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HOTEL REVPAR DECLINES
THREATEN DEBT-SERVICE COVERAGE
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| Lenders Should Be Alert For Possible Increases In Hotel Loan Defaults | |
| Atlanta, GA -- (October 30, 2001) - The Hospitality Research Group (HRG), the research affiliate of PKF Consulting, has completed a special study of hotel debt-service coverage given the current depressed state of the U.S. lodging industry. The research, based on proprietary financial data, found the number of U.S. hotels lacking the cash flow needed to pay their debt will more than double next year. |  |
As a result, the current forecast produced by HRG, in conjunction with Torto Wheaton Research (TWR) of Boston, projects that the average U.S. hotel will experience an 8.9 percent decline in the income received from the rental of guest rooms (RevPAR) from the period 2000 to 2001. RevPAR is expected to continue to decline in 2002 at an annual rate of 9.1 percent.
"In the 80 years that our firm has been tracking the U.S. hotel industry, we have not seen annual RevPAR declines of this magnitude since the Great Depression of the 1930s," says R. Mark Woodworth, pictured above right, Executive Managing Director of HRG. "Few hotel lenders have had to deal with such precipitous declines in revenues. Therefore, they are unprepared to gauge the impact on the ability of their borrowers to re-pay their loans."
Actual, Not Hypothetical Results
To examine how hotel debt-service coverage is effected by such a significant decline in RevPAR, HRG extracted information from its Trends in the Hotel Industry database of 3,300 actual hotel financial statements. An analysis was performed on hotels that experienced a RevPAR decline of 10 percent on a year-to-year, same store sales basis. "This analysis allowed us to observe actual historical relationships between movements in hotel revenue and the resulting changes in hotel profits. These are not hypothetical results," says Woodworth.
Given the high fixed-cost nature of the lodging industry, the survey sample was divided into two property types (limited-service and full-service) as well as two operating thresholds (high occupancy and low occupancy). "There is a difference on a hotel's ability to pay their mortgage that is dependent on their performance prior to a recession," notes Woodworth. "Our analysis dramatically proves the theory that the strong are better equipped to survive an industry downturn."
High Occupancy Hotels Will Not Appear On Lender Watch Lists
For purposes of the research, hotels with an occupancy greater than 70 percent were deemed "high occupancy" hotels. A group of approximately 70 "high-occupancy" properties experienced a decline in RevPAR in excess of 10 percent in the subsequent year and were analyzed for this study.
On average, the high-occupancy limited-service hotels experienced a 12.0 percent decline in rooms revenue (RevPAR), which resulted in a 9.8 percent decline in total revenue. Given these drops in revenue, the profits of the high-occupancy limited-service hotels fell an average of 24.6 percent. Applying relevant industry averages for financing, the 24.6 percent decline in profits results in a lowering of the debt-service coverage ratio from 1.76 to 1.32.
On the other hand, dramatic declines in revenues for high-occupancy full-service hotels resulted in a relatively small decrease in debt-service coverage. The high-occupancy full-service properties studied averaged a 13.0 percent decline in RevPAR, a 6.9 percent decline in total revenues, and an 8.6 percent decline in profits. The result was a lowering of debt-service coverage from 1.68 to only 1.54.
"While no lender likes to see debt-coverage ratios drop, they should be reassured that most stable hotels will still be able to generate enough cash to pay their mortgages," says Woodworth. "Of course, the lower debt-coverage ratios leave less room for error, so the operations need to be carefully monitored. Asset management is now more important then ever before. Yield management becomes critical to ensure the most profitable top-line, and the proper controls must be in place to keep costs in check," says Woodworth.
Low Occupancy Hotels May Become Delinquent
While it appears that hotels performing above market averages prior to the current recession will continue to pay their debts, those hotels already behind in performance are most vulnerable to missing loan payments.
Just as HRG studied high-occupancy hotels, an analysis of low-occupancy hotels was also performed. Properties with an occupancy of less than 70 percent were deemed "low occupancy" hotels. A group of approximately 120 "low-occupancy" hotels experienced a decline in RevPAR in excess of 10 percent in the subsequent year and were analyzed for this study.
Our sample of low-occupancy full-service hotels averaged a 16.3 percent decline in RevPAR, a 12.2 percent decrease in total revenues, and ultimately a 44.8 percent drop in profits. Low-occupancy limited-service hotels fared even worse. The low-occupancy limited-service hotels experienced 16.9 percent decline in RevPAR and a 15.9 percent decrease in total revenues that resulted in a 46.6 percent fall in profits.
"Because fixed costs already comprise a large portion of the total expenses for these low-occupancy hotels, the ability to further reduce expenses is minimal. This is why we see such dramatic declines in profitability," says Woodworth.
Given the extreme fall-off in profits, we observed an equally dramatic decline in the ability of these hotels to cover their debt obligations. For the low-occupancy, full-service hotels, debt-service coverage fell from 1.68 to 0.93. For low-occupancy limited-service hotels, the decline in debt-service coverage shifted from 1.76 to 0.94.
"Clearly, for hotels that were already under performing, the prospects for surviving the current recession are bleak," says Woodworth. "For the lenders to these hotels, careful consideration should be given to dramatic changes in the operation or an effective exit strategy."
"We believe the number of hotels in the U.S. that will experience a debt-service coverage deficiency will more than double in 2002," says Woodworth. "The owners of these cash deficient properties will have to reach in to their own pockets to pay their mortgages. The leniency of lenders will dictate how many of these properties actually are foreclosed upon. Foreclosure may be the proper move for a lender, but a workout might be just as justified."
Of the 3,300 hotel financial statements in HRG's proprietary database, 16.4 percent were unable to generate sufficient cash from operations to cover their interest payments in 2000. HRG estimates this number of increase to 20.9 percent in 2001 and 36.5 percent in 2002.
Downside Benchmarking
During the 1990s, lenders would avail themselves of the various top- and bottom-line benchmarking services to evaluate the growth of future income streams. However, in today's depressed operating environment, the purpose and benefits of benchmarking have changed.
"Lenders should now ask the question 'What does the bottom look like, and when will it get better?' The results of this study reveal that income declines will be dramatic," says Tom Lattin, Executive Managing Director of Capital Markets Services for PKF Consulting's affiliate company, Hospitality Asset Advisors, Inc.
Unfortunately, future actions may be limited when dealing with these distressed properties. "When looking at the characteristics of the low-occupancy hotels, there were some consistent factors among the sample. Old age, poor location, questionable affiliations, and improper market orientation were common attributes in the low-occupancy sample. Some of these factors can be changed. Some cannot," Lattin concludes.
In response to the increased demand for information on hotel profitability, HRG has developed a new "downside" Benchmarker report that allows a lender to estimate future profits and debt-service coverage under different revenue scenarios.
The Hospitality Research Group (HRG), headquartered in Atlanta, is the research affiliate of PKF Consulting, the international consulting and real estate firm specializing in the hospitality industry. HRG, along with PKF Consulting and hotel brokerage affiliate Hospitality Asset Advisors Incorporated, are wholly owned subsidiaries of Hospitality Asset Advisors International, a U.S. Corporation. HAA International has offices in New York, Boston, Philadelphia, Washington DC, Atlanta, Houston, Dallas, Los Angeles, San Francisco, and Singapore.