The U.S. economy will keep growing. But the pace is clearly starting to slacken as the boost from last year’s tax cuts starts to fade and the slowing global economy weighs on the U.S. Figure on GDP growth of 2.5% or so, a noticeable step down from 2018’s 2.9% rate. And the economy could flag by year-end. Don’t be surprised if growth in the fourth quarter slips below 2%. With so few workers to hire, firms will be hard-pressed to increase their output much unless they can figure out how to get more efficient with their existing workforces, a challenge lately. Look for the jobless rate to fall to a slender 3.4%. We expect the Federal Reserve to raise rates twice over the course of 2019, taking the bank prime rate to 6% by December. Long term rates are a different story, though. They may rise in the middle of the year before pulling back by the end of 2019 to near 3%, not much higher than now. Investors who are worried about an economic slowdown or recession in 2020 or 2021 will buy up Treasuries as a safe haven, which will keep yields fairly low. Rate hikes and slowing growth will keep inflation muted at 2.3% in 2019.
In an increasing interest rate and flat cap rate environment hotel investors are looking more at secondary and tertiary markets such as ours in order to achieve their desired return. We are also seeing many real estate investors from historically mainstream asset classes starting to look at hospitality as the asset that can still deliver their desired returns. Because multi-family and self-storage asset classes are being priced higher and higher with cap rates moving lower and lower, prices have skyrocketed. As a result these investors are looking to hospitality assets.
Hotel supply is expected to increase by 1.9 percent in 2019 slightly less than the 2.0% long term average that 2018 experienced. The robust economy continues to drive demand which is estimated to grow by 2 percent in 2019. This will make the 10th consecutive year of occupancy growth for the U.S. Occupancy levels are now at record highs. The only concern is the lack of ADR growth which is forecasted to be about 2.5 percent in 2019. RevPar is expected to increase by just 2.6 percent in 2019. The key moving forward is to keep operating expenses under control. The increase in operating expenses, will have to be under 3 percent in order to maintain the same return. The biggest culprit is rising labor costs. The scarcity of labor has led to rising wages which will squeeze profit margins.
The lack of easily available construction capital, or at least tighter standards for new construction activity is likely to be a self-correcting phenomenon for restricting new supply for hospitality assets. This coupled with the high increase in construction costs has caused many investors to switch from development mode to an acquisition mode which bears well for existing hotels.