HEI 2023 Midyear Update

August 9, 2023

Ted Darnall, Partner & CEO of Lodging and Technical Services, provides a midyear update and addresses customer buying behavior, trends, and HEI’s strategy to succeed.

Recognizing that it has been a few months since my last update, I wanted to defer this communication as much as possible to ensure that we had enough historical trend data to support some of our conclusions on market behavior and the most successful deployment strategies for most markets to maximize market opportunities. As we have communicated routinely over the past three years in this post-pandemic environment, our primary responsibility and focus must be on how to successfully manage the markets we encounter.

Challenges We Face

The need to perfect our speed and the capacity to be nimble as it relates to adjusting and revising strategies in real time results in our ability to successfully manage the markets we encounter. There are three huge challenges we face in the current environment. The first, which I mentioned above, is our speed and accuracy in adjusting how we sell against the current market environment. The second, which is becoming more important by the day, is our ability to stay proactive against market trends, ensuring that everything we do is designed to improve our performance as it relates to the baseline the market is providing. Our third challenge is how we continue to utilize our platform to rapidly and successfully adjust our cost per unit sold and to reduce our fixed expenses in a way that ensures we are maximizing the flow through potential associated with these market changes.

Market Projections and Forecasting

One of the largest and most important learnings in recent history is the realization that we as an industry have not developed into proficient predictors of market behavior. We are competent in our skills as they relate to our traditional practices of predicting trending occupancies and segmentation distributions in a dependable market. This results in a strong understanding and ability to adjust market occupancy performance projections when comparing stabilized markets to the trends of a mature and stable market. As we continue to work with a less-than-stable world – and in many cases are still experiencing significant volatility in the market environment – we must develop a new competency in market projections. This is needed in today’s environment as we must be as skilled in using the forecasting process not only to just report the news but also to proactively study how the market behavior changed our past competency of last year’s simple trend to a process that protectively extracts strategies designed to outperform the market in a proactive manner rather than just reacting to what the market gives us.

We may have become an industry that is too dependent on the market projections of these so-called industry experts as opposed to making our own forecast based upon more sophisticated market trends. Doing our own forecasting allows us to go well beyond occupancy to occupancy trending with the skill to focus on both the production of 2019 by segment and rate performance and add our skills of extracting behavior change to be aggressive in building those behavior trends into our future strategy. Compared to an environment where much of our industry is likely to still forecast more consistently with the industry norms of the past, we must now become less dependent on the expectations for the fall made by the “experts” and have a strategy in place designed to outperform the trends based upon actual performance as it relates to segment trends and group slippage. Said simply, we need to accept the current marketplace, take a more proactive approach to improving results against these likely market trends and straighten the curve by not just reacting after the fact.

For us this requires an evolution in our forecast process. We must shift the way we use this unique market data to not only improve our forecasting but also to use the greatly enhanced set of tools we have developed in the post-pandemic world to improve upon the most-recent market projections. We started to fade away from looking at strategy as a proactive process and focused on how we could react to achieve the best results in a basically reactive approach instead of in a proactive manner with the forecast we were developing. It is no longer a case of: How can we improve our ability to use high-impact strategies to elevate our performance above market norms? Now it is about changing from the habits of most of the industry, improving our analytic understanding of the forecasting process and using the outcome of the improved knowledge that comes from this process to begin to identify how we should manage other elements of our operation as it relates to the forecasts we are provided with. It is now about how we act on what we know will improve our performance against the essence of market behavior.

We can no longer solely depend on a very reactive approach to planning and problem-solving based on market forecasting. Today we must combine our traditional forecasting with better predictions of evolving market behaviors extracted from our improved market analytics. Said differently: Today, in this world of volatility and challenging forecasting environments, we can no longer depend upon reacting to our projections alone, but we must combine managing the marketplace we encounter with overlapping strategies that will improve our overall performance over that of the accepted consistent baseline. It is no longer enough to successfully flow your projected revenues; it now requires that you continue to excel in managing the market you encounter through awareness within each property of where further opportunities may exist.

This is especially important in environments where we have seen demand flatten and true baseline projections based upon sound, traditional forecasting methodologies deliver likely results that vary significantly from the 2023 budget. As you are aware, in our budget development back in August 2022, which resulted in the 2023 budget process, we looked to the professional market experts to assist us in developing the framework of the expected 2023 recovery. We all expected to see enhanced performance in the first quarter when compared to the previous year based upon the negative impact that the Omicron variant had on production in 2022. But in addition to that, most industry experts were challenged with the need to project the continued demand recovery that most of us were expecting in 2023. Unfortunately, that challenge required as much guesswork as science in identifying how and when the recovery would occur. This baseline demand change – in most cases – became more of an assumption of recovery based upon little data. With this lack of facts, their models started to reflect what was as much opinion as it was trends that were based upon a general industry agreement that we should start to experience a more rapid recovery over 2022 once we got beyond the Omicron increase of the first quarter.

Which brings me to the important nature of my correspondence today: The reality is that we have seen little closing of the gap in the past 12 months between current occupancy of our baseline trends and 2019’s occupancy performance. In fact, with the loss of leisure production from that of 2022, this 12-month trend has worsened over the past 90 days. Said simply, we have not made the progress the industry experts expected to occur in relation to closing the occupancy gap to 2019 levels as we have not experienced the steady increase in demand required to accomplish this. When one straight-lines today’s trends and adds a momentum-based forecasting overlay, they will likely see that each month moving forward in 2023 is experiencing a significant shortfall as it relates to the anticipated market recovery reflected in our 2023 budgets – although this varies slightly by market and has had moments of volatility.

Preparing for This Market Environment

Now we have studied these trends in great detail, ensuring that we are in fact analyzing the data properly. In short, the facts are that we are not experiencing the corporate transient recovery projected by these industry experts, who we looked to for guidance in the budgeting process. Although we continue to experience a slight increase in corporate business transient, this is almost always offset by a change in retail. On top of that, as more and more operators are trying to chase share to close the revenue gap from trend to budget, we are seeing further erosion in our premium transient rate through discount rates being available late into the booking cycle. This has been further complicated by a slowdown in group recovery and continued high short-term group slippage that has contributed to this amazingly stable, and now predictable, forecasting trend. Therefore, we are required not to follow the reactive practices of the past by reacting to market conditions by implementing a discount practice to gain share in the marketplace at wrong times in the booking cycle. Once thoroughly understood, this begins to result in the discounting of existing customers. By converting our strategy process to proactive efforts that increase performance of the baseline and by adjusting our strategies and objectives, we can best prepare for this market environment.

Unique Strategies for Specific Markets

To accomplish this, we have developed a number of individualized strategies to apply against distinctive market conditions in order to improve our performance against this baseline trend. Unfortunately, to fully understand how to best attack the market conditions we encounter requires our ability to comprehend, study and build upon this trend so that we can straighten the curve, improving our overall performance as it relates to this baseline trend represented in our market conditions today. Now, to accomplish this will require individual and specific diagnostics of each market. I think it is important to share with you our thinking as it relates to improving our overall performance against the baseline trend, allowing us to outperform the market. What we have learned is that although consolidated data helps us better understand market behavior – each market is local, requiring a cocktail of strategies that is designed to yield the best overall results for that specific market.

The Elasticity of our Customers and Impact on Performance

The key strategies that seem to be having the most material effect are our success in understanding, identifying and segregating the inelasticity of premium transient customers as compared to the elasticity of value in transient customers. Through a series of price tests performed not only on an entire segment but also more specifically on companies within our business transient accounts, we are developing improved knowledge and assigning a value against those accounts and/or segments that we see behave more in an inelastic manner.

On the flip side, we are identifying opportunities where it may be possible to affect our overall occupancy performance through the potential identification of what we have referred to in the past as “traditional value customers” where they demonstrate more elastic behavior. From here we can pull the tools out of the toolbox that were designed to measure base building through elastic value segments who book earlier in the booking cycle. Early indications are that we are starting to see a recovery in the value inelastic customer who traditionally books prior to 30 days before arrival. In addition, our diagnostic process has indicated that premium transient booking later in the booking cycle continues to be much more rate inelastic than the value customer who books earlier than 30 days before arrival. The most important strategies we deploy today are around maximizing the occupancy opportunity of our elastic value customers and those that assist us in building a base that could strengthen our occupancy performance prior to the introduction of aggressive pricing strategies later in the booking cycle with a much more inelastic customer.

From a pure transient perspective, this strategy will be deployed and effectively managed in most markets and represents an occupancy premium over the comp set prior to 28 days to arrival – but often operating at what could be as low as a 96% or lower rate index for this early base, with the value business base booking 28 days prior to arrival. However, we have seen extreme promise in yielding a peak demand booking cycle rate index when we flip the switch and go to premium pricing from day 28 up to the day of arrival at the point where we have approximately 40% of our projected demand on the books. This captures the balance somewhere between 101% and 104% rate index when well-executed through the use of premium room type, business transient pricing strategies and the elimination of advanced purchase product – all while restricting OTAs to retail pay at hotel levels. If managed well, this can result in a premium occupancy index and a consolidated average rate index premium.

As we continue to struggle with occupancy opportunities, especially during nongroup, midweek periods where market demand consistently falls short of room availability, this value-elastic customer advanced booking strategy is most likely to yield us our best midweek transient results. There are, however, additional learnings that require more rapid deployment in specifically maximizing rate opportunity around peak occupancy dates that is starting to develop during midweek periods in some markets. Even with market demand continuing to fall short of surpassing supply, we are starting to see a V-shaped pattern developing. Said differently, there seems to be one demand day, most likely a Tuesday or Wednesday, that represents the top of this V. This V peak has proven to be an excellent opportunity to yield additional rate. As the demand has continued to make this V-peak date more predictable, we have discovered an opportunity to drive rate more aggressively, resulting in a rate-index improvement driving the buying rate on both sides of the peak date – even when we still fall short of our available occupancy without a consistent group base. However, this is a key learning where we can harvest additional rate improvement with or without the group. It is our hope that this V pattern will continue to develop into more of a traditional bell curve as recovery continues. It is this type of market behavior learning that keeps our strategies proactive.

Our Top Priority: Group

Based upon these challenges and combined with the almost always available meeting space – group continues to be a top priority. As I mentioned in my last note, we were going to begin the process of testing rate with the original group inquiry response – especially with our P5 leads. A P5 lead represents leads that have been identified as a direct booking probability. That said, in a growing number of markets, we are finding success with this rate strategy. In an equal number of markets, it is also clear that rate, even in the early quote, can still potentially affect market penetration. It has been our intent to be no later than the second quote in response to potential inquiries. The buying practice of using the first three quotes to test the price point of the market seems to limit your future dialogue, with only those first three quotes received being used by many meeting planners. For this reason, and due to the occupancy gap to 2019, we continue to plan around and stress the focus on overall occupancy. We have once again become more aggressive in how we quote. Ensuring that our initial proposal is competitive with the first three quotes is still an important part of our strategy; however, we are testing being more rate aggressive with our P5 leads. Maintaining the practice of quoting quickly and staying competitive in pricing all but our P5 leads almost immediately led to improved closure rates, resulting in the highest conversion rates we have ever experienced in the history of measuring this key statistic within our organization. We do, however, see the opportunity to improve rate index with our P5 leads.

We understand and know the value of group on all planes. It is not only about occupancy but it’s also about meeting room, rental and event fees and all the other incomes that are traditionally associated with group room production. There is no question that group is becoming more competitive by the day as hotels start to realize the extent and the likely nature of the gap between market demand and their budget expectations. It is this market education that concerns us the most. As more and more property teams are experiencing strong influence from ownership to make up for the revenue shortfalls between their most recent forecast performance and budget expectations, we are seeing evidence that this concern is resulting in a loss of the premium rate performance that we have been able to achieve over the last year. In fact, we have experienced a noticeable 8% erosion in market rate performance between March, April and May as inexperienced management attempts to drive share through pricing, resulting in a direct, adverse relationship to rate.

Differentiating our Customers To Maximize Market Opportunities

Although we continue to believe that customer pricing is the key to maximizing revenue during these unique times, we have learned that there are clearly multiple customers to make up our demand in all segments. We have more inelastic customers who we refer to as “preference” buyers, and unfortunately, we are seeing a conversion back to value and/or elastic customers in the marketplace to whom price is a larger portion of the buying decision. Due to the fact that our preference customer, who desires a specific hotel, must be priced differently from the value customer, the success in maximizing transient revenue is in our ability to separate and identify these different customer profiles and manage them based upon the behavior that best matches our overall ability to maximize market opportunities. The strategies must be customized to each individual market since no market shares identical behavior. It is this modification of proven strategies and the follow-up execution that should allow us to harvest a better result for the markets we encounter. Our teams have put together hotel-specific strategies designed to ensure that we straighten the curve as it relates to the baseline market opportunity. As I mentioned earlier, it is our intent as of the end of August to forecast based upon current trends in order to lessen our influence associated with budget assumptions. In the next couple of weeks, we will be reevaluating trends and likely developing a more trend-based forecast for the rest of the year.

Conservative Forecasting

Now one may question why a more conservative approach to forecasting and/or a closer alignment to market baseline is important as opposed to continuing to carry influence originally outlined by the industry expert forecasters. There are two main reasons we have chosen to revert to traditional industry forecasting practices. The first is that this baseline gives us much better clarity as to what our revenue strategies should look like, how we should measure them and what impact they will have. The second is an equally important advantage of this approach: It is the history we’ve developed this year in our ability to manage effectively within the expense allocation outcome of our new forecasting process. If there is work to be done in our expense management arena, it is our responsibility to adjust cost in the month, for the month. Through this more conservative forecast – or one could say, more aligned with the baseline forecast – it limits our expense allocation to the hotels protecting us from any additional volatility at the property level or against a particular market.

Original Strategies

At this point it is important to comment on our results and learnings. To do this, I think it is important to describe what our original strategies were compared to what we know today. Obviously, after the first quarter our original guidance from CoStar represented not only an occupancy growth but also a slight rate increase. As you may remember, we came off a huge group share growth of over 500 points in 2022 over 2019 that we assumed was not likely sustainable, as a portion of this result came from our early adoption of a focus on short-term group lead opportunity that led to huge successes. But as the year progressed, we saw more competitors adopting this strategy, leading us to believe that we would likely end up giving some of this share back. As we built our RSP (room segmentation projection), assuming a slight decrease in group share and once again looking back at both 2019 and 2022 performance, we realized that in order to achieve the type of pattern identified by these industry experts, it required a noticeable increase in business transient share results as a percentage of total occupancy, which was still falling short of 2019. Meanwhile, retail maintained a slight rate and share premium with early-cycle OTA continuing to lag behind 2019. From this we developed a strategy and a forecast that could get us to the CoStar projections:

First, our retail share premium needed to hold.
Second, our business transient share needed to come back – but come back in a specific way that would be in line with the overall premium transient surge we had been experiencing through 2022.
This growth in business transient would represent a return to 2019 corporate demand, and this corporate demand growth would also carry over to group, allowing us to absorb the share shrinkage we expected in group.

Mid-Year Evaluation

Now that we are over halfway through this year, here’s what we have experienced:

First, and likely most important, the premium transient surge we were counting on for both occupancy growth and premium transient rate growth did not expand, it actually contracted.
Our continued focus on expanding our expertise in active lead management and transitioning to a transaction-based sales organization led to an even greater group share performance over 2019, now over a 600 basis-point increase in share.
Our focus on premium transient rate in the last 28 days of the booking cycle created over 100 points of improvement in rate index but has caused contraction during the summer months where we have experienced a notable change in the short transient pick-up surge that we had been experiencing through most of the post-pandemic period.
The assumption that we would hold our retail share again started to fade in April as we experienced a shift back to business transient, lessening the actual growth of the business transient segment when combined with retail, which had a negative effect on overall ADR.

So what does this translate to?

We have to close the gap between business transient pricing and retail pricing.
We need to build a stronger base of value customers 30 days prior to arrival.
We cannot chase occupancy with rate late in the booking cycle. We need our base growth to be sufficient enough to absorb any contraction that may come from exceeding a 100% rate index in the last 28 days of the booking cycle.
We must separate price inelastic customers from elastic customers.
We need to increase the rate of our P5 group customers.

We still believe this is possible through focusing our understanding of company buying behavior and refining our expertise with regard to pricing each segment at different points in the booking cycle.

“Rate Is Good, Cash Is King”

The last issue associated with this correspondence is the commitment we have made to improving and increasing our focus on profit per available room. There is little doubt in our review of today’s results, least of all into the near future as guardians of real estate value, that we must ensure that we demonstrate expert focus on profit per available room. We cannot afford to repeat the errors of the past, where industries that allowed obsession with market share resulted in a direct effect on profit, but instead we must maintain a traditional focus on the profitability of revenue opportunities. Early in my career, when working for a true entrepreneurial developer, I learned one important lesson: The only thing of interest to my boss was how much our net operating income (NOI) went up over the previous year. In fact, he often asked me questions on why the budget for projected cash flow was not the same as the actual cash flow. His almost exclusive focus, and correspondingly my heavily influenced focus, was on NOI improvement. In fact, it was not long before we were using phrases like, “Rate is good, cash is king.” The quick definition of this phrase was to remind us all that rate was merely a contributor, but NOI was the goal. With what we have faced and continue to face in this post-pandemic era, we need to understand the profit contribution of every unit sold, from a glass of beer to a guest room. We need to understand the true acquisition cost as a key component of that unit profitability and continue to focus and re-examine the purpose and true cost allocation of our fixed expenses. It is by managing fixed expenses and reducing variable expenses, such as acquisition cost and contract labor management, that we can improve our profit per available room, limit the impact of the current inflationary environment and not give up on our core mission of increasing real estate value. This is not a time to get confused between revenue share and profitability. When looking in the rearview mirror at industries that obsessed over share and how this led them to bankruptcies in the late part of the first decade of our current century, we see great evidence that the pursuit of market share without an understanding of unit profitability caused the collapse of critical American industries. In both the airline and automobile businesses, where share alone became the goal, a lack of awareness of unit profitability led to massive industry failures.

Today we look at both industries. We see an acknowledgment and understanding that is more focused on profit per car sold and/or profit per airline seat than ever before in the history of either industry, showing us that we are in an industry where losing the understanding of acquisition cost and fixed-cost basis allocation to each unit sold can result in a gain in market share but a decrease in value, which in fact can be even more important in an industry that may not experience cap rate expansion for the first time in almost 20 years. Since the turn of the century, we have created more value through cap-rate contraction than we have through improving cash flow. With the unknown future of cap rates in our industry, it is a must that we get back into the practice of focusing on profit per unit sold and/or profit per available room.

I am proud to say that as the outcome of our efforts to improve efficiency, deliver services on the enterprise level, our ongoing commitment to flattening the organization and the reallocation of responsibilities have accomplished a higher profit per available room on a consolidated YTD basis as compared to 2019 when adjusting for inflation. When you adjust those results for average rate increases, we still show an overall increase in profit per available room even when you factor in the inflationary environment we have encountered. This indicates that these efforts to improve profit per unit sold have reaped positive benefits. With the recent slowdown of inflation and our continued improvement of execution in many areas – such as developing expertise in better supervision by content experts and taking a more active role in the day-to-day supervision of our property execution team – we still believe there’s more work to be done in this new platform. It can and will further enhance our profit per unit results, ensuring that when we hold occupancy index, profit per available room becomes a more valuable indicator of our accomplishments, our results and our commitment to real estate value.

As I close our update on expenses, I want to update you on how we are using our new platform and supervision structure to ensure we meet our commitment to profit per available room. We have expanded our use of our platform to create a reserve of savings to absorb unexpected expenses to improve our compliance with HEI efficiency measurement tools. In addition, we are in the process of recalibrating our drivers and fixed expense allocation with the singular focus of improving our results without the traditional industry need for RIF or contingency plans, which cause huge distribution and morale issues on the property level and create another stall in performance. We are confident our new platform can create better results with less risk of harm. Once again, we want to thank both our operating team under the leadership of Rachel Moniz and our finance group under the leadership of Marcus Harris for their almost immediate recognition of the need and corresponding immediate leadership engagement with their teams on processes to respond to the market we are encountering that frankly few of us expected. This reinforces once again that an organization is only as good as its leadership, and that the HEI principals are simply the best leaders in the industry.

There is still work to be done – we are not in denial. We have a game plan in all disciplines and groups for guiding principles, ADR efficiency and profit per available room.

Thank You

Once again, as we face a new and even more challenging environment, and until we reach a time that we can all expect consistent improvement in our recovery, I remain proud to be associated with the corporate and property teams who simply never give up. Never in my career have I had the privilege of working with individuals who not only accept the challenges we face but are day after day questing to get it right. This is the mission we must embrace. We have learned that explanations are not results; results are driven through knowledge and our awareness of what is occurring. This unbelievable culture, which is truly rare in today’s environment, not only maximizes the full potential of our ownership community but also stays committed to the quality of our properties and associate tools. This is the culture we need to do our best job. In closing, I would like to thank both the outstanding members of the HEI team and our even more outstanding ownership community that provides us with the leadership and support we need to excel and continue to differentiate our culture as unique and impossible to replicate in today’s environment.

Ted Darnall, Partner & CEO of Lodging and Technical Services