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Has US Lodging Sector's Historic Growth Run Finally Reached a Tipping Point?

Analysts: As Growth Cycles Wanes, Hotel Metrics Not Likely to Experience Precipitous Declines of Previous Downturns
July 26, 2017
The U.S. hotel sector continued to enjoy record occupancies through the second quarter. However, the impact from the large number of new hotel rooms being added finally had an effect as the average occupancy rate for U.S. hotels declined for the first time since 2009.

Hotel property analysts expect peaking construction levels will likely result in more of the same during the second half of 2017, although to be sure, hotel fundamentals remain on generally solid footing. The overall four-quarter average rate for the largest U.S. markets ended the second quarter at 72%, well above the historical average of 66%, according to CoStar Portfolio Strategy data.

However, lodging REITs and c-corps will likely be providing future earning guidance at only the midpoint or lower half of prior estimates as demand remains choppy, with growing room pricing growth, according to Whitney Stevenson, hotel analyst for JMP Securities. That being said, demand growth remains in the low-2% range despite volatility in weekly revenue per available room (RevPAR) numbers, Stevenson added.

"We see upside potential as being limited to (hotel) portfolios with more luxury and leisure market focuses, and we see more downside risk for full-service portfolios concentrated in major markets," Stevenson said in a note to clients.

Occupanies Wane As Deliveries Ramp up

More than one-third of the 54 largest U.S. metros saw hotel occupancies contract from year-ago levels, according to CoStar data. Pittsburgh and Houston, which saw hefty levels of new supply even as their economies continued to soften, logged the steepest declines.

Hotel room bookings are generally still rising across the board, however, the pace of demand growth has slowed over the past year, noted Jeff Myers, managing consultant for CoStar Portfolio Strategy.

Meanwhile, about 49,000 new hotel rooms were added to CoStar's National Index last year, and the company is tracking another 100,000 rooms slated for delivery in 2017 and 2018, including the 73-story InterContinental Los Angeles Downtown, which opened its doors in late June. The 1,100-foot hotel developed by Korean Air and Hanjin Group at the site of the former Wilshire Grand Hotel is now the tallest building west of Chicago.

The elevated level of new hotel construction appears to finally be affecting the eight-year run of growth in demand, room rates and other fundamentals for the US lodging sector

"It’s been a fun run for hotel investors, but the sector may finally have reached the end of a phenomenal recovery period," Myers said.

Hotel Construction Pipeline Likely to Peak in 2017

Los Angeles, New York, and Dallas-Fort Worth are among the U.S. markets expected to see the largest increases in new hotel supply in 2017 over the previous year. The hotel construction pipeline is expected to peak this year, according to CoStar's forecast.

JMP's Stevenson said about two-thirds of all U.S. hotel construction remains in the limited-service hotel segment, in keeping of the broader array of markets open to limited-service versus full-service operators.

Although still increasing, growth in average room rates and revenue per available room (RevPAR) have dipped to their lowest levels since the Great Recession, according to JMP. Year-over-year growth in average room rates slowed to 3.3% during the second quarter, just above the long-term 3% average and about half of the peak rate earlier in the lodging cycle. Average revenue per available room (RevPAR) gains dipped to 3.1%, about 50 basis points below the long-term trend.

Case in point: Hilton Worldwide Holdings, Inc. on Wednesday reported growth in RevPAR. However, the highest rates of growth are occurring outside the U.S. market.

Hilton President and CEO Christopher Nassetta told analysts during the global hotel chain's second-quarter earnings conference call that the sector is experiencing growth, "but it is fairly anemic, broader growth."

The slowdown is reflected in investment sales volume, which has seen the largest declines among all major commercial property types. The $34 billion in hotel sales over the past four quarters is 14% below the total for the previous four-quarter period.

Lodging analysts and investors are closely watching another hospitality industry subplot play out. Last month, owners of properties branded by Hyatt Hotels Corp (NYSE: H) received notice that the company intends to terminate its agreement with online booking firm Expedia if they cannot come to an agreement by the July 31 expiration of their current contract. Expedia’s channels also include, Travelocity, Orbitz, Hotwire and Cheap Tickets.

If Hyatt, one of a shrinking number of global lodging brands that still own significant real estate holdings, pulls out of Expedia, owners of Marriott International (NYSE: MAR) and Hilton (NYSE: HLT) properties would have a valuable chance to benchmark the performance of Hyatt properties against their own hotels and resorts, Stevenson said.

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