08/04/2023 | by Sarah Borchersen-Keto
Lodging Analyst Roundtable

Lodging/resort REIT sector fundamentals held up well in the first half of 2023, following a 36% increase in revenue per available room (RevPAR) in 2022. Analysts are anticipating moderating growth trends in the second half of 2023, in combination with higher operating expenses and a likely return to pre-COVID seasonality trends. Low growth in supply offers longer-term tailwinds for the sector, as it continues to evolve in response to changing consumer preferences.

REIT.com spoke with sector analysts Bill Crow at Raymond James & Associates, Dori Kesten at Wells Fargo, and Chris Woronka at Deutsche Bank Securities about their views on some of the key factors shaping the sector today.

How would you describe broader lodging fundamentals at midyear, and what are you anticipating for the rest of 2023?

Bill Crow: 2023 is shaping up to be a tale of two halves. The first two to three months benefitted from easy comps, the modest recovery in business travel, and healthy group demand. As we got past the first quarter, tougher comps emerged while leisure demand began to normalize. The result is that demand growth has stalled, red-hot rate growth is cooling, and we are entering a low single digit RevPAR growth environment while battling higher growth on the expense front.

Dori Kesten: Despite the overhang of recessionary concerns for much of the last year and commentary that the U.S. consumers’ excess savings is winding down, lodging fundamentals held up relatively well in the first half of this year. Indexed to 2019, RevPAR was up almost 12% in the second quarter, from a peak of up 13.4% in the fourth quarter of 2022, with slight gains in rate but slowing demand growth over the quarters. 

Rate growth remains an important differentiator in this cycle versus all reported prior cycles in that the industry generally did not pursue the strategy of cutting rates this time to achieve incremental heads in beds. As a result, three years out from the lowest point operationally of the pandemic, rates are now 15% above prior peaks, whereas in prior downturns it had taken at least this long just to return to prior peak.  As we look to the second half, we expect U.S. RevPAR growth versus 2019 to slightly decelerate as compared to the first half, under the assumption the country enters a mild recession in early 2024. 

Chris Woronka: Mixed, but with a bit more stability and predictability than we've seen in a while. We are seeing the mix shifts and moderation in the broader pace of recovery/growth we expected, and along with that we are seeing a wider range of performance within various areas of the industry. Seasonality is also reverting to the 2019 trend line which means that, even though some travelers are continuing to enjoy the flexibility of combining work and pleasure trips, traditional peaks are peakier again, but shoulder periods also exist again.

The primary theme for the rest of the year is likely to be continued moderation in year-over-year RevPAR growth. We have already seen certain markets and segments turn negative in recent months. Muted supply growth is helping, but overall, it feels like we are in the later stages of a lodging cycle, not the early stages.

What performance trends are you seeing among the various lodging subsectors of leisure, business, and group?

Woronka: Group continues to perform very well and corporate transient demand seems to be holding up reasonably well. Group pricing is only starting to reset to higher post-Covid levels, and that should remain a good story in the near term. But we are seeing some softness in resort markets and even in some urban and leisure-centric markets on the weekends, particularly on the room rate side after two plus years of historically strong ADR (average daily rate) increases—upwards of close to 100% in some cases.

We are also hearing anecdotally that leisure travelers are a bit less likely to splurge on premium rooms or suites than they were during the early stages of “revenge travel” beginning in mid-2021 and throughout 2022. We are anticipating these trends to continue, directionally, for at least the next few quarters. We also think corporate demand could stagnate or weaken modestly from here, especially as we head into the fourth quarter and travel managers' budgets potentially become more restricted.

Crow: Leisure demand is ‘normalizing’ and price sensitivity growing (unless there is a Taylor Swift concert in the market). But leisure is also shifting to markets outside the U.S. as well as to cruises. Business travel continues to slowly improve, but interestingly at a pace below the return-to-office gains; we think business travel remains subdued until we get into 2024 and travel budgets are reset. Group, including association, corporate, and social, remains strong.

From a geographic perspective, what stands out to you in terms of lodging performance?

Kesten: Resorts remain the most talked about among the STR classified locations, given their leading rate recovery and the expectation of a fall-off in both demand and rate by mid-year 2023. Interestingly, resorts indexed to 2019 experienced the second strongest results among the other locations with respect to both demand and rate from year end 2022 to mid-year 2023.

Less talked about but still important to note is the deceleration in demand/RevPAR growth of interstate and small metro/town hotels to date. These two locations were early to recover, with demand exceeding 2019 levels, but have since trailed off, with the largest decelerations in growth from year-end 2022 to mid-year 2023, and demand now back below the prior peak. 

Crow: We are seeing the markets that were especially hot exiting Covid deliver weaker results with big urban, gateway markets showing better year-over-year growth. Essentially the reverse of the last 18 months, but the shift also begs the question whether we might see another reversal next year.

Woronka: Most key international regions (namely, Europe and Asia) are somewhere between nine months and 15 months behind the U.S. in terms of the recovery in travel, and U.S. travelers are finally going overseas again.

Within the U.S., it's hard to ignore the bifurcation in recent performance between resort-focused markets and group/corporate-heavy urban markets. New York City and Hawaii, which benefit from a high mix of international inbound demand and were later to reopen, are relative winners this year, while many Sun Belt markets are still doing very well relative to 2019 levels but are close to flatlining in terms of year-over-year growth. We are also seeing a shift among group bookings in several cities; Las Vegas, Phoenix, Denver, and San Diego continue to poach meetings and conventions from San Francisco and Los Angeles.

What sort of impact are higher operating costs, including labor, having on the sector?

Crow: We are seeing massive increases in property insurance premiums, aggressive property tax hikes, and labor wage rates continue to tally mid-single digit annual growth. Margins are under pressure and the labor unions are making aggressive demands, however, we expect more normalized expense growth of 3%-4% beginning in 2024.

Woronka: The big reset on higher wages was largely absorbed by hotel operators in 2022. The overall labor picture for hotel owners is much more balanced now, with worker availability still improving (at least modestly) in most markets. This year, the most notable labor trend has been the ability for hotels, especially select service ones, to replace costly contract labor with in-house full-time employees (FTE). Unfortunately, though, this is happening as occupancy rates are rebounding but room rates are generally stagnating or even declining in certain markets and segments.

There are other headwinds this year in the form of property insurance renewals (premiums are up 30%-40% or more for many hotel owners, whether or not they had a reportable event last year). Property taxes, which are often billed on a one-year lagged basis, are also up meaningfully. Finally, utilities are generally rising at a double-digit clip on a year-over-year basis. As we see it, room rates rose in 2021 and 2022, but costs didn't catch up until 2022 and 2023. That's why we are seeing negative margin growth this year, despite positive top line (RevPAR) growth.

Kesten: Labor and insurance costs remain a headwind to hotels’ bottom line. Labor costs, which typically account for 40%-60% of operating costs for the lodging REITs, was last reported at almost 20% above 2019 levels in the U.S., with 10% fewer workers and hours worked up just slightly, but with pay-per-employee up 30%. 

Management teams have estimated that labor costs should increase in the mid-single digits over the medium term, as compared to the approximately 7% CAGR (compound annual growth rate) of the last several years.  We believe the combination of higher costs per FTE, increased efficiencies, and reduced interest in the sector as an employer of choice should result in employment remaining down versus the prior peak over the medium term. The other material cost increase of late has been insurance costs, up 30%-50% for the lodging REITs this year, coming off a relatively heavy year of hurricane activity. 

Where, and how, are transaction deals getting done in the lodging real estate space?

Woronka: There are a lot of moving pieces, and the key players aren’t necessarily in the same place they were, strategically or financially, in 2019. We are seeing some very difficult decisions being made by public owners of hotels, in terms of handing keys back to the lenders on assets and/or portfolios that just can’t get to breakeven cash flow in light of higher interest rates, higher operating costs, and significant (perhaps deferred) capex needs. We have seen a few high profile give-backs recently and are likely to see more.

But we’ve also seen well-capitalized public REITs buying assets. Typically, they are buying assets that have strong in-place cash flows, don’t have near-term capital needs, and are in markets that should be pretty resilient over the long haul. You are going to see more hotel properties change hands, one way or another, over the next 12-18 months as more loans come due and extension or refinancing options remain limited.

Crow: There remains a sizable bidder pool for luxury hotels and resorts and there doesn’t seem to be too much difficulty selling higher quality, newer, and premier-branded select service properties. But in between, there are far fewer buyers today given the cost and availability of financing.

Kesten: The lodging transaction volume of the last two years has ranked in the top five years of the last 20, however, the pace of transactions slowed notably in the first half to down 50% year-over-year or down 7% versus 2019. While the volume has slowed, the price per key has been quite resilient, up over 10% year-over-year. Approximately 75% of the transactions completed (by value) in the first half were upscale to luxury hotels as compared to 70% in the year prior, and  approximately 50% were resort or urban locations in the first half as compared to 60% in 2022.  We would expect transaction volume to remain at muted levels for the near term as debt availability remains muted and with the cost of debt pricing uncertain.    

What new strategies are being used by the industry to generate increased occupancy?

Crow: The most important driver to incremental occupancy gains is largely uncontrollable: the U.S. is losing the travel trade wars. The U.S. needs to recognize the massive economic driver that is travel and tourism, and work to make inbound international travel easier, quicker, and more appealing.

Kesten: The brands continue to increase the attractiveness of their loyalty programs in order to drive the incremental guest and to stay on top of consumer trends (combined business/leisure trips, food and beverage concepts, high tech rooms/meeting space) and the American Hotel & Lodging Association continues its work to ease entry into the U.S. for inbound international travelers and to maintain as fair of a playing field as possible with respect to alternative accommodations. In general, we believe greater importance is now being placed on attracting the most profitable guests, not simply the incremental guest. 

Woronka: For a while, a rising tide lifted all boats. That’s really no longer the case. There has been a lot more focus on capturing the “B-leisure” occupancy that can result from a work trip being extended by a day or two, or across a weekend. Sometimes for the traveler that comes down to where they can get their corporate rate on weekend nights or which hotel allows them to use their loyalty points most efficiently. There has also been a push to fight for these often smaller, close-in, but premium rate small group meetings that happen when a manager decides to get all the remote employees together at an off-site location.

In a lot of cases, we are seeing higher-end hotels trying to reimagine their food and beverage operations to actually use these outlets as a draw. We’ve been told that hotels with rooftop bars are seeing triple digit percentage increases in total revenue versus 2019 levels. For select service hotels, sometimes the difference between 60% occupancy and 85% occupancy can be as simple as having recently completed a renovation, adding a pickleball court, or having the best fitness center. Seemingly little things matter as the battle for occupancy heats up from here.

Are there other themes or developments that you see impacting lodging real estate going forward?

Crow: Some of the things we are watching include: (a) we are in a multiyear period of very low supply growth that should set the stage for a continued recovery/expansion in lodging fundamentals; (b) we expect public to private M&A to be a positive catalyst for the sector, but who and when remains to be determined; and (c) the debt markets need to stabilize and rates/spreads come in a bit before we see a more interesting transaction market    

Woronka: We are continuing to see the lines between select-service and full-service hotels blur. The reality is, there are too many 30-plus year old, 250-plus room full-service boxes in airport or suburban locations that just can’t compete effectively against newer select service product. Due to territorial restrictions or other brand-driven limitations, many of these older hotels can’t adapt their operating models to generate acceptable returns for owners. This is ultimately going to play a role in reshaping what the industry looks like over the next ten to 20 years, in our view.

We are also seeing much more interest from developers/owners in building extended stay hotels. These are less than 10% of industry supply today, but an extended stay room can also be sold to a short-term guest. Optionality and flexibility are good.


Read Nareit’s Sector Spotlight on lodging/resort REITs from April, which highlighted performance in the sector at the end of the first quarter.