Forecast 2001: Markets in Flux

North America is ready, at last, to cool down, while certain European cities continue to peak. Latin America shows several encouraging signs, but Asia, despite its recovery, seems only slightly more vital than the Middle East.

By Tony Dela Cruz, Managing Editor -- HOTELS Magazine, 1/1/2001

Just 12 months ago, the global hotel industry seemed almost predictable. Major cities in North America and Europe were operating at peak levels, the lodging recovery in Asia had begun after much anticipation, and the risks of Latin America and the Middle East seemed in line with their historical, modest expectations. A year later, very little has stayed the same except for the peaking European markets. The North American economy has gone quickly from being prone to inflation to courting a recession, Asia has recovered but sits at an uneasy crossroads, and analysts have turned uncharacteristically bullish on Latin America. But Middle East tourism, particularly that of Israel, has been decimated by violence in the area. In other words, the constant is flux.

And it is the North American market that appears to be shifting the fastest. At press time, U.S. Federal Reserve Chairman Alan Greenspan declared the American economy was no longer threatened by inflation and might need an interest rate reduction to avoid falling into a downturn. One day prior, Jason Ader, senior managing director and lodging analyst for Bear Stearns, New York, downgraded six American lodging stocks tracked by the firm. "There seems to be little doubt that the economy is slowing, and history has shown that when the economy suffers, so do hotels," Ader says.

Eleven months earlier, Ader had upgraded the lodging sector although he says it may have been premature. Still, the largest hotel stocks were up in December more than 25% over the previous year. The analyst allows that the downgrade might also be premature, "but we believe in this situation it is much better to be the first one to react to a downturn than the last."

But John Fox, senior vice president, PKF Consulting, New York, says it is important to distinguish between stock market performance and actual hotel performance. In terms of room rate increases, for instance, "if we’re talking in Wall Street parlance, unless the increases are 10% or more, you’re no good," he says. "But for return on investment, increases between 5% and 10% are very, very remunerative."

The Gist

Only Wall Street seems overly concerned about flattening hotel performance in North America.
Europe, led by London, Paris, Amsterdam and Barcelona, continues to peak.
It is too early in Asia’s recovery cycle for the real estate market to do more than simmer.
Unrest in the Middle East, if it continues unabated, may eventually affect other regional markets.

Reasons To Believe

Fox says there are more reasons to believe the North American hotel market can sustain its growth than not. "[Room rate increases] will go above inflation," he says. He also points out how difficult it is to analyze room supply additions in the U.S. because there is a two- to three- year lag between starts and openings of full-service hotels. "The big increases in supply the last few years are now open and we’re absorbing the increases," he says

The strength of U.S. lodging fundamentals over the next year is also supported by a UBS Warburg survey of the senior management of approximately 700 hotels. UBS Warburg (New York) Lodging Analyst Keith Mills says the firm’s 2001 outlook remains positive, with the survey forecasting U.S. hotel RevPAR growth of 3.7%. Extrapolating the room rate and occupancy projections from PKF Consulting’s survey of 46 major American cities reveals a RevPAR increase rate of about 3.9%, so there is a concurrence among experts that the U.S. hotel business will continue to grow.

In the UBS Warburg survey, Mills notes 51% of the hotels are budgeting for 2001 RevPAR growth of 4% or higher, which he says is just slightly below the 54% response a year earlier. Those hotels anticipating RevPAR growth are skewing toward the Upper Upscale segment, where 65% of the hotels typified by Four Seasons, Hilton, Marriott and Sheraton have budgeted for RevPAR growth of 4% or higher.

Among other survey findings, Mills says 62% of the hotels surveyed are expecting profit margins to improve in 2001. However, 51% of the hotels expect competitive supply growth to be higher in 2001 than it was in 2000. "We expected this percentage to be lower, given the year-to-date trend of declining U.S. hotel construction starts," he says, but some comfort can be taken in the fact that U.S. hotel supply growth has been moderate for the past 13 months.

No Soft Landing

Optimistic analysts will argue even if the U.S. lodging industry is headed for its long-feared "soft landing" this year, it will be nothing like the industry crashes of the past 20 years. "Business in the U.S. is at or at about the highest level it has ever been," says PKF Consulting’s Fox. "It came through an early 1990s recession very well and is plateauing at a very high level right now."

Fox also notes although it may be fashionable to tag Paris and London as the standard-bearing cities for hotel performance, major coastal U.S. cities such as Boston, New York and San Francisco are "showing occupancies well ahead of those in the Euro-Centric region." Fox stresses that U.S. hotel performance is a story best told on a regional basis, but he also believes some parts of the U.S. are more indicative than others. "As the business goes on the two coasts, it goes nationally," he says.

For New York, Fox sees more of the same in 2001 as in 2000, where cities like New York were able to absorb added supply while seeing fewer new hotel rooms and fewer starts. Nationwide, UBS Warburg’s Mills predicts room supply growth will be 2.5%, lower than the firm’s earlier forecast of 2.8% and the consensus forecast of 3%, which he says translates to good news for hotel owners and operators.

Burning Issue: Tour Operators

Here is one trend some may find surprising: the growth of tour operators.

"The big thing that is happening is the tour operators are buying hotels in a big way," says Andries de Vaal, London-based partner for Deloitte and Touche. TUI owns 172 hotels, uniting under its banner six different brands, including Riu, Grecotel, Dorfhotel, Robinson, Iberotel and Grupotel. Indeed, TUI landed at #17 in the 2000 HOTELS 325 Giants ranking. The company also announced its entry into timeshare.

"TUI is seriously aggressive and looking to double the number of hotel rooms they control," de Vaal says, "and if they achieve that, they would rank in the top 10, globally."

De Vaal explains tour operators take a unique approach in building market share. "What these guys are trying to do is to own the whole of the value chain. They own the travel agency, the airline, the ground handling, some of the entertainment they provide and are now starting to own hotels. They can own the customer throughout the whole value chain," he says.

What’s unique about tour operators is their ownership of brands is incidental. De Vaal questions if hotel brand owners will fight back, perhaps by becoming tour operators themselves.

Europe’s Vested Interest

All the talk of brand alliances not withstanding, perhaps the most compelling relationship in the global lodging industry today is the bond between the U.K. and the American economies. Quite simply, a good portion of the business travel booked in London is attributed to investment banking and other transatlantic commerce. With London being such a key indicator of lodging markets on the continent, it can be argued that the tone, if not the overall performance, of Western Europe could be colored by the health of the U.S. stock market

"London is actually very sensitive to the U.S. economy," says Arthur de Haast, managing director, Europe, Jones Lang Lasalle Hotels, London. He explains the hedge fund crunch that slowed the U.S. stock market at the end of 1998 also held London hotel occupancies down for much of 1999. London rebounded in 2000, hosting conventions such as the American Bar Association, and the market has absorbed room supply additions. "If investment banking and corporate finance stay steady, then that’s the engine for the upper-upscale hotels in London," de Haast says. "Right now, there’s so much activity with bankers and advisors on airplanes shuttling between the U.S. and U.K."

Aside from London, analysts are keeping an eye on Paris, Amsterdam, Barcelona and Berlin, among others. Russell Kett, managing director of the HVS International office in London, says London and Paris are both entrenched in their peak form. "Both of those cities are pretty well at the top of their respective cycles," he says. "It’s not as though there is an imminent downturn that anybody is anticipating."

London And Paris Lead Way

Here again, Kett says, London and Paris are leading the way, with both cities trading well, and both having a limited number of hotel openings. "As supply grows only at a slow pace, you’ve got demand growing at a faster pace and helping to maintain strong levels of occupancy," he says. The result has been an increase in sold-out nights and a freedom to post and enforce higher room rates.

But Kett points out not every hotel in London has reaped the benefits of the high-demand market. "There have been certain hotels that have done exceptionally well and better than last year," he says. "And there have been pockets of hotels that haven’t done at all better and have just maintained their positions."

Similarly, many point at Barcelona as a rock solid destination, along with other Mediterranean cities such as Milan and Rome, which have enjoyed ongoing popularity, as primarily leisure destinations. "Last year’s hot cities are still hot," says Daniel Larkin, who heads up the PricewaterhouseCoopers hospitality practice for Europe out of London. He considers Spain the most inviting of the Mediterranean countries. "When you go down there, things are neat and clean. They work well and it’s a relatively low-cost place to do business," he says.

Most of the Mediterranean countries also have inherent barriers to entry, either through government control or pressure from existing hotel owners and operators. "People are trying to get into [the Barcelona] market but are finding it very difficult," says HVS’ Kett. "There are now opportunities for building in a limited sense—but not very much. Lack of available sites is generally the reason why more hotels haven’t been developed."

Amsterdam, meanwhile, exhibits the textbook tendencies of a healthy hotel market, with no new supply coming into the center of the city and strong demand and upward pressure on room rates as demand outstrips supply. Larkin says Amsterdam has emerged as an increasingly integrated high-tech center, "a very hospitable place for doing business, plus a city that is fun."

Jones Lang LaSalle Hotels’ de Haast says most major European cities can look forward to double-digit yield growth in 2001, with his personal favorite performer being Berlin, despite the city being overbuilt in the years following the collapse of communism. More recently, the German government has moved to Berlin and it has become a meetings center. "There is still a lot of rooms supply, a lot in the pipeline, but I do believe Berlin is going to be a good performer over the next couple of years," de Haast says. "It will be first or second in RevPAR growth after Barcelona."

Burning Issue: Consolidation

What better way to see a hotel takeover than from the eye of a participant?

It has been roughly one year since Hilton Hotels Corp., Los Angeles, acquired Promus Hotel Corp. of Memphis. Today, Hilton CFO Matt Hart, explains "it was really a question of scale," done to help ensure Hilton would remain big enough to compete with other large American operators like Starwood and Marriott.

He says it was either acquire Promus to get bigger or perhaps go private and become a niche player. "But the needs for technology and marketing cried out," he says. "And in order to make that work, you need large units to distribute the cost. That was the reason for acquiring Promus, and that has gone better than we could have imagined."

Hart says the company is "certainly strategically complete" with 1,900 hotels in markets "everywhere we want," along with a marketing alliance with Hilton Group in the U.K.

Hart does acknowledge that size sometimes demands more size. "We’re going to spend US$40 million on technology initiatives next year," he says. "If someone else spends US$100 million, then all of a sudden our’s is an inadequate number. Then you have to address that.

Tumultuous Middle East

Aside from North America, the only other regional market that might have an impact on Europe is the tumultuous Middle East. Andries de Vaal, London-based partner with Deloitte & Touche says "maybe Europe will suffer a little bit if Israel remains unstable, particularly for leisure travel from North America, if history repeats itself." The history he refers to is the Gulf War in 1990-91, when American businessmen stopped traveling to Europe altogether.

"The Middle East will always be volatile. Countries like Israel will suffer phenomenally from the current unrest," de Vaal says. "But we’re not learning anything new here; we see it all over the world repeated again. But also, almost without exception, we see business return to these regions after things settle down."

In contrast to the negative impacts of the stalled peace process, Europeans are being drawn to new tourist destinations like Dubai and the Egyptian coastline along the Red Sea. "What is interesting is places like Dubai are becoming very successful weekend break destinations for Europeans in particular," de Vaal says. "And Dubai is actively marketing itself as a holiday destination, which is a remarkable turnaround from even 10 years ago." He cites two compelling reasons for the newfound success of Dubai: Guaranteed sunshine and a five to six hours’ flight from Western Europe.

HVS’ Kett also sees the Red Sea coastline as opportunity filled. "There’s been a great amount of development and there continues to be a raft of projects in that whole coastline along the Red Sea," he says. "It is clearly an area that a lot of Europeans have yet to visit. At the moment, prices are quite low."

There are caveats, however. "The economic environment in which some of these hotels are trading, I would have to say, is becoming questionable in some locations," Kett says. "You can see the hotels down there continuing to struggle until demand has had an opportunity to catch up with supply."

Kett sees one other emerging market, although most American hotel operators might be compelled to stay away. "I was in Dubai recently and met with some Iranians, and the Iranian hotel sector is looking to expand and extend," he says. There is a feeling that the Iranian tourism industry can regenerate itself to previous levels, Kett says. "I wouldn’t be surprised if in a search for greater identity, [hotel operators] would start to look at Iran and put the troubles of the past behind them, start to move ahead and put the country back on the radar screen."

More Stable Than Before

One region marked by relatively less turmoil and more settling down is Latin America, according to Christian Charre, vice president, Jones Lang LaSalle Hotels and head of its Miami office. Although every Latin American country is a story into itself, Charre sees occupancy in the region increasing overall in 2001 provided the regional economy holds up.

He also sees 2001 being characterized by increases in domestic demand throughout the region. Latin America area occupancies average between 56% and 58%, he says.

The largest Latin American market, Brazil, actually saw its average occupancy decrease in 1999 compared to the previous year, dropping from 61.7% to 59.3%, according to Ricardo Mader Rodrigues, director of Horwath Consulting in São Paulo. The drop is attributed to increases in rooms supply and to weaker economic conditions.

The time-worn adage is if Brazil sneezes, with its 42% of South America’s gross domestic product, its neighboring countries catch a cold. Luckily, Charre says, much of Brazil has been trending upward for 2000. Representative of the hotel market’s drive for domestic business is the opening of Costa do Sauipe, in a northern province called Bahia, which is considered the country’s first world-class master plan resort.

"It has six high-end hotels, what you would expect to see in the U.S. but directed to the domestic customer," Charre says. "This gives opportunity for the middle class Brazilians to go on vacation in their own country, which is kind of new for them; people are realizing Brazil is becoming a more stable economic country."

Room supply for Brazil will be no problem in the coming year because São Paulo is expected to double its room count from 30,000 to 60,000 by the end of 2001. "The main problem is the capital market," Charre says. "This still will be an issue for the next two to three years." Currently, only telecommunications companies are able to command capital from investors in Brazil, he explains.

Burning Issue: Independence

With all the buzz in recent months being over the auction of the Compass Granada hotels, one of the bittersweet stories has to be the inevitable reflagging of many independent hotels in the company’s portfolio.

Fans of independent hotels will notice more often than not that most bidders for portfolios of hotels are either brand owners or buyers affiliated with major brands.

"It has never been more difficult for an independent to compete in this market and it will only get more difficult," says Bjorn Hanson, chairman of the worldwide hospitality practice of PricewaterhouseCoopers. "On the other hand, there are some unique features, and the boutique industry is a good demonstration of the concept of independent hotels."

Hanson notes that not everyone wants reliability, standardization and consistency. However, when it comes to competing on recruiting, training, procurement, investment, technology, investment in customer relations, it is just more and more difficult for non-branded hotels to compete. "That’s why we see companies such as Preferred launching the kinds of service offerings that allow independents to remain independent, but take on some of the benefits of a branded hotel system," he says.

Condo Hotels

There remain flexible options for financing hotel construction, such as the popular condo-hotel. Charre notes Accor was able to sell out an Ibis condo-hotel in less than 48 hours. Marriott International is doing something comparable in Rio de Janeiro, he says, where they are expected to build a US$70 million hotel. "As soon as it is done, they will securitize it and sell shares to individuals," he says.

Brazil’s largest neighboring country, Argentina, will stand in stark contrast, Charre says. With unemployment at 15%, "they are seeing the bottom there," he says. But international brands such as NH Hoteles and Hilton have been investing in Argentina and adding rooms to the market. The room additions will pressure average daily rates downward in 2001, but by 2002, Argentina should show positive growth in its GDP.

Chile, the only investment grade country in South America, remains a second-tier destination because of its narrow geography, more popular with developers of business hotels than resorts. Charre says that may change with improved airlift in and out of the country.

The balance of the Latin American countries have predictable characteristics governing their hotel environments. Charre says Columbia still receives many European tourists, for example, in Cartagena. "Not everybody is afraid to go to Columbia," he says. Charre calls Peru a "toss-up" for 2001; the country’s vacated presidency made it a hard sell for 2000, but he predicts "everything should be on-line in 2001."

Mexico Born Again

Of course, the biggest political shift in Latin America is the election of Mexico’s President Vicente Fox, a former Coca-Cola executive who comes from outside of the Institutional Revolutionary Party, which has ruled for more than 70 years. Fox promises a market-driven economy and 7% GDP growth.

Previously, observers say, Mexico’s economy has been dictated by policy meant to keep the ruling party in power, even if it meant dire consequences such as currency collapse or recession during non-election years.

In stark contrast, Charre says, under the Fox administration tourism will be allowed to rise on its own merits. Government hotel asset sales, for example, will be handled by professional management companies. Charre expects occupancies to rise above 58% and ADRs to improve as well.

Asia In Recovery

The fall of 1997 may be more than three years in the past, but experts say it has taken this long for the Asian economy to recover from the devastating effects of multiple currency collapses and an oversupply of hotels in the region. But even with room rates and occupancies slowly returning to pre-crisis levels, little activity is expected in 2001 because the hotel real estate market has not yet begun to churn.

Burning Issue: Technology

If hotel chain executives agree on nothing else, it is that the burden of technology investment over the width of a brand system can only be financed by the largest companies. Failing that, brand partnerships have emerged, with hotel giants jointly shouldering the cost of reservation systems and the like.

In just one example of a large hotel chain investing millions in search of a competitive edge, Carlson Hotels Worldwide, Minneapolis, has spent US$20 million on its core reservations and information management systems over the past three years. One of the results has been a wireless, portable data system called MACH-1, or Mobile Access to Carlson Hospitality, version 1.

The system facilitates the download of key data from Carlson’s CRS onto a palm-sized computer, thus enabling hotel management to make decisions in real time; complete audits of revenue and occupancy that once took weeks to generate.

"Now, if I’m the owner of a hotel, I can sit on an airplane and call up the GM," says Peter Blyth, executive vice president, development, Radisson Hotels & Resorts.

Carlson, which is primarily a franchisor, will have the system rolled out to all its corporate hotels by the end of 2000 and to franchised hotels by the end of 2001.

"I think the key now is that we’ve had a recovery, gotten through the worst of it," says Rudy Reudelhuber, vice president, Hodges Ward Elliott, Atlanta. "A lot of these companies in Asia are not over-leveraged and are able to service their debt, but market value is less than replacement value, so we don’t see a lot of transactions now or in the near future."

Still, a great many hotels in Asia are in the hands of bank restructuring agencies, having been seized from their original owners and placed with third parties to create investment grade assets. "I still don’t think the bank restructuring agencies are ready to sell," says David Gibson, managing director for Asia Pacific, Jones Lang Lasalle Hotels, Brisbane. "[The agencies] are going through the motions, meeting with investors, trying to finalize positions, to take control of the securities, but that is still a long process." Jones Lang Lasalle is an advisor to the Indonesian Bank Restructuring Agency.

In terms of market performance and recovery, Gibson says there are two pockets of economic health in Asia since the onset of the 1997 currency crisis. One pocket is less directly impacted by the currency crises, including countries such as India, Japan, China, Singapore and the Philippines, while the other pocket bore the full brunt of currency collapses and suffered socio-political disruption, as well. These are countries such as Indonesia, Malaysia and Thailand.

Reudelhuber notes "most people think Japan would be the first market in which we would see a sorting out of non-performing loan portfolios." He also feels that Japan, apart from most Asian economies, has the potential to return to robust growth in a way that would push RevPAR to levels that could sustain hotel market values above replacement cost, thus breaking a pattern that continues to haunt most of the Asian economies.

The lower pocket economies, meanwhile, continue to be haunted by flawed fundamentals, Gibson says. "In Malaysia, the RevPAR is basically going to remain stable, with a little growth, but occupancies are hovering around 50% to 60%." Even though Malaysia has good hotels and should attract good leisure business, he says, it still has the overhang of political instability. The same goes for Indonesia.

The markets set to make the most positive strides in 2001, according to Gibson, are Singapore, Bali, Bangkok, Tokyo and Hong Kong. "Singapore is one that is set up very well to capitalize on the recovery of the region," he says. "It’s a safe haven, it has a push up from the bottom end of the market, and arrivals on the top end which drive solid performance."

And despite oversupply being the root of Asia’s problems, there are a few destinations that could benefit from more rooms, Gibson says. Hong Kong’s convention hotels lost business recently to better-priced hotels in Bangkok. Phuket will become popular with leisure travelers looking to avoid political turmoil in other countries, while Singapore and Seoul, later in the recovery cycle, will be wanting more upscale rooms.