PKF Study Finds Fewer Hotels Deficient on Interest Payments

Low Interest Rates, Refinancing, and Rising Profits Are Major Factors

An improved hotel operating environment, coupled with low interest rates that encouraged debt refinancing, contributed to a 22 percent reduction in the number of hotel loan deficiencies in 2004, the first such decline since 1996. Although some hotels will continue to struggle, positive results for the first six months of 2005 and an upbeat forecast for the remainder of the year point to a continued improvement in the number of hotels generating sufficient cash flow to cover their interest obligations, a welcome sign to owners and their lenders.

These observations come from a special analysis of the data collected for the recently released 2005 edition of Trends in the Hotel Industry published by PKF Hospitality Research (PKF-HR), an affiliate of PKF Consulting. The study was based on approximately 1,000 properties that reported their 2003 and 2004 interest expense.

The average hotel in the PKF-HR study sample reported a 2.2 percent decline in their interest payments from 2003 to 2004. Since the PKF Trends survey consists solely of ‘same-store' properties that provided data for both 2003 and 2004, the reduction in interest expense can most likely be attributed to re-financing. With profits increasing and interest costs on the decline, the percentage of properties that failed to generate enough operating income to meet their interest obligations declined from 17.5 percent in 2003 to 13.6 percent in 2004.

PKF-HR's Trends in the Hotel Industry report presents 200 discrete hotel revenue and expense items. The 2005 edition marks the 69th annual review of U.S. hotel operations conducted by PKF. This year's sample draws upon year-end 2004 financial statements received from more than 5,000 hotels across the country.

Interest Coverage Ratios Improve

In 2003, the typical hotel paid $5,250 per-available-room (PAR) in interest expense, while earning a profit of $8,568 PAR. This equates to an interest coverage multiple of 1.63. In 2004, the average interest expense dropped to $5,133 PAR, while profits rose to $9,548, for a healthy coverage multiple of 1.86.

If interest expenses were to remain flat in 2005, and profits grow at our forecast rate of 15.5 percent, the coverage multiple could go as high as 2.15 in 2005. This means that hotels will be generating more than double the amount of money needed to pay their lender. The number of properties unable to cover their interest payments could decline to just 8.6 percent of the hotel population. Importantly, this high coverage level should result in a continued strong market for lending activity through 2006.

Fewer Limited-Service Deficiencies

Both limited- and full-service hotels benefited from declining interest payments in 2004, albeit to varying degrees. Within the study sample, limited-service hotels enjoyed 4.9 percent decline in interest expense, compared to 1.9 percent for full-service properties. Concurrently, the limited-service hotels in the sample enjoyed greater gains in profitability. In 2004, the deficiency rate for limited-service properties was 7.2 percent. On the other hand, 16.1 percent of the full-service hotels fell short of their ability to cover their interest payment for the year.

Hotels in the deficient pool are generally older, tired, independent, full-service properties with serious income shortages. These will likely phase out of the market over the near to intermediate term.

Relaxed Lending Criteria

The decline in deficient hotels is yet another indicator of the strong health of the U.S. lodging industry. Lenders will gain further confidence in hotel investments when they hear news like this. Due to the robust recovery of the lodging sector compared to other forms of real estate, we have already seen more liberal lending criteria for hotel loans.

PKF Consulting's recently released 2005 Hospitality Investment Survey found a relaxation of both investment return requirements and lending restrictions. Loan-to-value ratios crept up to more than 70 percent for first mortgages -- territory not visited since our surveys of the 1980s. In addition, debt coverage ratios continue to move in favor of borrowers as they seek more leverage. These terms indicate that lenders feel adequately protected from a recurrence of delinquency and default risk experienced in 2002 and 2003.

Copies of the 2005 Trends in the Hotel Industry report, which provides owners, investors, property managers, asset managers and others with detailed information on all aspects of hotel revenues, operating costs and profits, are available at PKF's online store at www.pkfc.com/store, or by calling Claude Vargo toll free at (866) 842-8754.

PKF Hospitality Research (PKF-HR), headquartered in Atlanta, is the research affiliate of PKF Consulting, a consulting and real estate firm specializing in the hospitality industry. PKF Consulting has offices in New York, Philadelphia, Washington DC, Atlanta, Indianapolis, Houston, Dallas, Los Angeles, and San Francisco.