(IND) Wells Fargo Securities Economics Group recently reported that Hotel Demand Will Remain Solid, but Cooling Is to be Expected

Hotel demand has surged in recent years, but the pace is slowing. Business and leisure travel is expected to remain robust, but moderating corporate profits and slowing overseas travel may cool the trend.

Hotel Demand Cooling, but Should Remain Solid Despite sluggish U.S. economic growth, hotel demand has outperformed most major property types over the past three and a half years. According to PPR, hotel demand is up more than 20 percent since bottoming in 2010 and the average occupancy rate is now at its highest level in more than seven years at 67.5 percent in the Q3. Hotel demand, as measured by occupied space, typically follows the trend in real GDP (top chart), but, in this recovery, solid improvements in corporate profits have been more telling.

Corporate profits surged early in the economic recovery and reached a cycle peak in late 2009. As a percentage of real GDP, corporate profits jumped to more than 13 percent this year, which is the highest gain since the BEA has kept records dating back to 1947. The surge in corporate profits is due to companies pulling back on the pace of capital expenditures and hiring in recent years. The upward trend in corporate profits has helped boost business travel, but, as exhibited in previous recoveries, the pace is moderating. With the pace of corporate profits slowing, lodging demand growth is also expected to moderate.

Leisure demand has also improved, but much of the gain is due to upscale travelers who are riding the wave of increases in the stock and housing market. International travel has also helped fuel leisure travel. Based on data from the Office of Travel and Tourism Industries, visitation from Canada and overseas travel from Brazil and China (contribution to overseas growth is more than one percentage point for Brazil and China) have also helped boost hotel leisure demand (middle chart). In fact, 90 percent of travel from Brazil this year has been pleasure travel. However, recent weakness in economic activity in the country could reverse this trend.

On the supply front, deliveries have been fairly low in recent years. Completions as a percent of stock have been below the long-run average of 2.0 percent for almost four years and are now 1.4 percent in Q3. While the national picture does not show an imminent oversupply issue, markets that have seen robust demand, including Austin and New York, may feel some pressure. Solid demand in these markets has stoked an increase in supply, with completions above 2 percent. Other markets with above-trend completions as a percent of stock include Salt Lake City, Columbus, Ohio, Philadelphia and Raleigh.

Hotel Outlook: Still Positive, but Slower Pace

With hotel demand moderating at the same time supply is ramping up, some markets, especially in large gateway markets (see Structured Products 2014 CMBS Outlook), could see smaller revenue growth. We also expect some downward pressure on average daily rates and slower gains in occupancy. However, the property type is still positioned for growth.

Source: PPR, Office of Travel and Tourism Industries and Wells Fargo Securities, LLC