posted by orlandovacationhome on Jan 8
Once again we diverge from our usual Orlando vacation home analysis and visit our parallel industry – The Hotel Business. Our contributing hotelier analyses what lower rates in the face of a major economic downturn mean to short term rental profitability. The similarities to the vacation home rental industry can also be drawn.
Concept
This article explains the relationship about and between a hotel’s ADR – Average Daily Rate (1) and GOP – Gross Operating Profit (2). We contend that for a 1% drop in ADR, a typical hotel could see a 3.6%+/- drop in GOP (Gross Operating Profit) based on a typical $70 ADR and 40% GOP margin. This concept is commonly referred to in part as “flow through”. For the purpose of this theory we will contend hotel occupancy (3) is able to remain constant.
We will conclude that if a hotel’s ADR drops 28%, GOP could rapidly approach zero and severely hinder many hotels ability to pay ANY debt service – the consequences of which would be dire in 2009.
We use only theoretical generalizations, but of the five local hoteliers we interviewed, none disagreed with the concept.
Lets do the Math
Thus, using a possibly flawed theory, a 28% drop in hotel ADR could result in a 100% drop in GOP. In effect, this would leave hotels with zero dollars to pay items such as mortgage, taxes and insurance.
The Fed recently dropping interest rates is initially helping those hotels with mortgages tied to the Prime Rate (4), but only to a limited extent. When GOP shrinks to a certain level, there always comes a point when there is not enough to pay the bills.
Even a 14% drop in ADR could cut some hotels GOP by 50%. For many hotels this would be challenging, especially when the Fed has little room to move the Fed Rate any lower.
How some hotels can survive a sustained (i.e. a year long) drop in ADR of 25%-30% in 2009 is hard to fathom because effectively many hotels would be unable to pay their bills. Banks may have to modify loan terms if they don’t want to become hotel owners. With a zero GOP and a zero mortgage, a hotel could still lose money when having to pay taxes and insurance.
Demand in Orlando is Highly Elastic
In highly competitive and fragmented markets such as Orlando, hotels will begin to quickly compete on rate. This typically will quickly deteriorate GOP. i.e. a $1 drop in ADR comes straight off (100%) a hotel’s bottom line in GOP.
Maintaining a higher rate with lower occupancy tends to be wiser as it allows a reduction in variable costs, thus not effecting GOP as quickly.
Hotels Are a Commodity in Orlando
The problem with Orlando is the hotel room is a commodity and the demand is highly elastic, thus if hotel owners do not respond aggressively in rate they run the risk of a vastly more disproportionate drop in occupancy and a significantly worse GOP.
Luxury Hotels Run Higher GOPs
This can be true, thus the theory would be modified, but one must remember these hotels can have much larger debt service levels and their ADRs (5) appear to be declining the most when compared to their mid-market and economy hotel counter parts.
Conclusion
A 25% to 30% drop in a hotels ADR even while able to maintain a static occupancy could have devastating consequences to the profitability of a hotel. If this is what the Central Florida hotel and short term rental community faces in 2009, the consequences will most likely be dire for the industry and economy as whole.
Disclaimer:
The authors of this blog are incompetent. Always consult with a qualified financial professional before making a decision of any kind. DO NOT rely on this blog. Please read our disclaimer(6). This article was written in part due to the mass of email we recieved on a previously related article(7). To help conceptualize the implications to the market place, we had the author write this as a follow up.
