Historically high hotel prices – in this economy?
Get used to it, folks.
Hotel companies advised hotel owners to keep rates at relatively normal levels during the pandemic, as discounted rates would not encourage people to book a stay during a health crisis and lockdown. This has allowed hotel companies to recover from pandemic lows much faster than in any previous downturn.
But with the economy on shaky ground these days, the old playbook of reduced interest rates has to be considered, right?
Incorrect.
The Federal Reserve’s effort to contain inflation includes rate hikes, including a 0.25% hike just this week. That makes it more expensive to borrow money to build things like real estate developments, including hotels.
Even under the best of circumstances, hotel construction in the US is a tall order given the high construction cost of materials and labor and supply chain issues that have delayed many projects. Any headwinds on the construction front means less new supply is entering the market.
Shrinking supply coupled with improving demand drivers like international and business travel means higher hotel rates are likely to remain.
For example, construction at Dream Las Vegas, part of Hyatt’s recently acquired Dream Hotel Group division, halted this month due to stalled funding plans, the Las Vegas Review-Journal reported. The developer behind the hotel blamed rising interest rates as the reason for the construction delay.
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More instances of this can make the situation worse. Fewer hotel rooms entering the market amid recovering demand mean prices are only going to go up.
“From an industry fundamentals perspective, we continue to feel very good. It’s the basics [of] Supply and demand — that’s what ultimately drives earnings,” Hilton CEO Christopher Nassetta said of hotel prices on the company’s fourth-quarter earnings call last month. “The supply side is pretty muted. We are currently experiencing the lowest offer we have ever seen, taking the US market as an example, which is our largest market.”
Waves of tech layoffs, a banking crisis and fears of inflation paint a bleak economic picture, but hospitality continues to thrive.
Not only has the hospitality sector been a leading source of job creation over the past few months with better than expected jobs reports, but it also reported massive gains for 2022 in the most recent earnings season. Big hotel CEOs seemed puzzled at the possibility of charging higher prices, and the trend doesn’t seem to be going away with the uncertainty in financial markets.
Luxury hotels in the US were up more than 24% from 2019 levels over the past week, according to STR data. Overall US hotel performance was 10.4% above 2019.
The Case of the Disappearing Hotel Rooms
Don’t look for relief in the form of new hotels opening anytime soon.
“Even before higher interest rates and the banking crisis, new hotel supply was quite subdued on a relative basis,” said Daniel Lesser, CEO of LW Hospitality Advisors. “Now, eight to nine months later, with interest rates rising and the banking crisis, it is becoming a challenge to get financing even to operate hotels that are making money. This makes it all the more difficult to crack construction financing for a new project.”
While there are signs that hotel construction is starting to pick up slightly this year, the overall US hotel construction pipeline of rooms actively under construction is not back to pre-pandemic levels.
Hotel businesses might be pointing to growth, but that’s being helped in part by conversions — deals where an existing hotel owner agrees to rebrand their hotel. This does not typically add more hotel rooms to a market. Sometimes it even means reducing the number of rooms.
Additionally, a significant number of hotel rooms have exited the system entirely during the pandemic as many owners converted hotels for alternative uses. This ranges from smaller hotels being converted into apartments to larger ones, like the Hotel Pennsylvania in New York City, being demolished for new property development.
“We still see quite a few older, functionally and physically outdated hotels [products] either converted for alternative uses or scrapped for new developments,” Lesser said. “CEOs are spot on that new supply is and will remain subdued and that will only put upward pressure on pricing power.”
Is relief in sight?
Rome wasn’t built in a day and neither were hotels. Certainly there must be some kind of relief across the board for travelers. Finally, leisure demand remains high and the business, group and international travel industries are coming back. Strong demand drivers are usually an incentive for developers to push new hotel projects to meet the need for more rooms.
Hotel companies might be pointing to slight increases in their respective sizes throughout the year, but it’s probably still not enough to weigh on rising room rates — particularly at upscale hotels.
“There is definitely not a new supply glut,” said Patrick Scholes, managing director of Loving and Leisure Equity Research at Truist Securities. “There are definitely some cities that have a lot of new offerings [like Nashville and New York]. But for the most part, there’s very little, if any, new offering. Where you see the offering is going to be … your midscale brands, many of them Hilton or Marriott brands, or even Wyndham’s new Echo brand.”
High interest rates might eventually lower inflation, but they’re not conducive to hotel deals and digging the shovel in the ground.
Deals were few and “European real estate transaction volume fell off a cliff as investors struggled to underwrite deals amid an uncertain interest rate outlook,” according to a Bloomberg report by MIPIM, an annual conference for the global commercial real estate market Real Estate Sector, held earlier this month in Cannes, France.
One of the few deals announced during the conference was the purchase of a Pullman hotel in Cannes, but that’s an existing asset – not exactly the sign of a new build ushering in a larger European hotel offering that will price your summer vacation lowers.
Both Fed and European Central Bank governors noted in recent comments that bringing inflation down is their top priority. Raising interest rates is their primary tool for doing just that.
If commercial real estate remains paralyzed by high interest rates, tensions in the travel sector remain: Many people still want to stay in hotels, but developers don’t have the financial resources to build more supply to meet that demand.
Until that changes, it remains a scenario where owning a hotel is great—and not so great being the one paying the nightly rate.
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