It’s been a fun run for hotel investors, but the sector may finally have reached the end of a phenomenal recovery period. At just over 72% in 17Q2, the National Index occupancy rate (four-quarter average) remained head and shoulders above the 66% historical average, and many metros boasted record-high occupancies. However, as seen in Exhibit 1, the occupancy rate was slightly lower than in the previous quarter, marking the sector’s first occupancy loss since 2009. Nationally, occupancies improved by only about 40 basis points since 16Q2, and more than a third of metros saw occupancies contract from year-ago levels. Most notably this included energy-exposed markets Pittsburgh and Houston, which got the double whammy of slowdowns in their economies combined with hefty doses of supply. Room bookings are still on the rise pretty much across the board, but the pace of demand growth has shrunk over the past year, contributing to the lack of occupancy improvement.
Peak supply is here and will likely cause occupancies to lose more ground in 2017. About 49,000 rooms came on line in the National Index markets last year, and CoStar is tracking another 100,000 rooms with delivery dates in 2017–18. Despite healthier fundamentals, the pace of construction remains relatively slow compared to previous recoveries. As shown in Exhibit 2, the pace of deliveries is only now reaching the long-term average and, based on the underway pipeline, will likely top out this year. Los Angeles, New York, and Dallas-Fort Worth are among the metros that will have the largest 2017 supply increases relative to 2016.
The pace of room-rate growth has come back down to earth as construction increased and occupancies lost momentum. As of 17Q2 year-to-year room-rate growth has slowed to 3.3%, which is just above the long-term 3% average and about half of the cycle’s peak rate. With occupancies tilting in the wrong direction and room-rate growth losing steam, year-to-year RevPAR gains slid to 3.1%, which is about 50 basis points below the long-term trend. The results for both room-rate and RevPAR gains are the lowest the nation has seen since the recession. Slowing performance has been mirrored in transaction volume, which registered $34 billion over the past four quarters, 14% below the value of what sold in the previous four-quarter period.
Despite getting later in the cycle, the hotel sector is still on solid footing fundamentally and as such may present opportunities for investment. The biggest caveat is an economic downtown. During the Great Recession, which featured heavier construction than what is taking place now along with one of the worst economic contractions in history, national occupancies fell by about nine percentage points. Although the next downturn will likely be less daunting, if occupancies were to fall by that much today, they would land in the 63% range. This is below the historical average but much healthier than was seen during either of the past two recessions. In this scenario places like Boston, the Bay Area, Denver, and Portland could actually maintain occupancies that are above their historical norms through a recession.