Chapter 3: Hotel Economics Tourism Economics Chapter 3: Hotel Economics

Introduction Economics of public lodging closely reflect the general and regional economy Heavily capitalized public lodging is as much a business of real estate and finance as it is of lodging operations Hotels and motels comprise the bulk of rooms available to the public Hotel economy is a cyclical business Overbuilding is a problem The Lodging industry includes hotels, motels, all suites, resorts, conference centers, inns, bed-and-breakfasts, timeshares and retirement homes with meals and other services. Related lodging enterprises are all-suites, resorts, conference centers, inns and bed-breakfast hostelries. Timeshares can be included and retirement homes that offer meals are a related business. Airlines own or are affiliated in one way or another with hotels. Airline and travel agency computerization has produced a worldwide network of travel information upon which much of the lodging business depends.

Statistics of Travel Industry In 2011, the global hotel industry revenue was $457B, and by 2016 it is forecasted to reach $550B In 2014, Europe’s occupancy rate was highest at 68.8%, while the Asia Pacific region saw a rate of 68.6%. In 2014, average room rates were $120/night in the US, while room rates in the Middle East were the most expensive at $167.95/night. Most expensive hotel rooms in the world on average are located in New York City at $360/night. http://www.ahla.com/uploadedFiles/_Common/pdf/Lodging_Industry_Trends_2015.pdf http://www.statista.com/statistics/247264/total-revenue-of-the-global-hotel-industry/

The 2015 US Lodging Customer 40% traveled for business, 60% traveled for leisure Business room night stay 63% are male, 50% ages 35-54 78% travel alone Pay $147 per room night Leisure room night stay 57% are 2 adults, 39% ages 35-54 80% travel by auto Pay $131 per room night http://www.ahla.com/uploadedFiles/_Common/pdf/Lodging_Industry_Trends_2015.pdf

US and International Tourism US receives larger share of international tourism than any other country In 2013, international travelers spent an estimated $180.7 billion, of which, $140 billion was spent at destinations in the U.S. $41 billion on passenger fares on U.S. carriers. The U.S. share of 2013 world tourism receipts was at the top (12%); more than double that of second-ranked Spain International travelers to the United States increased 5% over 2012 to a record 69.8 million. International arrivals grew by 8% to a record 32.0 million. These markets accounted for 46% of total arrivals to the U.S. Canadian arrivals also increased by 3% to a record 23.4 million. Mexican arrivals posted a slight increase of 1% to 14.3 million arrivals https://www.ahla.com/content.aspx?id=36332

Statistics of Travel Industry Some important statistics International hotel room growth rate: 2.6% in 2015 US account for one quarter of the world hotel rooms Europe accounts for 45%. US lodging business represents 1% of GNP More and more lodging chains are getting out of the ownership business. The ownership of the lodging chains as well as names of the lodging properties keeps changing.

Hotel Income Hotel Income: Hotel income derives from operations and from franchise fees and management fees in some cases. Developers get income from building and then selling the properties. Franchise fees: up to 9 % which can translate into a 20% room revenues increase for the franchised hotel. Franchising (for franchisors) is about 25% more profitable than building or operating hotels, since franchisors are largely risk-free and could remove the franchise if the franchisee failed to make fee payments or live up to the franchise agreement.

Financial Problems Financial problems: Cycles of overbuilding, when occupancies rise and investments look promising, too many hotels are built and time is needed for demand to catch up to supply. Subject to the whims of the economy; occupancy rise in prosperity, falls in recession (for, example, the recession that started in 2008 kept hotel occupancies low even though hotel rates were stable or declined). 1980s, foreign investors jumped into the US market due to cheap American dollars. Supply outpaces demand causing large debts that interest payments outgrow income even with relatively high occupancy and good management. By the end of 1993, overbuilding stopped, but thousands of rooms had been taken off the market. The average number of employees per 100 guest rooms dropped from 70 to 50. Some hotel developers in the 1980s profited big time. Mr. Hammeter’s developments netted about 188 million when he sold properties in Hawaii. Location, location, location. https://www.zacks.com/commentary/51904/hotel-industry-grows-on-economic-recovery-time-to-invest

Hotels Include any public lodging establishment ranging from the bed and breakfast family operation of a few rooms to the mega hotel of several thousand rooms Hotel can be classified according to Rate Structure, Location, and Type of guests Rate structure Budget hotel such as Motel 6 often hiring a husband and wife to run the property with an apartment provided to keep their salary low. Limited service properties such as Comfort Inn, Hampton Inns and La Quinta chains (the basic Hampton Inn costs about $31,000, not including land, a room to build, compared to $80,000 or more a room for a full-service business hotel). A free continental breakfast is usually provided in the lobby. The upscale such as Hiltons, Hyatts, Sheratons, and Marriotts, full service hotels with at least one restaurant and a concierge service. Labor costs are high, about 34 to 38 % of gross income. Resort hotels can be any properties that concentrate on attracting group business but advertise as a vacation property, can have sports attractions on site.

Hotels Mega hotels are those with 1000 or more rooms. MGM grand Hotel and Theme Park in Las Vegas contains over 5000 rooms, claimed to be the world biggest hotel when it was built. Of the 151 mega hotels in the world in 1991, 100 were located in the US, Las Vegas had 18. Asia and Pacific region had 30 of these properties, 12 in Japan, and 11 were in China. Convention hotels cater to visitor and the leisure traveler. Large luxury hotels such as the Waldorf Astoria in New York City and the Ritz of Paris cater to high-level business and affluent pleasure travelers. All-Suite hotels provide complimentary breakfast and cocktail hours, seek both business and pleasure traveler Airport hotels service the air traveler and are usually attached to large and international airports.

Casino Hotels Casino Hotels are different from the usual commercial hotel Highly profitable when well located and marketed Provide glamour, entertainment, and excellent, yet inexpensive, food and beverage that entice the visitor into the casino The odds favor the house, which means if the visitor plays long enough they will leave minus 10 to 20% short of what is bet The hotels construction and the major reason for its being is the casino Profits for casino hotels can be enormous, for example, up to 40% of Hilton Hotels’ profit is taken from its Las Vegas hotels. Casino hotel business is very competitive because the next hotel is always bigger and more outrageous than the last. Operating a casino hotel is more complicated than the usual hotel. Security is the number one issue. Entertainment costs and other expenses are computed to keep profits coming, even though top-notch entertainers are paid in millions Gambling is becoming more widespread so the number and variety of these types of establishments is going to grow Currently 39 states have Casino gaming resorts. Up from 2 in 1988. http://www.bloomberg.com/news/articles/2014-04-03/casinos-close-as-revenue-falls-in-gambling-saturated-u-dot-s

Casino Hotels Casino visitors and conventioneers behavior: Visitors spend nearly $500/person per visit Conventioneers spend nearly $1000/person per visit The high-roller’s average bit is between $150 and $250. The average slot machine player bets $3 per pull and averages 300 lever pulls on a machine The total input in each machine is therefore $900 per player. Casinos make between 5 to 8 percent profit on each machine 55% of the total dollars bet in a casino is in the slot machines, yielding an average of 80 percent of a casino’s profit. The remaining 45% of the bets placed (on blackjack, roulette, etc.) only yield 20% of the profit. The Atlantic City attracts busloads of gamblers (1000 to 1500 charter buses) who stay between 4 and 12 hours. This proved to be unfortunate for the city which has very little economic benefit in terms of infrastructure growth, from the gambling.

Casino Hotels Factors related to the volume of casino gambling: The regional and national economy, especially those regions close to the casinos (California is believed to provide half, or more, of the visitors to Las Vegas and Reno) The national sentiment for legalized gambling which, in the 1990s, has been increasingly tolerant about gambling in its many forms Airfares, and the cost and availability of gasoline (fuel shortages raise the price of gasoline and aviation fuel as was saw in the last 2000’s). Exchange rates (favorable rates for Europeans and Asians increase travel to US casinos). Casino marketing and glamour (worldwide coverage of casino openings has increased the number of foreign visitors to the 39 states that currently have casino gaming). The numbers of retired people who casino gamble is rising as are the number of “junkets”(expense-paid trips paid for by the casinos).

The Lodging Leaders Most of the large hotel companies have moved out of ownership into franchising or management contract. Franchising A Franchisee has access to the brand’s marketing, greater operational control and greater ease in obtaining lenders, due to the use of the brand A Franchisor can expand the brands presence without much investment, profit from fees and marketing revenues, save time and money on cost of franchise agreements and eliminate significant investments and liabilities http://www.hotel-online.com/News/PR2004_3rd/Sept04_FranchiseAgreements.html Management contracts The owner of a hotel employs the services of an operator to act as an agent to provide professional management for a fee The owner takes all the risk http://hotelmule.com/wiki/Management-contract

The Value of “Location” Three most important things about a hotel… in reality it depends upon the market(s) being sought by management and other factors: A resort hotel’s value depends in large part on its natural surroundings A convention hotel is enhanced by a convention center nearby An airport hotel must have rooms in or near a busy airport Location can be enhanced by management A locations value is what the market value of the hotel is at any time. Market value is what the hotel can produce in profit, appreciation, or can be sold for later

Hotel Room Rates Set to what management believes can be charged and still attract the maximum number of guests. Rack rate Rate that is published as being the standard rate for each of various kinds of rooms offered by the hotel Average Daily Rate (ADR) What the hotel actually receives in revenue, computed by dividing room revenue by number of occupied rooms Can be 20 to 50% lower than published rates The “right” room rate can be determined by what competitive hotels charge, dependent on cost and “what the market will bear”. Some believe the “price” is in the eyes of the guest, price is a symbol of quality Fixed cost for a hotel run about 70 to 75% of income, variable cost 25 to 30%.

How to determine the hotel rates: 1)The Hubbart Formula Lays out the steps needed to cover all costs and provide a 15% profit on investments. The process works backwards. Find total annual revenue needed to cover all costs and provide 15% return. Divide by the projected number of rooms that will be sold in the coming year. Works were there is little to no competition and helps to obtain a correct ADR Named after Roy Hubbart of Chicago, a major proponent of the formula.

2)The Dollar per Thousand Rule $1 should be charged for each $1000 invested per room. If a 100 room hotel costs $4 million, the cost per room would be $40,000. Room rate for a fair return would be $40 ($40,000 per room cost divided by $1000). Calculation assumes a 70% occupancy level over life of hotel and 55% house profit from room sales. House profit is defined as all profits except income from store rentals, and before the deduction of insurance, real estate taxes, depreciation, and other capital expenses. ADR increases as occupancy increases. Less expensive rooms sell first and as they are sold out, higher priced rooms are sold, raising ADR. A return of 10% of invested capital was considered a minimum goal. Other determinants of room rates include: Increases due to high seasons or major events. Package deals for vacationers or weekend specials.

Economic Analysis of Hotel Operations Hotel Economic Life Expectancy Rapid growth in first 5 to 10 years, level out for 8 to 15 years, then decline in revenue. Average economic life is about 40 years. Forecasting Sales Use past sales, reservations and group bookings as a base for forecast. Apply current economic trends (occupancy rates). Reflect special conditions that will change sales (conventions in town). Subtract from the forecast a number that represents any negative factors (opening of a competing hotel). Yield Management Used to discount or increase room rates to maximize income. Set up to automatically project room demand based on historical records. Try to attract customers at the maximum price they are willing to pay. Personnel Budgeting Predict how many staff will be needed throughout the sales forecast period No more, no less

Economic Analysis of Hotel Operations Food and Beverage Economics Take in half as much in sales as rooms do, only 10 to 20% in profit Group food service in hotels can be more profitable than service in restaurants Room service is believed to be a loss in profit even though the prices are high due to labor costs Market and Feasibility Studies Studies done by a third, unbiased party, before hotel is built Studies include competition analysis, projected costs and income, and supporting information that indicated the likelihood of profitability for a hotel in a certain location Collects information about occupancy and room rates, employment data and demographics for the locale and surrounding area

Economic Analysis of Hotel Operations Operating Ratios Indicators of efficiency and to compare operating results with hotels of similar character and location Use the ADR and the guest occupancy rate Profit margin (net income compared to total revenue is the rations in which investors have the most interest since it indicated the ability of the venture to pay back their investments Lenders and owners are interested in liquidity and solvency ratios, these indicate the financial soundness of the investments Current assets divided by total assets indicates the percent of assets that can be quickly turned into cash

Future Trends Given a free market society, hotels will continue to be cyclical in profitability. Hotel construction depends on tax laws, economy, and investing psychology, there are likely to be too many hotels in some locations and too few in others. There will be periods during which there are too many rooms for the current demand, for particular kinds of hotels, at particular locations, during certain seasons. Lead times for the construction of hotels makes it possible to be certain to the need for hotels when they stay open.