Why hotel profits grew last year despite slowing revenue

(By limiting the growth in operating expenses, some managers were able to drum up profits during a year with a 0.2-percent rise in occupancy.)

U.S. hoteliers enjoyed a seventh consecutive year of increasing profits in 2016 despite a slowdown in the rate of revenue growth. According to the recently released 2017 edition of Trends in the Hotel Industry by CBRE Hotels’ Americas Research, total operating revenue, driven by a 0.2-percent rise in occupancy and a 2.5-percent growth in average daily rate, increased 2.4 percent in 2016 for the average hotel in its survey sample. However, by limiting the growth in operating expenses to just 1.6 percent, managers at the Trends properties were able to extract a 3.7-percent increase in gross operating profits for the year.

“The competitive market conditions faced by U.S. hotels in 2016 have been well documented. With the results of the 2017 Trends report, we now have an understanding of the impact that the modest revenue gains had on the bottom line,” R. Mark Woodworth, senior managing director of CBRE Hotels’ Americas Research, said in a statement. “Clearly, U.S. hotel operators saw the threat of stagnant or declining occupancy and slow ADR growth and reacted by controlling expenses. The 3.7-percent increase in profits is the lowest we have observed since the Great Recession, but was a commendable accomplishment given the upward pressures on labor and distribution costs.”

The Trends in the Hotel Industry report is the firm’s annual survey of operating statements from thousands of hotels across the nation. The 2016 operating data collected for the 2017 survey was compiled in accordance with the 11th edition of the Uniform System of Accounts for the Lodging Industry.

Controls and Cuts

The report found that the nominal 1.6-percent increase in operating expenses during 2016 was achieved by a combination of controlling variable expenses and cutting costs that are more fixed in nature. Understanding that the typical hotel in the sample experienced an increase in occupancy, it was noteworthy that operated departmental expenses (with a high degree of variable costs) only grew 1.7 percent during the year. Concurrently, undistributed expenses (with a high degree of fixed costs) increased just 1.3 percent.

“With hourly compensation for hospitality industry employees increasing by more than 4 percent, it was somewhat surprising that total labor costs grew by just 2.8 percent for the year. This implies that managers controlled staffing levels and/or increased productivity,” John B. (Jack) Corgel, professor of real estate at the Cornell University School of Hotel Administration and senior advisor to CBRE Hotels’ Americas Research, said in a statement. “In spite of the noble efforts, for a second year in a row, it was the salary and wages component of labor costs that drove the increase in total labor costs, not employee benefits.”

Labor costs comprise roughly half of the operating expenses. The other half of the operating expenses consists of a variety of fees, commissions and costs for goods and services. In total, the growth of these other operating expenses increased by 0.3 percent in 2016.

“Hotel operators benefited from low inflation, as well as a reduction in the costs for items such as food and utilities.  However, as revenues continue to rise, so do the costs for related expenses like credit card commissions, management and franchise fees,” Woodworth said. “The one expense item that really stood out was the 6.8-percent increase in commission payments made to travel agents, [online travel agencies] and other intermediaries. This is consistent with what we are hearing from our clients.”

Location Matters

The growth in gross operating profit during 2016 was 3.7 percent for the entire Trends sample. However, when analyzing the data by regions across the country, CBRE Hotels’ Americas Research observed some differences. GOP growth was strongest for hotels in the Mountain/Pacific (7 percent) and South Atlantic (6.1 percent) regions. Conversely, properties in the South Central region suffered a GOP decline of 0.4 percent.

“We constantly advise our clients to pay attention to their local markets. In 2016, there was great diversity in economic performance across the country," Corgel said. "In Texas, there is a depressed energy industry, while technology continues to drive the economy in California. When looking at the 2017 Trends survey results by geography, the relationship between local economics and lodging performance becomes evident.” 

Diversity in performance also was observed by property type. The resort hotels in the Trends sample enjoyed the greatest GOP increase (6 percent), while limited-service profit growth was restricted to 1.4 percent. “For the resort properties, it was mainly a revenue story. Compared to others in the sample, resort operators achieved the greatest gains in occupancy, ADR and other operated department revenue during 2016.  However, limited-service managers, facing a higher degree of fixed and uncontrollable costs, struggled to curb increases in their expenses,” Woodworth said.

Future Focus on Expenses

In the March 2017 edition of Hotel Horizons, CBRE Hotels’ Americas Research is forecasting revenue-per-available-room growth rates ranging from 1.7 to 3 percent from 2017 through 2021. At these levels, management’s ability to control costs will enable profit growth.

“During the next few years, owners and operators should spend just as much time thinking about expenses as they do RevPAR. Effectively managing those two metrics will dictate the profitability of their operations," Woodworth said. "Ultimately, it is bottom-line profits that influence values, stimulate transaction activity, pay the debt and provide returns for owners and investors.”