Does the current U.S. hotel cycle have room to grow?

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It’s the question of the hour: Is a recession around the corner? And if so, how do hotel investors start preparing today?

“The hospitality sector is very sensitive to economic movement,” John Chang, SVP, research services at Marcus & Millichap, said during a recent webinar titled “2020 Hospitality Investment Forecast: Mastering the Markets” hosted by the firm. “That’s a natural thing because [revenue per available room] is most significantly affected by economic movement, much more so than retail, office or industrial, which have long leases. Of course, hotels are market to market, every day.”

For example, during the Great Recession circa 2007-2009, as gross domestic product hit negative gains, RevPAR growth plummeted to -16.6 percent, according to data compiled by Marcus & Millichap Research Services, STR and the U.S. Bureau of Economic Analysis. As of September 2019, GDP growth has notched 1.8 percent, while RevPAR has grown 1.1 percent. 

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“Currently, we still have steady growth. We’re still generating positive RevPAR, and the economy is still growing,” Chang said. “While that still has a bit of a positive momentum to it, the question is whether there’s a recession around the next corner.”

He said that this growth cycle has been running for 10 years plus a quarter, which puts it at the same length of the longest growth cycle in the history of the United States.

“There are a lot of investors out there who think, ‘Wow, we’ve been at this for over 10 years. We’re at the longest expansion ever.’ They are waiting for the other shoe to drop,” Chang said. “Throughout this cycle, we’ve been really mid-range in terms of our growth. It’s kind of been in that Goldilocks zone, especially for commercial real estate.”

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But the data shows that this cycle, which started in 2010, has garnered 26 percent GDP growth. Chang said that’s right in the middle of the pack when looking at past expansion cycles. For instance, the cycle from 1961 through 1970 saw GDP growth of 54 percent. In the cycle from 1991 through 2001, GDP grew 43 percent. In 1983 through 1990, the metric saw 38 percent growth, and GDP grew 29 percent in the cycle from 1950 through 1953. That points to some promise regarding this cycle, Chang said.

“Even though this has been going on for a very long time, we never got to that point where we overheated. We didn’t really overdevelop as an industry, and we didn’t really overleverage—all of the things that you normally see in a fast growth cycle,” he said. “That gives us the potential to continue to extend it forward. It’s been touch and go over the last few months, but it’s still looking like we have some legs to this cycle.”

How to Prepare

Even so, the economy isn’t stagnant and there are bound to be some headwinds. Chang said there has been some volatility seen over the past year.

“On one hand, you had the Federal Reserve pushing interest rates up, and now they’re coming back down. On the other hand, you have the trade war. And although we have some of the trade issues at least stabilized, this could heat up overnight,” he said. While recent reports say the U.S. shouldn’t expect interest rates to rise for some time, President Trump did take to Twitter on Monday morning announcing that he would restore tariffs on steel and aluminum.

But should a downturn be on the horizon there are ways for investors to plan ahead, according to Brian Waldman, executive VP, investments at Peachtree Hotel Group. First up, know when it’s time to make the right investment.

“At this point in the cycle, if you’re making an investment and you’re just counting on the economy to carry you through, it’s probably not the right time in the cycle to be making those investments,” Waldman said during the webinar.

When determining whether to invest, Peachtree looks for an asset’s opportunities to shift operations, whether it’s on the revenue-generation or on the expense side, driving more cash to the bottom line. In other words, strategize to improve cash flow to create incremental value beyond what the asset is doing today.

“When I say we improve the operations or improve the cash flow, it might be through the ability to drive top line. It might be through the ability to be better managed. Very often it has to do with a renovation or repositioning strategy,” Waldman said.

Additionally, he said that company leaders will look for assets that are “recession-proof,” in areas such as college markets or hotels next to medical centers.

“Regardless of where you are in the economic cycle, people are going to go to college. Same thing with medical centers. The economy doesn’t drive how many people are getting sick. We’ve also bought some hotels that are beachfront in stable markets,” Waldman said. “When we make investment decisions, we’ll typically look at what that market did through the last cycle.”

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