Hotel Sector is on ‘Glidepath to Oversupply,’ But Chicago Could See a Soft Landing

by Kristin Harlow

I am heartened to see that my projections for 2016 in the Midwest hotel marketplace — particularly Chicago, my home market — held up fairly well.

In a column that I authored for Heartland Real Estate Business this time last year, I pointed out “the question of whether supply will outpace demand is changing from if to when in many of these markets.”

Robert Habeeb, First Hospitality Group

Robert Habeeb, First Hospitality Group

That trend line has continued, although the momentum of it in some markets has, to some extent, delayed the inevitable. The demand side of the equation exceeded expectations in the fourth quarter of 2016 and so far in the first quarter of 2017. This has helped markets absorb the additional supply.

I also wrote in last year’s column that “perhaps the single most important factor to watch with regard to the Chicago hotel market in 2016 is whether and to what extent strong leisure demand will continue to offset the influx of new hotel properties.”

Sure enough, we saw strong leisure demand during the traditionally busy part of the year, and Chicago welcomed a record number of visitors during the first three quarters of 2016. Strong leisure and group segment performance during this period helped overall demand increase by 2.2 percent, and leisure demand set records in each of those first three quarters.

Peak of cycle passes

Now with 2016 in the rearview mirror, the big question is what happens next? What will 2017 look like?

In Chicago, even strong demand won’t be enough to keep up with new supply. Official projections from CBRE’s December 2016 Hotel Horizons forecast report suggest near record levels of occupancy and average daily room rates that are expected to “level off.”

To my mind, that’s a bit of an understatement as I expect rates to drop. But I will say that I have been pleased to see that, for the most part, hoteliers have thus far avoided shooting themselves in the foot. That’s what has surprised me most about 2016 — my fears about rate drops not being realized.

It wreaks havoc on the industry when owners and operators respond to a softening market by overreacting and cutting rates to the point where the deceleration of rates outpaces weakening demand. The fact that it didn’t happen last year stands in stark contrast to 2008, for example, when precipitous rate cuts exacerbated already significant structural issues.

Obviously 2016 was not 2008, but it is still promising that there has been more rate integrity than I expected in light of the softening demand.

RevPAR declines ahead

I still see the industry on a glide path to oversupply. And when supply growth outstrips demand, we see revenue per available room (RevPAR) moving in a negative direction. I expect to see a RevPAR decline of around 5 to 6 percent in 2017 into 2018 before supply growth levels off and we once again begin to move back toward equilibrium between supply and demand.

Based on current forecast, we expect a modest year-over-year decline in RevPar in 2017, perhaps 3 to 4 percent as the new product coming on line is absorbed.

Here in Chicago, 2017 will likely continue to see more growth in submarkets outside of the central business district, specifically the south and west sides of the city. As gentrification continues apace with new retail and residential development, hoteliers are discovering quality opportunities. Meanwhile, hotel starts are on the rise.

Red flags remain

Unresolved fiscal issues are still raising concerns at the city, county and state level. The combination of significant unfunded pension liabilities, rising taxes, inflation and interest rates is a potent cocktail.

Another issue is the negative publicity associated with Chicago’s gun violence and crime problems. While certainly tragic — and clearly something the city needs to address — the everyday reality for tourists is no different than in any other major American city. Perception matters, however, so this bears watching.

Political game changer

A significant wild card in all of this is the impact of a Donald Trump presidency on the marketplace. Markets have generally responded favorably so far to the prospect of President Trump. I’ve called the election a “game changer,” and I maintain that statement.

A big shift in economic policy in Washington, D.C. could really heat up the cycle again and either shorten the upcoming slowdown or help the industry defy conventional wisdom a little longer. We are in uncharted waters, and it will be fascinating to watch and see what — if any — long-term impact the surprising 2016 election outcome has on the industry and on the nation’s economy.

—By Robert Habeeb, President, CEO, First Hospitality Group. 

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