When you think about property, you should really be looking at its worth as the present value of future cash flow streams. This is true for residential, commercial, rental or travel property. One reason is that property is fungible, meaning what is a owner-occupied primary residence ca just as easily be a rental accommodation. It might even be a Bed & Breakfast. What is a hotel today can always become a condo, like New York City’s Plaza Hotel. An apartment building can become a condo conversion as well. It is this fungibility that creates an arbitrage opportunity when one property market gets out of whack with the others as the residential property market did.
Now that residential property is coming back to earth, it is increasingly apparent that other markets like commercial real estate (CRE) were also bid up to unsustainable levels. Hotels are another area of excess where there is going to be a lot of pain. Witness this recent post from Calculated Risk:
“OK, so now it’s official. The first quarter of 2009 experienced the worst year-over-year revenue per available room drop in the U.S. lodging industry’s organized history.”
Jeff Higley: Catching up on hotel topicsNote: RevPAR is Revenue per available room – a key measure in the hotel industry.
From HotelNewsNow.com: STR reports U.S. data for week ending 2 May
In year-over-year measurements, the industry’s occupancy fell 11.6 percent to end the week at 55.7 percent. Average daily rate dropped 8.6 percent to finish the week at US$99.42. Revenue per available room for the week decreased 19.1 percent to finish at US$55.33.
Along those lines, I caught a story in today’s New York Times which suggests hotel owners are cutting back on renovations in order to meet their cash flow needs. The Times article has this to say:
A $6 million renovation of the hotel was supposed to be completed earlier this year. But Personality Hotels, which owns the Vertigo, formerly known as the York, and six other hotels in San Francisco, decided to save money by leaving part of the building untouched.
Yvonne Lembi-Detert, the president of Personality Hotels, said that she had already bought everything needed, from tiles to TVs, to complete the transformation of the hotel’s 97 rooms. But the one thing she doesn’t have right now is enough money.
All over the country, hotels are halting or postponing renovations in numbers not seen since 2001, when the terrorist attacks led to a retrenchment in the travel industry, according to Chad Crandell, the president of Capital Hotel Management. This time, the cause is a decline in revenue — both occupancy and room rates are down in most cities — coupled with the difficulty of obtaining credit.
For hotel owners, “the name of the game is capital preservation,” said David Loeb, an analyst with Robert W. Baird & Company in Milwaukee.
Most large hotel companies, Mr. Loeb said, “have ratcheted down their capital plans, to focus only on life safety kinds of concerns.” Companies want to have cash reserves, “in case things get worse for the industry,” he said.
“If they started something, they’re going to finish it,” he added. “But we’re seeing very little optional spending.”
If this doesn’t sound familiar, it should. There have been lots of stories about homeowners cutting back on repairs and maintenance in order to make their mortgage payments. This was one of the problems with stretching to buy ‘as big a house as you can,’ the conventional wisdom in the bubble years. Owning comes with lots of hidden expenses.
The long and short of this is two-fold. First, we should expect the cost cutting to continue unabated in terms of non-residential property investment – and this includes the travel & leisure sector as well as commercial real estate. Obviously, this will be a drag on GDP. Investment levels at least thirty percent below today’s investments are not an unreasonable expectation as I argued in a recent post (see the section on fixed investment). Second, a lack of maintenance has negative social implications. Whole neighbourhoods will fall into disrepair in the American exurbs and in the inner city, increasing crime and violence there. When all is said and done, many Americans are going to find renting a more palatable option than they have in this past decade. In my view, that’s a good thing. As people start renting, over time the great property arbitrage of this past decade will cease to exist. Rental and purchase prices will come into line, making real estate an interesting market again. Until then, expect continued writedowns in residential property and many more writedowns now from travel & leisure-oriented firms as well as CRE-oriented REITs.
For more on the social aspects of renting versus buying, see an April article from the Economist called “Shelter, or burden?”