Lodging’s Rapid Improvement Offers Promise for 2011

By Maria Maslovsky, Moody's Investors Service: Year-to-date fundamentals have strengthened significantly year-to-date, and Moody's expects the improvement to continue in the medium term, although we acknowledge the potential risks of another broad economic slowdown.

Year-to-date fundamentals have strengthened significantly year-to-date, and Moody’s expects the improvement to continue in the medium term, although we acknowledge the potential risks of another broad economic slowdown.

Following the recovery in the underlying economic drivers of the hospitality sector, we anticipate lodging REITs to benefit from rising earnings and to translate them into solidifying their balance sheets and credit metrics, which would in turn drive ratings improvement. Moody’s has a positive outlook for the real estate fundamentals in the hotel sector; however, the rating outlook for hotel REITs continues to be negative owing to the material leverage and earnings deterioration that the lodging REITs experienced during the cyclical trough. No other property sector saw deterioration that was so precipitous.

During the most recent recession, RevPAR (revenue per available room, a key industry statistic) declined from its all-time high of $65.50 in 2007 by 1.9 percent in 2008 and by a dramatic 16.8 percent in 2009, according to Smith Travel Research. This extraordinary deterioration, reflected the inherent volatility of the lodging segment where both contract term and rate are re-set every night a room is sold.

The same daily re-pricing mechanism is currently responsible for the sector’s equally prompt and powerful recovery. In the first half of 2010, RevPAR grew by 2.3 percent, according to Smith Travel. The preliminary STR data for July indicates continuing year-over-year growth of 8-10 percent for that month as compared to 8 percent in June.

Accordingly, the forecasts for the lodging industry are upbeat. They range from the 1.8 percent RevPAR growth in 2010 projected by PricewaterhouseCoopers to the 4.3 percent anticipated by Smith Travel and 5 percent expected by PKF Hospitality Research. For 2011, the forecasts continue to be optimistic with Smith Travel predicting 5.3 percent year-over-year growth, PricewaterhouseCoopers anticipating 6.3 percent and PKF expecting 6.9 percent.

Moody’s believes that the rapid improvement in hospitality fundamentals will aid lodging REITs in strengthening earnings and restoring the credit metrics weakened by the recession. Specifically, in the case of Host Hotels and Resorts, Moody’s has recognized that improving industry conditions have already contributed and will continue to bolster this REIT’s cash flows. Accordingly, we revised Host’s rating outlook to stable from negative in June 2010.

Still, Moody’s remains cognizant of the remaining uncertainties with respect to the economic recovery and the potential for a “double-dip” recession, which could crimp the resurgence of lodging fundamentals currently under way.