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.

According to the Mortgage Bankers Association, (1) an incredible one in ten mortgages in the USA are now one month or more behind in their mortgage, or in foreclosure. This was up 7.3% from a year earlier.

Florida continues to share the brunt of the foreclosure crisis (look up by zip code here(1A)). The statistics specific to the metro Orlando vacation home market are difficult to assess, but they do appear to be on the front line of the foreclosure crisis.

USA unemployment has surged losing 533,000 jobs in November (2) alone.  This was the most in 34 years. The unemployment rate also increased to 6.7% according to the labor department. Many economists are predicting a 8+/-% unemployment rate nationwide (3) by mid 2009.

Unemployment is also hitting Florida hard, especially in markets such as Orlando where the hospitality industry has been laying off thousands of employees (4).  In addition, metro Orlando has begun to see systemic drops in the number of tourists visiting the area in November 2008 (5) .

There are rumors major Orlando hospitality employers may be making larg cut backs in January 2009 which may only add to the overall local economic problem.

Yesterday Wyndham Worldwide announced it is laying off 4000 people nationally. Previously, Westgate Resorts also announced it is making major lay offs. Both companies are major employers in the Orlando hospitality market and vital to the local economy. In addition, hotels around Orlando have been quietly laying off hundreds of employees every week and some major restaurant companies have even closed. Other hotel and timeshare companies based in the Orlando area have yet to publicly announce similar cut backs, but rest assured, they are underway.

Hospitality corporations in the Orlando area are cutting back on previously sacred items such as Christmas parties and even birthday cakes for long term loyal employees. Some theme parks according to Reuters may also be looking at significant scaled job cuts . Hotel revenues recorded a free fall in November 2008 in the metro Orlando area and everyone employed in hospitality is now feeling the pinch.

Convention groups are cancelling at record rates, and the ones that are coming are booking very slowly. Companies who were about to book groups in the Orlando area are hesitant to do so, as they are looking for ways to trim budgets.

Orlando’s largest international market, the UK, has seen the British Pound drop like a stone and the cost for a British tourist to visit Orlando shoot up 30%+/- in the last 3 months alone. The UK booking window for the peak summer months is typically done in January. Orlando can expect to see a significant decline in the number of British for the summer of 2009 as the UK economy falls apart. The British will most likely go to destinations much closer to home such as Spain and within Great Britain itself.

All these concerns indicate that the vacation home industry will also get hammered over the next year or two. This is of particular concern to us.

There is no sugar coating this scenario. The world economic crisis impact on the Orlando hospitality economy is having a very bad effect, and about to get worse, much worse. We anticipate the worst economic downturn in Orlando possibly since the great depression, but then no one can predict the future, including us. We are incompetent non professionals just expressing an opinion.

Data for Orlando vacation home occupancy and rate is difficult to collect, as the industry is very fragmented. However, as market indicators, we are inclined to consider hotel data trends to help as a mirror to the vacation home industry.

Recently SMITH TRAVEL RESEARCH, a provider of hotel industry data, reported that revenue per available room tumbled 13.2 percent nationally during the week Nov. 9-15, 2008 compared to a year earlier. Revenue per available room, or RevPar as it is termed, is a key gauge of a hotel’s revenue performance.

At the local level, metro Orlando has begun to see the largest drops in both rate and occupancy across the board for the hotel industry since 2001. For the week ending November 15^th, 2008 hotel Rev PAR dropped by a whopping 27.3 % according to the ORLANDO CVB records .

So what are the ramifications for the Orlando vacation home market? Hotel data now tells us that a short term combination of rate and occupancy are in a state of significant decline. Not a surprise given the current economic environment, but the level and rate of the decline is much more devastating than what is being reported on some media outlets. It remains to be seen if these short term indicators become longer term trends for the Orlando market and can provide some basis for an Orlando tourism forecast.

Possible ramifications in the vacation home industry could include:

1. Rev PAH (Revenue per available home), is going to most likely drop significantly, as occupancies decline and some owners and home managers alike, quickly drop their rental rates.

2. This could impact vacation home prices due to the fact that vacation homes would have a lessened ability to generate income, which would logically be reflected in the underlying home sales prices.

3. Like any business, those homeowners that are best positioned to “hunker down” will be the ones that survive. Such factors could include: limited levels of debt, high rental occupancies, good locations and marketing strategies, excellent maintenance, and the overall experience of a good vacation home management company.

The good news for families, and even some event type groups seeking economic alternatives to hotel rooms, is that they may now logically consider the benefit of vacation homes. This helps the vacation home option become more mainstream. Please see our other posts detailing the economic viability of renting Orlando vacation homes and the value they provide to consumers. In addition, the best run vacation home management companies will most likely survive and the services they provide will become more essential.

In conclusion, there is no sugar coating the data. The drop in both rate and occupancy appears to have come so quickly and deeply that major media, and even many in the tourism industry, do not yet recognize. Expect possible systemic failures in Orlando’s tourism industry if these trends continue. Unfortunately, no one can preidict the future including us.

As always, our blog tries to inform you objectively, so subscribe. Check the ORLANDO CVB data here.