Fundamental problems

National Report—Flo Lugli clearly remembers the shock that passed through the travel industry after the 9/11 terrorist attacks grounded travelers. Now the EVP of marketing for Wyndham Hotel Group, Lugli was moving through the ranks of Cendant and Travelport during that last significant industry downturn.

“I remember back after 9/11 and everyone said nothing would ever be the same again. Everything was different. It’s a new normal,” Lugli said. “Then we had some really boom years and people forgot about that.”

Each time occupancy levels dip and hotel owners and managers aren’t meeting forecasted revenues, analysts and investors are assured the hotel industry is cyclical by nature and will surely rebound.

But nearly two years into another downturn—a downturn many are calling the worst in history—hoteliers are again left pondering the same harsh realities: Will supply and demand levels ever return?

Or are we forced to adapt the business model to compete in a “new normal?”

Lugli said she doesn’t buy into a permanent shift in the hotel industry’s fundamentals. She admits we’ve seen an evolution of the market and the customer, but she remains optimistic that financing will come back and things will eventually get better.

Most hoteliers seem to share the same sentiment. Even if it’s as far off as 2015, most say there is a light at the end of the tunnel.

“Go back however far you want to go back. History is a great teacher; there are a lot of lessons in history,” said Jim Anhut, SVP of new brand development at InterContinental Hotels Group. “Cycles repeat. From our perspective, we’re in a pretty deep trough here, but things will recover.”

Smith Travel Research has been looking at history for nearly 25 years. Since the company began collecting data in 1986, there has never been a larger decrease in year-over-year revenue per available room than the 15.9-percent fall from January 2008 to January 2009. The closest revenue losses were from January 2001 to January 2002, when RevPAR fell 13.2 percent. By 2003, the industry had rebounded rather quickly, posting a 2-percent year-over-year increase in January. This time things are a little different: From January 2009 to January 2010, RevPAR was down an additional 7 percent.

The data is forcing some to shed their optimistic outlooks and get down to brass tacks.

Hubert Joly, CEO of Carlson Hotels, said revenue per available room in some cities around the world is down as much as 45 percent.

“That’s a significant reset,” he said. “Companies have to learn how to make money in that new environment.”

“We finished 2009 at about 55 to 56 percent occupancy. Frankly, that level does not sustain pricing power, does not sustain paying your debt,” said Mark Carrier, SVP of the B.F. Saul Co. hotel division and chairman of the Holiday Inn Owners Assn. “That’s why we’re in the straits we’re in.”

In a poll conducted by the HotelWorld Network, 43 percent of respondents agreed that demand decline was the biggest problem facing the hospitality industry today. Of the 630 participants, 32 percent reported rate discounting is the industry’s biggest problem and 10 percent pointed to a lack of debt.

Causes
Although the economy can be blamed for both business and leisure travelers cutting down on trips, excessive supply has much to do with the current downturn as well.

Carrier said many franchisors proliferated the market with subsets of their brands and then “went wild” approving licenses.

“There was a lot of liquidity and a lot of people did deals—both in terms of what they paid for hotels and actually developed hotels—that did not have, even at that point, the fundamentals to support long-term success,” Carrier said. “People could get capital so easily that they weren’t restrained by good underwriting.

“It’s going to take us a while to reach a level of occupancy that’s going to sustain an increase in profitability.”

As far as exactly how long it will take, most hoteliers are unwilling to even take a guess. Joly is certain a hospitality industry rebound is directly correlated to the level of economic development. He said the greatest uncertainty lies in GDP growth over the next 10 years.

“GDP growth in the U.S. in particular will largely determine how quickly the hospitality industry rebounds and whether we go back to the RevPARs we had in 2007,” he said.

Solutions
Thorsten Kirschke, Joly’s right-hand man overseeing Carlson’s operations in the Americas, said the recession could actually benefit the industry by washing out start-up hoteliers who jumped at the opportunity to make a buck during the industry’s peak.

“People who shouldn’t have been playing in this game in the first place have had severe financial problems,” he said.

A rise in unemployment and a credit market meltdown contributed greatly to the industry’s perils. But clearly a lack of underwriting and oversupply can also be blamed, and hoteliers can learn from the mistakes made during robust times to avoid future troughs as deep as the current one.

John Arabia, principal analyst at Green Street Advisors, said the cyclical nature of the industry most likely will never flatten.

“It’s a business with high fixed costs and nightly business that isn’t visible past two or three weeks out,” he said. “That’s going to lead to vulnerability.”

He did say the hotel industry would benefit if companies operated with lower leverage levels. Often times, companies combine high financial leverage with high operating leverage, and history has repeatedly shown that is a recipe for disaster.

Arabia predicted the current trough will last longer than those in the past, but he said he is certain supply growth will remain muted through 2015 and profits will return.

“I am more than confident that this industry will see profits well in excess of 2007 levels,” he said. “I see no evidence of a permanent shift in travel patterns.”

He warned that when profits return, investors will think they’re sustainable and will find people to give them capital. But hopefully, he said, the industry will have learned and capital will be priced appropriately.

As Lugli markets Wyndham brands to the industry, she remains confident the industry will look back at this downturn as just another in the cycle.

“Things will get better and we’ll forget these dark times and then we’ll make the same mistakes,” she said. “We’ll overbuild. That’s just what we do.”