Lodging Woes Linger in Troubled Times

Few businesses felt the sting from the collapse of Lower Manhattan's Twin Towers more than lodging. Not only was the impact immediate -- the Marriott World Trade Center hotel was destroyed and the Millenium Hilton was severely damaged -- but it has continued to linger.

Last year's tragedies have resulted in lower occupancy, cheaper rates and depressed profits for the hotel sector. Now, even as we rebuild from the attacks, the challenges of a chronic reduction in business travel and an anemic economy continue to haunt hoteliers.

But Sept. 11 may have only been the catalyst for overly bullish investors to see the real erosion in hotel fundamentals. And, if the pundits are right, the swoon may not subside anytime soon.

No Demand

Travel -- especially corporate travel -- has suffered in the aftermath of Sept. 11, and that severely crimped the bedrock of hotels' lucrative income stream: the rack-rate-paying business traveler. Although the impact was expected in New York, the lack of demand for luxury hotel rooms has crept across the country to major business centers like Washington, Chicago, Atlanta, Denver and all the way to West Coast markets like Seattle, San Francisco and Los Angeles.

Leisure travel hasn't been spared, either. Roadside hotels have seen business pick up as vacationers travel the highways instead of the skies, but high-end resorts have felt the double squeeze of travel worries and economic uncertainty.

"The decline in lodging demand began well before Sept. 11," says Carl Tash, principal at Cliffwood Partners, a Los Angeles real-estate investment firm, and a member of the TSC Real Estate Roundtable. "The decline has as much to do with corporate profitability, the economy and how to easily save money. And that may not be close to over."

Mixed Signals

Even as lodging demand plunged, the sector outperformed the broader market from the October lows through July, on near-continuous hopes that the fear would dissipate and business travel would resume.

However, RevPAR data -- industry vernacular for revenue from each hotel room -- have bounced around without a trend for months. Although these numbers have risen significantly since immediately after the attacks, they still show no real sign of consistent recovery.

"The recent volatility of weekly RevPAR evidenced in this week's results suggests that the trend toward an industry-wide recovery in hotel demand may be interrupted by weekly setbacks," notes CreditSuisse First Boston lodging analyst Brian Egger, referring to the weekly Smith Travel Research lodging statistics.

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The real problem plaguing the hospitality industry is the economy. "In a weak economy, travel budgets are easy targets," says Tash. "Layoffs also mean less corporate travel, which also pressures demand. That especially hurts those companies that cater to the business traveler."

That's why Tash is wary of upscale hotel operators like Starwood (HOT Quote), Hilton (HLT Quote) and Marriott (MAR Quote).

Focusing on Cheap Keys

Instead, Tash is beginning to take positions in a group of companies that he thinks will provide value in the early stages of an economic recovery. He's buying simplicity. "We are sticking with real estate where we can get a cheap price per key," he explains, referring to a company's relative value based on per-room metrics.

That's leading him to smaller operators and hotel REITs that have stabilized more quickly than the larger operators. He's established small positions in companies like Boykin Lodging (BOY Quote), Innkeepers USA Trust (KPA Quote) and Felcor Lodging Trust (FCH Quote). "They may be boring, but in this market, I want to own boring," he adds.

While he's been nibbling at these stocks, he does think there's some risk at current prices. "They could get somewhat cheaper," he said.

Electronic Shocks

Online discounters pose another challenge to the industry. Services like priceline, Expedia, Orbitz and a host of single-market discounters are pressuring hotels to release unused rooms for deep-discount programs.

"The Internet is destroying pricing power," says Tash. "However, the only reason that is happening is we have no demand. The Internet is a symptom of the demand problem."

Speaking of demand, one area where Tash thinks there is significant risk for prolonged weakness is the high-end leisure markets, including destination resorts that excel in a thriving economy but are challenged as consumer confidence and spending power weakens. "Consumers are becoming house-rich but cash-poor," he says, suggesting that disposable income will continue to shrink.