LUXURY HOTELS REMAIN a popular choice for developers, but they also are likely to feel the impact of the forecasted economic downturn before other segments, according to an article from CBRE Hotels Research. The segment’s higher development and operational costs can also come with higher profits and prestige, but they are not for everyone, the article said.
Branded luxury hotels accounted for 0.7 percent of U.S. hotels, and 2.3 percent of rooms, as of August, according to STR numbers given in the article, “Luxury Hotels: Elevated Occupancy and Expenses” by CBRE’s Senior Managing Director R. Mark Woodworth and Director of Research Information Services Robert Mandelbaum. They make up 1.2 percent of the current STR pipeline, either under construction or planned.
There are several attractions to the segment despite the higher cost of construction and complexity of operations, Mandelbaum and Woodworth wrote. Luxury hotels tend to achieve premium occupancy and ADR, resulting in higher profit levels. Also, municipalities are more likely to provide development subsidies to attract high-end hotels, and there is the prestige of owning one.
For the article, Mandelbaum and Woodworth pulled performance data on a sample of 261 chain-affiliated and independent luxury properties from CBRE’s September 2019 Hotel Horizons report and Trends in the Hotel Industry database. The data showed that branded luxury hotels saw an average occupancy premium of 750 basis points between 1989 and 2018.
“When analyzing the pace of luxury hotel development, it becomes evident that these occupancy premiums have stimulated the interest of developers and helped justify the higher construction costs,” the authors said.
At the same time, the timing of surges in the luxury segment often hits in the latter half of a coinciding market expansion because of the longer time needed to build a luxury hotel.
“Therefore, the first few years of operation have frequently happened in depressed market conditions, and declining levels of occupancy and ADR,” Mandelbaum and Woodworth said. “This unfortunate timing trend has made is difficult for luxury hotel owners and investors to earn a return during the initial years of operation.”
That bad timing may apply to luxury developments under construction now as CBRE predicts national GDP will shrink to less than 1 percent by early 2020, bringing demand for lodging to 1.3 percent growth at the same time.
“The economic slowdown is forecast to impact properties in the luxury chain-scale earlier. CBRE is forecasting the pace of demand for luxury hotels to end 2019 at 0.4 percent, a much greater fall off in performance relative to the overall U.S. lodging industry,” the article said. “Fortunately for luxury hotel owners, new competition is projected to increase at less than half the long-run average annual change in supply for this segment over the next three years. Given the modest growth in new supply, luxury occupancy levels should remain above 73 percent, and ADR growth will follow the national average, through 2022.”
By comparison, earlier this month, Mandelbaum forecast that registered historic hotels might have an advantage in an economic downturn. The historic hotels were forecast to see a 1.2 percent RevPAR increase for this year compared to a national projection of 0.9 percent for all U.S. hotels and 0.8 percent for contemporary upper-upscale and luxury hotels.
Also, luxury hotels earn higher non-rooms revenue as well, an average of 32 percent from F&B and 6.7 percent from other operated departments for hotels in CBRE’s sample. But, operated department expenses also are higher, averaging 44 percent of total revenue while the overall average of hotels in CBRE’s Trends database is 36.9 percent.
“Developers and investors are attracted by the occupancy and ADR premiums, as well as the prestige, of owning a luxury hotel,” the article said. “However, these benefits come with the challenges of higher construction costs, operating expenses, and a history of poor market timing. Clearly it takes a certain owner who can appreciate and tolerate the unique development and management demands of a luxury hotel.”