The Big Apple's hotel building bonanza of recent years swamped the market with an overabundance of supply. But even now with permanent closures expected and fewer rooms available, hotel operators won't be able to price up in a way to turn big profits.
Even before a global pandemic upended the travel industry, New York City hoteliers were grappling with declining revenue amid a massive amount of supply hitting the market. Coronavirus then tanked travel demand and led many hotels to suspend operations. Analysts expect as much as 20 percent of the city’s hotel supply — roughly 25,000 hotel rooms — to permanently close.
But the New York City hoteliers that manage to make it to the other side of the recovery shouldn’t take a victory lap.
“It’s a hard prediction to make but even if you took 20 percent of the rooms out, I still think it’s a long slog to getting to a profitable level,” Pebblebrook Hotel Trust CEO Jon Bortz said.
Pebblebrook sold most of its New York City portfolio in the years leading up to coronavirus due to poor market fundamentals, Bortz added. The lodging real estate investment trust now only owns one hotel in the city, the Roger New York. The portfolio strategy came down to limited pricing power and the high cost of running a hotel in New York.
Property taxes on Pebblebrook’s New York portfolio doubled between 2010 and 2016, Bortz said.
“We sold the rest of what we owned because we were disturbed about the supply we thought would be never-ending and the dramatic increase in real estate taxes the city has imposed,” he added. “New York is particularly challenged and has been sort of under attack from all directions.”
Occupancy rates in New York City hovered around 85 percent between 2012 and 2019, according to STR. The city also saw a record level of nearly 70 million tourists in 2019. But Bortz said it was difficult to make money and raise rates off the high occupancy due to all the supply flooding the market.
While hotels under construction are generally expected to be completed, the city is still looking at permanent closures.
Revenue per available room is expected to decline 70 percent at New York City hotels in 2020, according to CBRE. That is the steepest drop of the 60 U.S. markets the real estate firm tracks and well above the expected 52 percent national average RevPAR decline for the year.
The early travel recovery is generally favoring leisure markets over urban hubs like New York. Beach destinations like Panama City, Florida — which posted a nearly 89 percent occupancy rate the week of June 20, according to STR — are outperforming dense markets. New York hotels ran at a nearly 44 percent occupancy the same week.
Until business travel and conventions return, many of New York’s larger hotels with hundreds, if not thousands, of rooms will struggle to make enough revenue to sustain operations. Group business travel drives nearly a third of room revenue across luxury and upper upscale U.S. hotels.
“Tourists will return, but those big boxes (large urban hotels) rely on corporate group and corporate transient business,” said Jan Freitag, senior vice president of lodging insights at STR. “Corporate group is the big question here: How comfortable are people going to feel being around other people to attend meetings?”
Lenders have been flexible and offered some debt service relief to owners, typically with three to six-month forbearance terms. But many New York hotels have already been closed for three months, meaning bills will once again come due at a time when travel demand is still depleted.
Hoteliers also have to grapple with added expenses needed to operate a hotel in the current environment.
New cleaning regimens are estimated to cost the entire hotel industry $9 billion annually, or about $30,000 for a 150-room hotel. Labor costs are expected to rise due to more time needed around cleaning public spaces and turning around rooms between guests. New York’s heavy labor union environment could also factor into closings.
“Hotels have to fall out of business, adapt to survive, or hopefully have the pocketbooks to pay the mortgages,” said Patrick Scholes, managing director of lodging and leisure equity research at SunTrust Robinson Humphrey. “The union rules make it challenging. Union hotels typically have lower profit margins to start with, so those are going to be under more pressure.”
Waiting in the Wings
A sharp drop in supply should typically benefit the New York City hotel owners that manage to make it to the other side of the recovery. Less supply means pricing power goes back to the owners rather than the flood of leisure travelers.
But there are still plenty of hotel rooms in the development pipeline.
Roughly 21,000 hotel rooms were in various stages of development at the end of 2019, according to NYC & Co.
The New York market lost between 5,000 and 10,000 rooms following each of the last recessions in 2001 and 2008, said Mark VanStekelenburg, a managing director of CBRE Hotels Advisory.
“When we look at this time, it’s a different situation than any of the other cycles because of the abruptness of either the restrictions or drop in demand or a combination of the two,” he added.
Coronavirus has been drastically worse for the hotel industry than the prior downturns, and CBRE estimates the market will take until 2024 to return to 2019 performance levels. Despite the grim outlook, CBRE expects New York City’s closure rate will be closer to 10 to 15 percent rather than the 20 percent other analysts have reported.
“New York is a unique place. It’ll come back, but it doesn’t mean the owners will be the same or that the buildings will have the same use,” Bortz said. “I’m not surmising the demise of New York, I just think it’ll be hard to make money in the hotel business for a while.”
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Photo credit: New York City is struggling with the coronavirus-related downturn in travel, but experts say its problems started with a supply glut in recent years. Anthony Quintano / Wikimedia