Chart 1: Hotel Market Cycle
Naturally, as we move up the cycle, we expect development activity to increase and eventually for new supply to enter the market. In reality, the cycle doesn’t always act according to its script. Because of the long lead-time between the initial planning, financing and construction times of hotels, we often see new supply coming into the market at inopportune stages of the cycle. Studying Chart 2, it becomes apparent supply increases sometimes come at a time when there isn’t the demand available to absorb it, which leads to deceases in occupancy.
Chart 2: U.S. Hotel Performance (Supply, Demand, Occupancy Change), 4-Quarter Moving Average
The increasing cost of land and building materials in the early-to-mid 2000s contributed to the low levels of supply growth experienced in 2004-2006 (see Chart 3 below). Many developers were tempted by the occupancy and ADR gains found in the hotel industry at the peak of the cycle in 2006-2007. Because it takes 18 months or longer to build full-service hotels, many of these properties that began construction in 2006-2007 didn’t enter the market until 2008-2010, when the industry had fallen into a deep recession.
Chart 3: Supply Change and Producer Price Index
To justify construction of a new hotel, many variables must fall in line: First, the market must have unsatisfied demand. Historically, this became apparent in larger-than-normal increases in ADR and occupancy. Prolonged occupancy increases in 1994-1995 fueled the supply gains in 1997-1999, while the strong demand in 2004-2007 stimulated a massive infusion of development and ultimately an increase of 260,000 rooms during the three-year period of 2008-2010. Second, the cost of land and raw materials must be sufficiently low. The years of 2005 and 2006 saw the lowest level of new supply growth since STR (the parent company of HotelNewsNow.com) began collecting data, yet occupancy and ADR increases were the largest of the decade. During the first half of the decade, the producer’s price index saw increases of 250% that were driven largely by oil prices and the housing boom, as Chart 3 illustrates. Note: The large increase experienced in 2008 was a result of the oil price bubble.
At PKF Hospitality Research, we spent a good part of the past 10 years fine-tuning our Hotel Horizons econometric forecasting models for hotel demand, ADR and changes in supply. Because building a hotel doesn’t happen overnight, by lagging our variables that go into the model we are able to account for the time it takes to develop and construct a new hotel. The two principal variables that compose our supply equation are occupancy and ADR. New development is triggered once these variables move beyond a certain point, which varies by market. Other variables, such as PPI, will be added when circumstances warrant, like we saw in the early to mid 2000s (Chart 3). Our current Hotel Horizons supply forecast calls for very little supply growth during the next five years. The occupancy and ADR variables from which new supply is triggered are not projected to return to levels that warrant supply additions until 2012-2013 at the earliest. Returning to Chart 1, these levels occur approximately at long-run average occupancy and equilibrium ADR—ADR combined with occupancy that provides satisfactory returns to developers and capital suppliers. This news, coupled with the 18-month development time of a hotel and a PPI forecast that remains at elevated levels, translates into small levels of new competition throughout our forecast period.
Some markets, however, are still faced with the task of absorbing large quantities of new supply. Fortunately, the markets welcoming new additions during 2011 and 2012 either saw a milder decline than most, such as Pittsburg and New Orleans, or saw a very strong rebound in 2010, for example, New York and Miami. Still, 30 of the 50 of markets that PKF-HR forecasts are projected to have supply increases of less than 1% during the next two years. On a national level, supply is not forecast to increase beyond its long-run average until 2015. We expect available rooms in the U.S. to climb 2.3% in 2015, primarily because of above average occupancy and ADR levels in 2013 and 2014. Thanks for reading along with us, we welcome comments and discussion on where you think the hotel market cycle will be heading next.
