Asset-light brand owner/operators are better positioned relative to hotel owners over the one-to-two year Rating Outlook horizon given broadly diversified portfolios and lower fixed costs.

Fitch recently increased its 2023 U.S. GDP growth forecast to 2.0% from 1.2% in June, following stronger-than-expected GDP data for 1H23 and a continued expansion in consumption in July. We still expect a mild recession, though now anticipate this to occur in 1H24. We expect growth to slow sharply in 4Q23 before turning negative in 1Q24 and 2Q24 as monetary tightening increasingly weighs on demand. However, the peak-to-trough fall in GDP should be mild by historical standards at 1.1%, compared with an average of 2.1% in previous post-war recessions (excluding 2020).

As the U.S. consumer weakens into 2024, we see downside risk to hotel sector fundamentals from a normalization in leisure rates, coupled with slower U.S. economic growth. Many companies indicated leisure rates are 25%-35% above 2019 levels, or more, when reporting 2Q23 earnings. However, they have softened as post-pandemic “revenge travel” dissipates, more U.S. travelers are vacationing overseas and the recovery in alternative forms of hospitality accelerates, such as cruising. Positively, we expect hotel room supply growth to remain below the long-term historical average of roughly 2% for the next two years, and possibly longer, given challenging borrowing conditions and depressed hotel values in key, large urban markets.

Lodging C-corps are best positioned to outperform in the current environment, given broadly diversified portfolios and lower operating and financial leverage relative to hotel owners. The flexible cost structure and recurring fee-based income supports attractive margins for brand owner/operators, including Wyndham Hotels & Resorts (BB+/Stable) and Hyatt (BBB-/Stable). Moreover, their extensive development pipelines require minimal capex since they are typically funded by franchisees/owners, although owner financing is an important consideration in assessing future net room growth given the current volatility in the financing environment.

Conversely, the high operating leverage of hotel owners, including REITs, leaves them more susceptible to pressure from lower ADRs due to leisure rate pressure and a shift toward lower-rated group business travel and away from leisure demand. In some cases, such as Host Hotels (BBB-/Positive), these factors are exacerbated by outsized portfolio exposures to key urban markets, such as San Francisco and Seattle, that are struggling to attract travelers due to safety concerns and lower inbound visitation from select Asian countries. Ryman Hospitality Properties’ (BB-/Stable) focus on the recovering large group segment differentiates it from peers and helps balance the company’s more concentrated by assets, geography and chainscale (i.e. hotel quality).

Moreover, we expect hotel margins to come under pressure due to rising insurance, labor and energy costs amid lower ADRs. Insurance rates have shown high double-digit annual increases for properties with outsized exposure to climate events. Labor expenses are rising due to increased hotel staffing as occupancies recover to normalized levels, as well as wage inflation. Lower property taxes due to hotel value declines are unlikely to provide much near-term relief given what is typically a complex, time consuming process for challenging valuation assessments.

Contacts:

John Kempf
Senior Director, U.S. Corporates
+1 646 582-4710
john.kempf@fitchratings.com
Fitch Ratings, Inc.
33 Whitehall St.
New York, NY 10004