While the coronavirus significantly impacted the international travel and tourism industries in January and February, it wasn’t until the first week of March that it began to have a huge impact on the U.S. lodging industry. A new analysis released by the U.S. Travel Association projects that decreased travel due to coronavirus will inflict an $809 billion total hit on the U.S. economy and eliminate 4.6 million travel-related American jobs this year.

According to an Oxford Economics study, a 30 percent decline in hotel guest occupancy could result in the loss of nearly 4 million jobs, with $180 billion of wages and a $300 billion hit to the GDP – crippling the hotel industry, the local communities they serve and the U.S. economy.  

As the weeks progress we are likely to see continued weakness and further erosion in occupancies, ADR and RevPAR and as a consequence net operating income. As a consequence many hotel owners are likely to engage in stress testing their hotels, if they haven’t already done so.

In anticipation of a slowing economy and the possibility of a recession in 2020, we assisted several clients in late 2019 undertake stress tests on their hotel assets. In our post we briefly outline an approach we have taken to assist our clients.

Given the likely depth and duration of the downturn, it is critical that hotel investors immediately stress test the hotels in their portfolio to ensure they can proactively consider the impact of varying economic scenarios and assess strategic alternatives.

The most common method of stress testing is the effect on net operating income (NOI) generated by the hotel. Declines in occupancy, ADR and RevPAR adversely affect NOI. NOI is typically the starting point to assess the ability of the hotel to repay its indebtedness.

No two downturns are the same but there are normally many similarities. Similarly, no two markets or hotels are going to react to a downturn in the same way. However, the historical performance of a market or hotel category may provide some clues on how they may react in future downturns as illustrated in the following graphs.

The following graph clearly illustrates that the economic downturn in 2008 had a larger impact on RevPAR than the downturn after 9/11. The impact on chain scales varied significantly as well. The Luxury market witnessed the largest declines after both downturns, while the Upper Midscale experienced the least declines.

Peak RevPAR Declines for Hotel Chain Scales in 2002 & 2009

Source: STR & Hotel Investment Strategies, LLC

The following graph illustrates that Resort and Airport hotels suffered the greatest drop in RevPAR after the Great Recession, while Interstate and Small Metro/Town hotels witnessed the smallest declines.

Peak RevPAR Declines for Hotel Location Types in 2002 and 2009

Source: STR & Hotel Investment Strategies, LLC

Not only can there be significant differences in the declines in RevPAR for a particular market over different demand shocks, e.g., San Francisco (-32.5% in 2002 and -18.9% in 2009), there is also significant differences between markets, e.g., Philadelphia -7% in 2002 and San Francisco -32.5% in 2002.

2002 & 2009 Peak RevPAR Declines – TTM for Top 25 Hotel Markets

Source: STR & Hotel Investment Strategies, LLC

Stress testing your hotels at this critical time can help prioritize your actions and assess strategic alternatives for the most vulnerable assets in your portfolio. As a result hotel owners and management companies are accelerating efforts to fortify cash positions in a bid to survive the current downturn and to strategically position their businesses for mid-term and long-term growth.

Based on our analysis of the relationship between a market’s RevPAR performance and its historical RevPAR beta, we are able to forecast the likely diminution in RevPAR performance for any market in the country based on our forecast of total U.S. RevPAR. Our forecasts provide, not only point estimates, but also confidence intervals around our forecasts, essential inputs in any vigorous stress test.  

If you downgrade RevPAR by three grades e.g., mild shock, moderate shock or severe shock and determine the consequences, how can you know if the scenario you built is reasonable? The main limitation of stress testing is that it’s hard to know exactly what the appropriate dimension or the appropriate extent of the stress test should be.

Rather than use a series of common downside variables across the entire portfolio, e,g., RevPAR down 10%, 15% and 20%, we calculate the historical RevPAR beta for a market before the demand shock and calibrate it with the historical RevPAR downturn as illustrated in the table below. Based on the RevPAR beta between the last downturn (2009) and December 2019 for each market, we can determine the likely range of RevPAR declines for each market, based on our univariate forecasts of RevPAR declines for the total U.S.

Previous Downturns Provide Roadmap for Future Downturns – Use Hotel Beta for Future Stress Tests

Source: Hotel Investment Strategies, LLC based on STR data.

Stress testing should be an ongoing process of thinking through what risk a hotel investment has. If you would like to discuss how we can assist you with your stress tests, please feel free to contact us on 973-723-0423 or drop us an email. I look forward to hearing from you.