DOUBLE-DIGIT PROFIT GROWTH FOR U.S. HOTELS IN 2004 AND 2005

Strong Revenue Growth Overcomes Some Expense Concerns

The typical U.S. hotel achieved an estimated 13.3 percent increase in profits in 2004, and is projected to enjoy another 14.1 percent boost to the bottom-line in 2005, according to the 2005 P&L Forecast published by PKF Hospitality Research (PKF-HR). This improved profitability follows a three-year industry recession that saw unit-level hotel profits decline 36.2 percent from 2000 to 2003. Hotel profits are defined as income before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization.

The forecast is based on a preliminary analysis of U.S. hotel financial statements collected by PKF-HR for its 2005 annual Trends in the Hotel Industry survey. The analysis considered all hotel property types throughout the nation and incorporates the recently released results of the PKF/Torto Wheaton Research (TWR) Winter 2005 Hotel Outlook forecast.

The turnaround in profitability starts with strong increases in hotel revenues. PKF-HR estimates that total hotel revenues grew 7.3 percent in 2004 and will increase another 7.0 percent in 2005. Leisure, business, and convention travelers began to hit the road again during the second half of 2003 and continued into 2004. With hotel occupancy rates approaching pre-recession levels, hotel managers have been able to get more aggressive with their pricing strategies. In 2004, the hotels in our Trends sample are estimated to have increased their room rates by a healthy 3.7 percent. Look for an additional 5.3 percent jump in 2005. Separate research conducted by PKF-HR has found that hotels are most profitable when they are able to drive their revenue by increasing room rates.

All Hotels Benefit

The recovery in hotel revenues and profits appears to be occurring across all types of hotels. All five property types tracked by PKF-HR are projected to experience double-digit increases in profits in 2005.

While all hotels should enjoy strong profit gains in 2004 and 2005, PKF-HR foresees the full-service, resort, and convention properties experiencing the greatest bottom-line growth. With more extensive facilities and services, the increased guest counts at these properties also generate additional sales in their restaurants, lounges, banquet halls, recreational outlets, and gift shops.

Some Expense Concerns

With guest counts and revenues on the rise, hotel managers find themselves in a different operating environment than the previous three years of austerity spending. PKF-HR estimates that hotel operating expenses rose 5.5 percent in 2004, and will increase another 4.6 percent in 2005. During the recession, hotel managers cut labor costs and other operating expenses in an effort to maintain as great a profit margin as possible. Now, the combination of increased business volume and deferred expenditures forces management to determine the best way to spend their newfound revenues. Some expenses are more controllable than others.

One operating expense that always concerns hotel managers is labor costs. PKF-HR believes that payroll and related costs are the dominant drivers of increased operating expenses in 2004 and 2005. Naturally, increased business activity requires more employees. However, given the improvement in the economy, not only will it be increasingly difficult for hotel managers to find qualified employees, but there will be upward pressure on wage rates and salaries as well. In addition, government statistics show that employee productivity gains are starting to wane after years of growth. This trend is particularly acute in the hotel industry where most operating functions are manually executed, not automated. Upward pressure on labors costs will have a great impact on the operating costs of such highly staffed operating departments as rooms, food and beverage, and recreational outlets.

Two other departments where PKF-HR has recorded relatively strong increases in costs are marketing and maintenance. However, increased expenditures in these two departments can be viewed as investments. During the recession, several hotels had to defer renovation and refurbishment projects. This puts added pressure on the day-to-day maintenance of furniture, fixtures, and equipment. The increase in spending for marketing can be justified to preserve or increase a hotel’s competitive position in the rising market.

Some Expenses Under Control

Most operating expenses are on the rise. However, some costs are starting to moderate in their growth.

While the threat of terrorism has certainly influenced the upward movement of hotel insurance costs, it should be noted that this expense item started its trend of annual double-digit growth in 2000. Fortunately, it appears that this trend tapered off in 2004. PKF-HR estimates that the amount U.S. hotels pay for their general liability and property insurance declined 5.8 percent in 2004 and will grow at a modest rate of 3.7 percent in 2005. Moderation in insurance costs is certainly welcome, given that this expense has more than doubled since 1999.

Utility costs have historically concerned hotel managers. While energy conservation programs have been put in place at many hotels, this cost is largely uncontrollable by management. Hotel energy expenditures have fluctuated dramatically in the past few years, ranging from a 9.0 percent increase in 2000 to 5.5 percent decline in 2002. The fear of high prices for crude oil made headlines in early 2004. However, by year-end 2004, PKF-HR estimates that hotel utility costs rose 4.0 percent, and should increase by just 3.0 percent in 2005.

Profits - The Real Bottom-Line

Everyone is forecasting that hotel revenues will rise during the next few years. That is fairly obvious. What the 2005 P&L Forecast shows is that despite increased operating costs, this revenue growth will result in strong gains in hotel profitability. Profits are the true measure of the health of the U.S. hotel industry. Ultimately, the profits earned by U.S. hotel owners will dictate renovation, investment, development, and transaction activity, not just increased revenues.

PKF-HR's 2005 P&L Forecast provides estimates of all major revenue sources and departmental expenses for hotels. The Forecast contains projections for resort, convention, and all-suite hotels, as well as full- and limited-service properties. Copies may be purchased through the firm’s website at www.pkfc.com, or by calling Claude Vargo at (404) 842-1150, ext. 237.