2003 U.S. Hotel Profit Loss To Be Reversed in 2004; Expense Creep and Control Influence Profitability

Atlanta, GA, May 18, 2004 – U.S. hotels suffered a third consecutive year of declining profits in 2003, according to the 2004 edition of Trends in the Hotel Industry survey conducted by PKF Consulting and the Hospitality Research Group (HRG). PKF Consulting and HRG announced the availability of its 68 th annual Trends report today (www.hrgonline.com).

“The operating profit for the average U.S. hotel in HRG’s Trends sample dropped 12.4 percent in 2003, this after declines of 19.4 percent in 2001 and 9.6 percent in 2002,” says R. Mark Woodworth, Executive Managing Director of Atlanta-based HRG. “This marks the first three-year decline in hotel profitability since the early 1960s.”

The 12.4 percent shrinkage in profits was the result of a 1.8 percent decline in the typical hotel’s revenues, combined with a 2.1 percent increase in operating expenses. “Hotel operators have been on a ‘low-carb’ program over the past two years and were able to cut expenses to mitigate revenue losses,” says Woodworth. “However, after two years of extreme monitoring, hotel managers faced the reality that there are some operating expenses for which they have minimal control.” Leading the growth in operating expenses was a 3.1 percent increase in labor and related costs.

On the bright side, HRG, along with forecasting partner Torto Wheaton Research (TWR), anticipate that U.S. lodging industry performance will rebound significantly during 2004. Based on the HRG/TWR Spring 2004 Hotel Outlook forecast, hotel revenues should increase 7.6 percent in 2004. This increase in revenue should result in a 14.3 percent increase in profits for the year.

“A 14.3 percent increase in profits sounds strong, but U.S. hotel profits are off 36.2 percent since 2000. The 14.3 percent increase projected for 2004 just barely brings hotel profits back to 2002 levels,” Woodworth concludes. “For perspective, we did observe annual profit growth in excess of 15 percent during the mid-1990s, so this rate of growth is achievable.”

The 2003 results come from the firm’s recently completed Trends in the Hotel Industry survey, an annual review of U.S. hotel operations conducted since 1935. This year’s sample draws upon year-end 2003 financial statements from 4,000 hotels across the country. Profits are defined as income after management fees, property taxes, and insurance, but before capital reserves, debt service, rent, income taxes, depreciation, and amortization.

Rising Employee Benefits a Concern

At 45.3 percent of all operating expenses, labor and related costs represent the largest expense item for hotels. Therefore, the 3.1 percent increase in labor and related costs incurred during 2003 contributed significantly to the 12.4 percent decline in profits for the year. In 2001 and 2002, hotel managers were able to cut labor costs in light of declining revenues during those years.

“There are two components to hotel labor costs,” says Robert Mandelbaum, Director of Research Information Services for HRG. “First are the salaries and wages paid directly to hotel employees, which went up 1.8 percent in 2003. However, it is the 7.1 percent increase in employee benefits that really concerns hotel owners and operators.”

Employee benefits include items such as payroll taxes, payroll-related insurance, subsidized employee insurances and meals, and retirement plans. “Our clients are having trouble balancing the desire to offer their employees benefits like health insurance and 401 K matching with the cost of providing such benefits. In addition, some benefits are government mandated with little room for management control,” notes Mandelbaum.

Energy and Insurance Go Up Again

Two expense items that have concerned hotel owners and operators in recent years have been utility costs and insurance.

“Despite deregulation of the utility companies and increased conservation programs at the property level, hotel energy costs continue to rise,” says Woodworth. “Except for a slight reprieve in 2002, hotel energy costs increased significantly since 2000. In 2003, hotel utility expenses increased 5.9 percent, the largest percentage increase of any overhead cost incurred by a hotel.”

The cost to provide property and general liability insurance again rose significantly in 2004 (20.6 percent). “Certainly the terrorist events of 2001 caused a spike in insurance premiums, but the surge in hotel insurance costs actually began back in 2000,” notes Woodworth. “Since 2000, hotel insurance costs have more than doubled (114.7 percent). Fortunately, our clients are reporting some stability of insurance prices so far in 2004.”

Marketing and Maintenance Investments

Two expense areas experiencing increases in 2003 were the marketing and
maintenance departments. However, a case can be made that increased
expenditures in these two departments were necessary to preserve and promote U.S. hotels.

“On the surface, the 1.9 percent increase in hotel marketing expenditures does not appear to be significant,” Mandelbaum observes. “It should be noted that the 1.9 percent increase was the result of a 3.7 percent increase in salaries and wages for the department, while expenditures for property level advertising, marketing, and promotion were cut. Apparently, hotel managers believe that personal sales efforts are needed to attract business back to their properties. Therefore, they are making the investment in human capital.”

Unlike the marketing department, the majority of the 3.2 percent increase in maintenance expenditures was not personnel related. Instead, the increased expenditures in this department were mostly attributable to the purchase of replacement parts for furniture, fixtures, and equipment. “We know that several major renovation projects have been put on hold since 2001. However, during this same period, hotels have also cut back on their day-to-day maintenance. During 2003, this deferred routine maintenance became overdue and the minor repairs had to get done,” notes Mandelbaum.

Limited-Service, Limited-Expenses

While all hotel categories suffered drops in both revenue and profits in 2003, the magnitude of decline in performance did vary by property type. Of all the different hotel categories, limited-service hotels experienced the smallest declines in revenues (0.3 percent) and profits (3.7 percent). Convention hotels, on the other hand, endured the greatest fall-off in revenues (2.6 percent) and profits (16.2 percent).

“Given the profusion of operating expenses and labor requirements at full-service, resort, and convention hotels, it is not surprising that these property types experienced the greatest declines in profits in 2003. Conversely, limited-service and all-suite hotel managers experienced the least severe declines in profitability,” notes Woodworth. “This further exemplifies the fact that rising operating expenses contributed significantly to the decline in hotel profitability in 2003.”

The following chart lists the change in hotel financial performance by property type from 2002 to 2003.

Of the properties participating in HRG’s Trends survey, 57.6 percent experienced a decline in total revenues during 2003. A total of 65.5 percent suffered a decline in operating profits.

Cost Controls Essential In 2004

“Barring a catastrophic event, the majority of U.S. hotels should benefit from increased revenues in 2004. The key to driving profitability will be the discipline to maintain control over the costs for which they have some degree of influence,” says Woodworth.

Unfortunately, hotel managers have historically not demonstrated an ability to control costs during periods of recovery. Separate research conducted by HRG reveals that coming out of industry recessions, hotel managers have spent money at a pace greater than the growth of revenues, and/or at a pace greater than inflation. “These practices have limited the bottom-line benefit one would expect to receive from increases in revenue,” adds Woodworth.

The following chart lists the relative growth of hotel revenues and expenses in the three years following historical U.S. economic recessions.

To order a copy of the 2004 edition of Trends in the Hotel Industry, call (404) 842-
1150, ext 237, or visit the HRG On-Line store at www.pkfonline.com.

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. PKF Consulting has offices in New York,
Boston, Philadelphia, Washington DC, Atlanta, Houston, Dallas, Los Angeles, and
San Francisco.