As we navigate through 2023, the hotel industry is facing a unique set of challenges that are reshaping the landscape for commercial real estate investors. From potential recession fears to labor shortages, these hurdles are testing the resilience and adaptability of hoteliers across the U.S. However, one of the most significant factors impacting the industry is the rise in mortgage rates. This increase is not only affecting the cost of acquiring new properties but is also having a profound impact on hotel operation costs.

The correlation between mortgage rates and operation costs might not be immediately apparent, but a closer look reveals a complex interplay of factors. Higher mortgage rates mean higher interest payments, which in turn increase the overall operating expenses of a hotel. This situation is further complicated by the fact that these rising costs come at a time when many hotels are already grappling with other financial pressures, such as labor shortages and rising utility costs.

The Impact of High Interest Rates

High interest rates are casting a long shadow over the hotel industry, particularly in the area of hotel development. Traditionally, hotel development has been fueled by construction loans. However, with interest rates on the rise, these loans are becoming more expensive. This increase in borrowing costs is making it more challenging for projects to be financially viable.

David Wani, CEO of Twenty Four Seven Hotels, has expressed his concerns about this issue. He predicts a slowdown in hotel development in 2023 due to the higher interest rates. Developers now face the daunting task of ensuring their projects are strong enough to bear almost double the interest rate compared to what they would have paid for a construction loan in 2022.

Securing financing for hotel projects has become increasingly difficult. This challenge is not only affecting new developments but is also impacting existing properties. For instance, the second quarter of 2023 saw a sharp 70% fall in total transaction volume from the same period in 2022. This decline is a clear indication of the difficulties that hoteliers are facing in securing the necessary financing for their projects.

Labor Shortages and Rising Costs

Labor shortages have emerged as a significant challenge for the hotel industry. The lack of available workforce is putting a strain on hotel operations, leading to increased costs and reduced efficiency. Richard Jones, executive vice president and chief operating officer at Hospitality Ventures Management Group, highlighted this issue, stating that the labor shortage is one of the most significant challenges anticipated to persist.

To combat this, hotels are implementing various strategies. One such strategy is being as competitive as possible in each market to minimize turnover. This involves ensuring each employee is properly positioned with wage scales and ramping up onboarding and retention tactics. Another strategy is the cross-utilization of employees, such as between front-office and food-and-beverage departments, in hotels that have the ability to flex roles.

In addition to labor shortages, rising energy and electricity costs are also impacting hotel operations. Over the course of 2022, these costs increased significantly compared to 2021 and pre-pandemic levels. To overcome some of these utility cost and labor challenges, some hotels, like Twenty Four Seven Hotels, are increasing their linen pars to reduce the amount of laundry done per day and investing in systems to manage temperature settings for an entire hotel from one place.

Market Trends and Performance

The hotel market is experiencing a variety of trends, with average daily rates (ADR) being a key focus. Despite some markets experiencing monthly ADR declines in the past two months, they maintain the highest inflation-adjusted hotel rate gains. For instance, Las Vegas, despite experiencing a peak 12-month average ADR in March, still has inflation-adjusted hotel rates 18%, or $28 higher.

Inflation is playing a significant role in hotel rates. When adjusting for inflation, only two of the seven major cities in the Western U.S. had ADR exceed inflationary growth - Orange County and Sacramento. This indicates that while nominal rates may be increasing, the real value of these rates may not be keeping pace with inflation.

A case study of the Western U.S. hotel markets reveals a mixed performance. While most locations exceeded 2019 levels, San Francisco and San Jose are the only two major cities in the western U.S. not experiencing peak ADR since 2019. These locations are missing corporate travelers due to the heavy tech presence, with many tech companies utilizing remote work. This highlights the importance of understanding local market dynamics when assessing hotel market performance.

Strategies for Reducing Operation Costs

In the face of rising operation costs, hoteliers are exploring various strategies to keep their expenses in check. One such strategy is appealing property taxes. Property taxes can constitute a significant portion of a hotel's operating expenses, and successfully appealing these can result in substantial savings. This approach requires a thorough understanding of the local tax laws and a careful evaluation of the hotel's assessed value. However, when done correctly, it can be a powerful tool for reducing operation costs.

Other cost reduction strategies include operational adjustments such as increasing linen pars and investing in systems to manage temperature settings for an entire hotel from one place. By increasing linen pars, hotels can reduce the amount of laundry done per day, thereby saving on labor and utility costs. Similarly, investing in centralized temperature management systems can lead to significant savings in energy costs. These strategies, while requiring an initial investment, can lead to substantial long-term savings.

The Future of the Hotel Market

Looking ahead, the hotel market is likely to continue facing challenges. The high interest rates that are currently slowing down hotel development are expected to persist, potentially leading to a further slowdown in the industry. This could result in a decrease in hotel transaction volume, as securing financing for hotel projects becomes increasingly difficult.

However, it's not all doom and gloom. Despite these challenges, there are still opportunities to be found. For instance, a slowdown in development could lead to less competition for existing hotels. Additionally, as the industry adapts to these challenges, new strategies and approaches for managing operation costs and improving efficiency are likely to emerge.

Conclusion

In this article, we've explored the current landscape of the hotel industry, focusing on the impact of rising mortgage rates on hotel operation costs. We've seen how high interest rates are slowing down hotel development and making it more challenging to secure financing for hotel projects. We've also delved into the labor shortages and rising costs that are putting a strain on hotel operations.

We've analyzed market trends and performance, highlighting the role of inflation in hotel rates and the mixed performance of hotel markets in the Western U.S. We've also discussed various strategies for reducing operation costs, including appealing property taxes and operational adjustments like increasing linen pars and investing in temperature management systems.

Looking ahead, the hotel market is likely to continue facing challenges, with the potential for a further slowdown in hotel development and a decrease in hotel transaction volume. However, opportunities still exist for those who are adaptable and strategic in their approach.

For commercial real estate investors, the key takeaway is the importance of staying informed about market trends and being proactive in implementing cost-saving measures. While the current challenges may seem daunting, they also present an opportunity to innovate and find new ways to improve efficiency and reduce costs. By doing so, investors can navigate these challenges and position themselves for success in the evolving hotel market.

In the face of uncertainty, knowledge and adaptability are your most valuable assets. Stay informed, stay flexible, and you'll be well-equipped to navigate the future of the hotel industry.

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