Lodging demand trends continue on a solid recovery trajectory, despite heightened global macroeconomic risk stemming from European sovereign debt concerns and a slowdown in China, according to a bevy of reports that hit the market this week.
While the ongoing hotel recovery is expected to be uneven, it is a recovery nonetheless, observers say, and one clearly reflected in recent investment activity. The pace of hotel real estate investment in the Americas reached a four-year high in 2011, as transaction volume swelled to $15.2 billion, a 24% increase from 2010 volume, according to Hotel Investment Outlook, a new research report from Jones Lang LaSalle Hotels. And Americas hotel transaction volume in 2012 will at least match 2011.
Perhaps the poster child for this uneven but upward recovery is Starwood Hotels & Resorts Worldwide Inc. Building on a year of record growth and deal activity in 2011, Starwood said it plans to open an additional 80 new hotels in 2012, following last year's addition of 81 new hotels around the globe.
The expectations of U.S. hospitality executives have tempered, but the overwhelming majority remains bullish on the marketplace as investors look to pick up where they left off in 2011 - hunting for deals.
The U.S. hospitality industry is also keeping a watchful eye on Washington, DC in 2012 as the country prepares for further political gridlock amid another election-year showdown for the White House, according to the DLA Piper 2012 Hospitality Outlook Survey.
After a flurry of deals in 2011, current market conditions remain favorable for investment, while business travel is expected to increase for the second consecutive year. According to DLA Piper survey respondents, a strong appetite exists for hotel transactions, fueled in part by an expected - and significant - uptick in private equity investment activity, as well as flattening asset values. These factors are expected to far outweigh any concerns over hotel debt issues or any election-related market malaise in 2012.
Room Rate Increases Driving RevPAR
Fitch Ratings' base case outlook for the U.S. lodging sector this year currently reflects 4% to 5% industry-wide growth in revenue per available room (RevPAR,) followed by mid-single-digit growth in 2013. This is a deceleration from the 8% growth realized in 2011, which was slightly stronger than Fitch's original forecast of 5% to 7% RevPAR growth for the year.
Fitch reduced its RevPAR outlook for 2012 slightly based on slower broader economic growth estimates. At this point, Fitch said it believes RevPAR growth in 2013 could meet or slightly exceed 2012, based on its current forecast of a modest macroeconomic acceleration in 2013 and muted supply growth.
RevPAR growth has been increasingly driven by higher room charges (average daily rates,) while occupancy growth has been decelerating, which is typical of a maturing lodging cycle.
In second-half 2011, ADR was a bigger driver of RevPAR growth than occupancy. Fitch expects this trend to continue in 2012 and 2013, as hotels begin to achieve optimal occupancy levels, which will contribute to stronger margins and profitability.
Of special note, luxury, upper upscale, and upscale hotels have shown the greatest improvement, which Fitch said it expects will continue in 2012 as those segments continue to rebound from the steepest declines.
Supply Will Still Trail Historical Norm
U.S. supply growth will be less than 1% annually through at least 2012 and 2013, which provides cushion to downside scenarios. This is well below the long-term historical average of roughly 2% in supply growth, and contrasts sharply with the situation during the recent recession when supply growth was peaking at more than 3% in 2008 and 2009.
Hotel property-level operating performance should continue its solid improvement in 2012 and 2013 as a result of the favorable supply/demand outlook.
Fitch expects the current ratings of transactions with high hotel exposure to remain stable in 2012. The majority of transactions with higher hotel exposures were floating-rate transactions originated during 2005 through 2008 and were subsequently downgraded between 2009 and 2010.
Increased hotel loan origination in 2011 should extend into 2012, based not only on improved industry factors but also the increased volume of loan maturities.
The hotel sector has historically demonstrated the most cash flow volatility of the major commercial mortgage-backed securities (CMBS) property types due to the daily resetting of rates and high operating leverage.
Beware of a False Sense of Security
Hospitality market fundamentals look set to continue the recovery which started in 2011 in spite of continuing uncertainty and the prospect of further upheaval in the global and regional economies, according to Ernst & Young's latest Global Hospitality Insights report.
"The conventional wisdom suggests that key fundamentals should be on the wane, but that has not happened yet and, due to many factors, we don't believe it will occur in 2012," said Michael Fishbin, Ernst & Young's leader of Global Hospitality Services.
Nevertheless, Fishbin suggests hotel operators and investors need to stay focused and not have a false sense of security from the overall numbers.
"The situation for the hotel industry is markedly different from market to market, and global operators need to be on their toes and ready to react to rapidly changing conditions," he added.
"This isn't a time for hotel operators to abandon the principles that allowed them to navigate through the recent economic downturn," Fishbin said. "Companies should take advantage of this breathing room to reassess and examine their capital agendas to make sure they are using cash wisely and efficiently as well as preparing for future growth."
Hotel Financing Should Be More Liquid
The competitive landscape will shift to greater equilibrium between public and private equity capital sources, and debt markets are expected to become more liquid as the year progresses.
"Investors have been closely monitoring the state of the economy and its impact on the hotel investment market," said Arthur Adler, managing director and CEO-Americas for Jones Lang LaSalle Hotels. "Despite the recent volatility, the Americas region will continue its positive momentum in 2012 and hotel operating performance is expected to improve, driven predominantly by increasing room rates."
During 2012, considerable differences in the buyer audience will emerge as REITs pull back and private equity, institutional and offshore sources re-emerge.
"The gates are opening for eager private equity and institutional buyers willing to take calculated risks in primary and secondary markets. REITs are likely to be less active buyers as their share prices are still well below the highs of the summer of 2011, although they may make a comeback in the second half," Adler said. "We expect that quality hotels with positive current yield will be the best positioned assets for investment. Additionally, lenders, banks and special servicers will be more motivated to sell assets."
In the U.S., demand from offshore buyers remains active. Middle Eastern capital will selectively pursue opportunities, primarily in East Coast markets, while investors based in China and Southeast Asia will scour the West Coast for purchases. European investors are expected to remain quiet in 2012.
Adler added, "While the volume of foreign capital invested in the U.S. will not move the needle on a national basis, foreign investors will define the market in several gateway cities."
Starwood Eyes Pick Up in Luxury Segment
Even against a backdrop of economic and geo-political uncertainty, 2011 was a record growth year for Starwood. Around the world, Starwood opened 21,000 new hotel rooms - the largest organic growth in its history. Importantly, the company also signed 112 new hotel deals, the highest number of new deals since before the global economic crisis.
"Our global multi-brand growth continues unabated and Starwood is particularly well positioned to take full advantage of growth anywhere in the world, whether in established markets or in fast growing economies," said Simon Turner, president of Global Development for Starwood. "In 2012, markets like Brazil, Africa, the Middle East and Indonesia will be ones to watch. In developed markets, conversions continue to drive growth. In Europe, while financing for new builds is scarce, there is a large landscape of independent hotels ripe for flags, and we're also keenly focused on an expected uptick in portfolio transaction activity in North America which should lead to heightened conversion opportunities."
Denise Coll, president of North America for Starwood said, "In North America, the company signed more new deals in 2011 than in 2010 or 2009. Conversions continue to dominate, and Sheraton and Four Points by Sheraton are leading our growth with great Westin and Luxury Collection conversions as well."
More than 60% of Starwood's new hotels this year will be in the luxury and upper upscale segment including the 30th St. Regis hotel, the 80th Luxury Collection hotel and the 45th W hotel.
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