To say that the COVID-19 pandemic was a financial disaster for the hospitality industry would be an understatement. The impact of the global health crisis on hotels and other hospitality sectors was extensive. But these bad times appear to be over.
As the nation puts the pandemic in the past, U.S. hotels, restaurants and travel destinations are finding new life as they approach pre-pandemic levels of revenue and activity. At the same time, the recovery has been uneven and many properties may end up going bankrupt if the economy continues to cool this year. Commercial mortgage brokers must learn from the difficulties of the pandemic so they can evaluate properties and identify their underlying values without being misled by tough economic circumstances that may cloud their true worth.
The years from 2011 to 2019 were favorable to the hospitality sector and good times appeared to lie ahead. By 2019, the U.S. travel and tourism industry had reached annual sales of about $1.1 trillion. International and domestic travel was booming. Forecasters saw continued expansion and construction of many new projects. The industry’s future appeared to be, in a word, rosy.
Then the pandemic hit. Few observers could have imagined the devastating effects it would have on the global economy and more specifically on the hospitality sector.
Travel and tourism sales fell by nearly half in 2020. While the actual number of hotel closings is hard to ascertain, it is estimated that half of all U.S. hotels were in danger of closing. More than 110,000 eating and drinking establishments closed in 2020. About 670,000 jobs in hotel operations and nearly 4 million jobs in the broader hospitality sector were lost that year due to the pandemic, according to the American Hotel and Lodging Association.
Before the pandemic, the nation’s 5.4 million guest rooms generated more than $169 billion in annual revenue. A year later, room revenues had been cut in half, causing disruptions for major hoteliers. Marriott, for example, reported that it temporarily closed about 25% of its 7,300 hotels around the world. In the first few months of the pandemic, Marriott’s North American occupancy rates fell to 10%.
Despite this gloom and doom, the hospitality sector has since bounced back with unexpected strength. The U.S. hotel room occupancy rate reached 62.7% in 2022, not too far below the 67.6% level seen in 2019.
The industry’s workforce was expected to return to pre-pandemic job levels this year. Hotel revenues and profits reached record levels in 2022 due to strong demand and pricing power. Unfortunately, so did labor costs, and economic headwinds in 2023 may threaten the pace of further recovery and expansion.
“The picture of the hospitality industry is somewhat disjointed. Mortgage brokers need to take the time to research current industry trends to see which properties are worth buying and which should be avoided.”
The hotel sector is rebounding, as it always does, but in slightly different ways. Here are a series of U.S. hospitality industry statistics to keep in mind:
- The average daily rate (ADR) has now surpassed pre-pandemic levels. As of early February 2023, the ADR was $145.35, an increase of nearly 14% from the same week in 2019, according to data analytics company STR.
- Revenue per available room (RevPar) also has topped pre-pandemic levels. STR reported that RevPar was at $80.45 as of the first week of February, up 5.6% from the same week in 2019.
- Pent-up travel demand is sweeping the U.S. and the rest of the world as leisure travel exceeds pre-pandemic levels.
- New construction projects are growing and hotels in major cities are running at high occupancy rates.
- Deloitte, a leader in corporate accounting, estimates that by the end of 2023, spending on business travel will reach 68% of 2019 levels.
These statistics sound encouraging, right? They should. Still, the picture of the hospitality industry is somewhat disjointed. Mortgage brokers need to take the time to research current industry trends to see which properties are worth buying and which should be avoided.
The market has changed. Leisure travel is now king; business travel is returning but more slowly. The result is that hotels and resorts in select metro areas are seeing excellent returns. But many other properties, used to relying on business travelers week after week, are not recovering as fast. The industry’s full recovery may not arrive until 2024 or 2025. It may even be influenced by the next presidential election.
While still lagging, business travel has had a surprising comeback. The number of business travelers declined drastically early in the pandemic. But group travel and convention traffic has been returning. The Center for Exhibition Industry Research reports that convention center business activity has steadily improved and is expected to reach pre-pandemic levels in 2024.
But the performance of hotels in individual markets (especially smaller ones) is varied and depends on many factors, including location and surrounding activities. The market for small-group business travel remains slow to recover. This is due to many reasons, including the growth in home offices and changing attitudes about travel. Small-group travel should change somewhat. The hospitality industry may never fully recover this market segment, which could be a damaging future trend for hotels with meeting spaces.
The post-pandemic recovery has also resulted in soaring labor costs. The job market is tight, which has created a major upswing in hourly wages for hospitality employees. In many markets, the increase in hourly pay rates has grown by 25% to 50%.
Many of the major hotel chains were providing limited services to guests (such as fewer housekeeping and meal offerings) coming out of the pandemic. Some of these services are returning and this trend is growing. But the costs to provide these services is well above previous levels.
Added to this are today’s widespread inflation issues, creating an environment where hotel profit margins have been severely disrupted. Costs for all items used in hotels, including food and beverage outlets, are creating challenges.
At the same time, lending rules are changing. Early in the pandemic, banks gave some borrowers forbearance on their loans, but these policies have ended. Banks are not looking at debt-service-coverage ratios and borrowers are being required to pay interest. Profit margins have eroded, however, putting borrowers in a jam.
A perfect-storm scenario has arrived. In the past, borrowers could use short-term loans to cover their positions until the economy stabilized. But inflation has driven up interest rates considerably. As such, there appears to be a crisis looming for existing owners who are in debt.
With recessionary alarm bells ringing a bit softer of late, the final three quarters of 2023 should show growth throughout the hotel industry. Many new hotels will be added to the current inventory while some existing hotels may close or be adapted for new uses.
There are a few other trends to look for this year. The Airbnb model of home rentals will continue to expand. The “hybrid hotel” — a building that includes hotel rooms and a combination of transient facilities, extended-stay rooms and offices — will grow in popularity. Despite brisk business, foreclosures may increase due to the decline in profit margins. But there is a significant amount of equity ready to step in as investors look to buy value-add assets.
Renovations will play a big part in this transition. During the pandemic, many hotels did not receive tender loving care. Major brands, quiet for the past few years, are now becoming aggressive and demanding improvements to their facilities. And as assets change hands, new owners will need capital to complete upgrades.
The leisure travel market is expected to stay strong. Workweeks are being shortened, and the amount of leisure travel is expected to continue growing this summer and beyond. Staycations (vacations near home where work is often part of daily activities) should become more common. Due to the remote-work policies of many companies, employees have more freedom to choose where they want to be while working. Why not at a resort with their family by their side?
The food and beverage sector will continue to change. Along with the traditional restaurant experience, hotels will include expanded pantry areas where guests can purchase food and drinks. Takeout and “grab-and-go” facilities, such as DoubleTree by Hilton’s Made Market, will become more popular. And as always, hotels will continue to refine their service offerings to find new revenue streams that offset the additional costs of labor.
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What’s important for the mortgage broker to remember is that the hotel asset that’s in foreclosure today may simply be the victim of the pandemic and its effects on profits. The physical asset is the same as it was before the arrival of COVID-19. And a new owner will have a value-add investment opportunity that, in many cases, could be as little as 30% of the replacement cost of the hotel.
A new cycle has started and new owners are finding ways to offset increased costs. They have smaller investments in hotels that can compete due to their low-cost basis. Keep searching for these borrowers. The low basis in these assets should give lending committees a degree of security that the mortgage will be secure and protected. ●