appearing due to high interest rates.”
The Fed thinks that one reduction in the interest rate will be most likely. The current rates are stifling economic activity, with household debt at record levels and credit card debt nearing a record high. Consumers are reaching their spending limits, leading to spending fatigue. Credit card interest rates are at their highest ever, with some credit at 30% interest and 90-day+ delinquency is high, according to the Federal Reserve Bank of NY.
The commercial real estate sector, particularly the office and hotel segments, is grappling with a significant rise in delinquency. A substantial amount of debt, approximately $900 billion, is due for refinancing at a high rate of 500 basis points, with $100 billion in the hotel sector. The delinquency rate for commercial mortgage-backed securities has notably increased, surpassing 6% in May.
Consumers are still spending on hotels; employment is substantial, and there is pent-up travel demand, but the “revenge” travel days are over. People working at home want to get out, which has increased bleisure travel. Baumohl feels the economy is weakening but not yet weak. He assumes that current policy continues, meaning a Biden victory in November, and that GDP growth will be 2% next year.
The Hotel Industry Forecast
Hotel analysts continue to forecast an increase in revenue per available room in 2024, but the industry faces some headwinds. Consumers have spent nearly all their savings earned during the pandemic. The savings rate is only 3.2 percent, well below historic levels. Inflation remains stubbornly high, and interest rates will remain higher for several months.
Operating costs continue to erode profit margins. Insurance, for example, is 244% of 2019 levels, and Leisure and Hospitality wages are up 134% compared to 2019, according to CBRE. Corporate and group demand continues to improve and is approaching pre-pandemic levels, while inbound international travel is almost at 2019 levels. In other words, it's a mixed bag of data that doesn’t bode particularly well for net income.
What Does Our Future Look Like?
Deal flow has been muted for the last 18 months as the market has endured the higher-interest-rate environment. This will change when the Fed drops interest rates. We had a soft Q1, which was anticipated, but we also witnessed a slight drop in demand from leisure travelers at the end of Q2. While there has been a dip in domestic travel, we are buoyed by the promising surge in international travel this month despite the dollar's value.
The outlook for business travel is also encouraging, with an increase in local negotiated rate and large corporate business. The group market is also displaying signs of growth.
While average daily rate is not growing ahead of inflation, we are bullish about new corporate growth surrounding artificial intelligence. Due to increased technology and security conferences and events, AI could help reinvigorate office and hotel demand.
Companies developing language models or those that embed tools will drive the applications. A new wave of technology could usher in the next boom period after some settling in during 2025 and 2026.
Energy, labor and insurance costs continue to climb in the short term, significantly affecting our operating profits. California was trying to increase the minimum wage to $25. The brands are pushing us to complete renovations via property-improvement plans or fixed renovation cycle management. The renovation costs continue to increase, driven by supply and labor costs, but for those who have patience, there is a reward later this decade as travel is a birthright!
Enjoy the remainder of the summer!
Robert Rauch, CHA, has been an owner-operator of hotels for several decades and is founding chairman of Brick Hospitality, owner of R. A. Rauch & Associates, Inc.
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