A blue-chip panel of hospitality consultants look for the industry turnaround

Where are we? Where are we going? How soon will we get there? These three key questions were at the heart of most panel discussions and personal conversations during last month's New York University International Hospitality Industry Investment Conference in New York City. To get in-depth opinions on these questions, Lodging Hospitality hosted a private panel discussion during the conference with six of the industry's leading consultants. The panelists were all contributors to Hotel Investments Issues & Perspectives, published earlier this year by the American Hotel & Lodging Association Educational Institute.

Lodging Hospitality: What is the state of the hotel industry at mid-year 2003?

Randy Smith, Smith Travel Research: We're disappointed. We thought by this time we would have seen more of an improvement than we've seen so far. Demand seems to be there, a little bit softer than we had hoped, but it's coming around. We've been surprised at the sharpness of the declines in room rates. It is broad-based and not isolated to one segment.

Sean Hennessey, PricewaterhouseCoopers: Our research shows decreased demand due to both the weakness in the economy and an aversion to travel. Consumer propensity to travel has decreased to a level we haven't seen before.

Lori Raleigh, International Society of Hospitality Consultants: The glass is still more than half full. From an investor perspective, the issue is alternative investment performance. As challenging as it is in the hotel environment now, we're still stacking up pretty well compared to other investment choices. The stock market, although it has improved since the beginning of the year, is still down almost 14 percent on a rolling 12-month average. While there's a ton of money looking for a home, the big issue for investors is getting comfortable with the risks of the new environment.

LH: Can you compare the current industry environment with any other time frame?

Smith: Not really. We've done a lot of analysis comparing the first four or five months of this year to 1991, during the first Gulf War, and the differences are very stark. The industry was in terrible shape back then. We had too much debt and we weren't prepared for any kind of downturn, so the industry lost staggering sums of money. This time around, the industry is fairly healthy. We don't have a lot of debt, and the debt we do have has had fairly low interest rates. The industry continues to make money, although we've dropped back to levels of profitability we haven't seen in seven or eight years.

LH: How does the health of the hotel business in the rest of the world compare to the U.S.?

Jim Burba, Wimberly Allison Tong & Goo: It's not quite as volatile. The impacts of Sept. 11, 2001 terrorism were felt in certain markets around the world, but to a much smaller degree. Paris and London and some other cities have been affected because Americans aren't traveling overseas, but if you go to some other parts of Europe business has been fine and continues to be. Asia, of course, has its own dynamics, which are far more severe than anything we've had to deal with.

LH: This downturn in the industry has been relatively free of foreclosures, delinquencies and those kinds of problems. Will that continue?

David Neff, Piper Rudnick: I don't see things changing for the next year or so. There are a number of reasons why we haven't seen a return to what we saw during the last downturn. The biggest factor is that the industry is in such better shape today. There is so much more equity in deals. What will be more telling is when some of these loans start coming due, and whether lenders take a different approach to mature loans than they do with loans that are still in the middle of their term. They may take a more aggressive approach to borrowers, which might create a lot more strife, more foreclosures and more bankruptcies.

Hennessey: Investors looking at the hotel sector now are those who hope to ride the upside of the cycle. They won't necessarily be in the industry forever, but they want to make some money when times are getting good. They say, 'The last time the market went up, it did so very quickly, so I don't want to miss it this time around. I'm willing to get in a little early, ride the bottom for a while and then hit the upturn fully.'

Burba: One thing everyone is afraid of now is the distribution channel situation. Maybe a solution to our problems comes when we learn how to manage that scenario better.

Raleigh: As an industry, our focus has always been on managing yield from the top down. Managing yield from the bottom up represents huge potential for every property.

Smith: We allowed the online auction process to get away from the industry to a point where we're no longer pricing our own product. We need to learn how to manage that process a lot better than we have been.

LH: There seems to be a lot of money available to this industry, but deals don't seem to be flowing. Do you see that dam breaking any time soon?

Rachel Roginsky, Pinnacle Advisory Group: There is too much money chasing too few deals. Deals are coming on the market, but the question is how to price these deals. It's very challenging to do valuations based on income anymore. Our clients are buying based on replacement costs or on where they want product. It's certainly not based on any future cash flow.

LH: What are the challenges in valuing hotel properties in this environment?

Raleigh: It's important to keep in mind the factors that can affect value. Net income is obviously one of them; changes in the underlying real estate is another. Others are changes in the availability of capital and changes in the risk-versus-return spectrum.

Hennessey: We recently updated a study we did for the city of New York, which shows that for the past two years revenues dropped at the typical hotel by 25 percent, while cash available for debt service dropped close to 60 percent. So very small improvements in revenues can lead to very large improvements in net income. Right now, we don't see any direct indication that those good days are coming back quickly, so it's a bit of a gamble on the part of investors hoping for that kind of turnaround.

Roginsky: Our clients are looking at a longer-term horizon for the turnaround. In the past, it would happen in four or five years; now it is six, seven, eight years, so at some point between now and seven years, there will be a turnaround.

Raleigh: The other big opportunity at the property level is the cost of distribution. When you analyze profit contribution by type of business, it's fascinating to see that some repeat business costs one cent on the dollar, while reservations from some of these merchant model Internet distribution sites can cost as much as 35 cents on the dollar.

LH: Are these permanent changes in the business, or part of the short-term environment we're in?

Burba: My recollection of other recessions is that the group segments often get inactive. It's a problem today, but I don't think it's a permanent problem. When people feel safe and a little more flush, they'll go back to those conventions.

LH: What about the potential problem of commodization of the industry caused by Internet travel distribution sites?

Roginsky: Consumers are opting more for price now because we're in a recession. Once that's over, people will be willing to spend more, and they'll probably look again at the brands.

Raleigh: From an owner's perspective, for certain types of hotels it's very challenging to justify the economics and cost of a brand. There are still a lot of independents out there, and in some ways the Internet has leveled the playing field. Brands that can deliver in a cost-effective manner will be fine, but those that can't will have difficulties.

LH: Will the roles of brands change?

Smith: I question the value of some of the brands. They're supposed to help their hotels operate more efficiently; they're supposed to deliver guests, but all of those functions are in question at this time. The big successful brands aren't going away, but some of the lesser-known brands will come under a lot of scrutiny.

LH: Does this mean more friction between owners and brands and thus more litigation?

Neff: You see that anytime the economy goes down. Owners are looking for someone to blame, so you have a lot more litigation in general.

LH: What's driving new construction?

Hennessey: In New York specifically, we have a larger pipeline of proposed projects than we've had in a long time. The philosophy of many developers is that New York is not going away and it takes three, four or five years to get a project from concept to reality and hopefully the economy will be rolling by then.

Roginsky: The problem is that there are fewer lenders putting money into these projects. There are a lot of developers who want to build, but there is a wall that comes down when they approach lenders.

Burba: Almost everything we see now, mostly at the mid-upper and upper level, is not a standalone hotel; rather, it's a mixed-use resort, and that's why it works. You take a hotel, add timeshare, add condos, residential, anything that plays off of the brand of the hotel, then you have a deal.

Smith: There is still a lot of growth potential for certain types of products. For example, a lot of markets may still be undersupplied with extended-stay rooms. There are niches all over the place, and everyone wants to find that niche. That's the big gamble: Developers say, 'The hotel I'm building is the exception to all of these forces at work'.

LH: What are the biggest short- and long-term challenges facing the hotel business?

Roginsky: Short term, it's the economy. Long term, it's technology.

Burba: The economy, the airline industry and all those things we can't control will work out someway, because they always do. The biggest challenge we face that is new to us is the technology challenge, the managing of the customer interface through the Internet.

Raleigh: We underestimate the potential impact of the airlines' problems. The airlines lost more money in the past couple of years than they made in the whole history of the industry. We read about a lot of restructuring, but there will be a lot of changes to lift capacity at major destinations. We might restore the demand when the economy picks up, but I'm not sure the decreases in lift capacity will ever reverse in some markets.

Neff: In the short term, it is terrorism. After Sept. 11, one thing we were told is that there will be another attack in the U.S. Another terrorism event would be very negative for the economy and negative for the hotel industry. God forbid it happens at a hotel, and the impact could be devastating. In the long term, the challenge is technology. Someday someone is going to figure out how to provide good videoconferencing technology from our computers. At that point, there will be less business travel as people can see each other face to face over their computers.

Hennessey: In the long term, one issue that will become more prevalent in the next year or so is the huge wave of refinancings starting in late 2004 and '05, which is the 10th anniversary of the introduction of the CMBS market. There are a lot of properties that at one time had strong stable cash flows and have been able to survive because the leverage is at a level that works for them. They will become less desirable candidates for refinancing. There will be a huge change in the capital structure in the next few years, and it's unclear how that will play out. LH

Cautious optimism was the catchphrase at last month's New York University International Hospitality Industry Investment Conference. Just about every speaker from Bill Marriott to Steve Rushmore held high hopes for a hotel industry turnaround, but no one knew when it will happen or what will be the catalyst to kick-start a rebound.

At the CEOs Check-In general session, an unusually frank Henry Silverman of Cendant Corp. expressed his concerns about the impact of technology on the future of the lodging industry. "The Internet and other technology makes all rates visible, which makes me wonder about the effect on yields," he told the audience.

Hilton chief Stephen Bollenbach was the most self-assured CEO, calling Hilton "strategically complete as a company. We feel we can compete where we want in all segments." As a consummate dealmaker, he added that the company is always shopping for acquisitions, "but only for bargains."

The most riveting event of the conference was former New York City Mayor Rudolph Giuliani's speech following his acceptance of the Lodging Hospitality Stephen W. Brener Silver Plate Award.

Do you want to read more? A full transcript of the roundtable discussion is available on the Lodging Hospitality website. Go to www.LHonline.com. Free registration is required to access the site.

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