According to the Bureau of Economic Research, the US has experienced 11 economic recessions since 1937, while the duration of these recessions have ranged from 6 to 16 months. 

Using the Trends database, we measured the change in unit-level hotel financial performance for the years that correspond to the peak-to-trough contraction phase of the designated recessionary period.

The expected result of this analysis is that the decline in all hotel performance indicators mirrors the decline in the economy.  What surprises did we learn?

Revenues and Profits

As expected, the most likely impacts on lodging attributable to an economic recession are declines in both revenues and profits .  During 9 of the 11 economic downturns, occupancy levels drop because of declines in the demand for lodging accommodations.  Despite deteriorating market conditions, hoteliers aggressively sought to maintain room rates.  In 8 of 11 recessions, ADRs actually increased during the contraction period.

Unfortunately, during 7 of 11 earlier economic downturns, ADR gains fell short of offsetting declines in occupancy, thus leading to diminished levels of total revenue.  In each instance when revenue declined so did profits.

Expense Control

Prior to the 1990-1991 recession, hotel managers were rarely able to reduce operating expenses in response to declining levels of occupancy and revenue.  However, management generally kept expense growth under control.  Except for the downturns that were driven by inflation (1973-1975 and 1980-1982), expense growth during recessions prior to 1990 averaged less than one percent.

On the other hand, expense control was the saving grace for hotels during the recessions of the early 1990s and 2000s.  Facing declines in both occupancy and ADR, hotel managers actually cut costs in 1991, 2001, and 2002.  Analyzing the Trends reports for these respective years, it is not surprising to find that operators looked at their payrolls to find the biggest source for cost cuts.

 Impact of Inflation

Contrary to popular belief, U.S. hotel revenues and profits do not always contract during economic recessions.  During the 1973-1975 and 1980-1982 recessions, high inflation was a primary contributor to the nation's economic woes.  U.S. hotel managers responded by raising prices (ADR) in excess of 18 percent over the respective two-year periods. 

The increases in ADR helped to offset the declines in occupancy, thus resulting in revenue gains of approximately 11 percent.  While inflation helped grow revenues, operating expenses also accelerated.  Tempering the benefits of the 11 percent growth in revenues were 13 to 15 percent increases in the cost of operations.  Fortunately, hotels were still able to achieve minor gains in profits between one and three percent during the two previous recessions when high inflation also was present in the economy.

What To Expect

PKF-HR has developed an econometric forecasting model that relies on historical lodging data from Smith Travel Research (STR) and economic forecasts from Moody's Economy.com (Moody's) to project the future performance of the U.S. lodging industry.  As of January 2009, economic forecasts from Moody's indicate a recession that is estimated to have begun in November 2007 and the distress should last through 2009. 

During this time period, the forecast calls for persistent reductions in employment and real personal income, the two most relevant drivers of lodging demand.  Projections for growth in the consumer price index are modest, so the current downturn will not be an inflation driven recession like we saw in the 1970s and 1980s.

As of January 27, 2009, PKF-HR is forecasting lodging demand to decline a cumulative 4.2 percent from 2007 through 2009.  Reduced levels of demand, combined with a 5.6 percent increase in the supply of hotels rooms, will result in a 9.1 percent decline in occupancy during the two year period.  By year-end 2009, occupancy is forecast to be 57.2 percent, the lowest level since STR began tracking national lodging performance in 1988.  Obviously this is something we have not seen before.

Which historical operating practices will U.S. hoteliers carry forward into the current recession?

Since the depths of the 2001 recession, we have observed yield management practices that have resulted in greater than expected gains in ADR.  This implies that hotel managers will once again raise room rates during the current recession.  However, given the depth of the anticipated declines in occupancy, PKF-HR believes it will be a challenge for hotel managers to continue this practice.  While ADRs increased 2.4 percent in 2008, the January 27, 2009 forecast of PKF-HR calls for a 4.6 percent decline in 2009.  This continues a pattern of rate discounting that began in the early weeks of the fourth quarter of 2008.

While room rates are forecast to decline, we are comfortable that hotel management will continue the recent historic trend of reducing expenses in the face of declining revenues.  The incident of fewer occupied rooms and guests will automatically result in a reduction of the variable component of operating costs.  In addition, some of the excess services and amenities that have expanded during the prosperous 2004 through 2007 period will be eliminated.

PKF-HR is forecasting expense reductions of 6.1 percent during the two-year period of 2008 and 2009.  Unfortunately this is not enough to cover the anticipated 10.3 percent decline in total revenue during the same period.  The net result is a forecast 20.5 percent drop in unit-level profits for the typical U.S. hotel during the current recession.

The 2008-2009 recession could cause some of the most challenging years for U.S. hoteliers.  Fortunately, the fiscal health of lodging industry has been strong going into the current downturn.  Despite the grim forecast, unit-level profit margins are expected to remain in the mid to high 20s.

Industry veterans know lodging is a cyclical business and eventually there will be a recovery.  However, that does not lessen the pain that will be felt during the year.

R. Mark Woodworth is President of PKF Hospitality Research.  Robert Mandelbaum is the Director of Research Information Services for PKF-HR.  Both are located in the firm's Atlanta office.  To purchase a copy of "The Financial History of the U.S. Hotel Industry" with data from 1930 through 2007, please visit www.pkfc.com/1930.  Portions of this article were published in the January 2009 edition of Lodging.

¹  Before deductions for capital reserve, rent, interest, income taxes, depreciation, and amortization.