Hitting Them Hard: How much of a blow will tariffs deliver to the hotel industry?

The hotel industry is doing its best to dodge the administration’s tariffs by finding alternative solutions. While not everybody’s taking blows, some players are clinching the administration’s trade approach to avoid additional shots and move on to the next round.

“The economy was robust last year due to the $1.5 trillion tax cut and the massive increase in government spending,” said Bernard Baumohl, chief global economist at The Economic Outlook Group, a Princeton, NJ-based economic forecasting firm. “But much of this stimulus is really a sugar high; there’s very little protein in it. The benefits of the tax cuts will fade over the next two years, and the government simply can’t ramp up additional spending since the U.S. is already locked into $1 trillion budget deficits as far as the eye can see.”

Warning signs
Despite a healthy economy in 2018, over the next few years, economic growth is expected to slow. “We’re assigning a 45% chance of recession in the next two years,” Baumohl said. The economy’s growth is projected to drop from 3.1% in 2018 to 2.4% this year and 1.5% in 2020, according to recently published data by The Economic Outlook Group. There are a few reasons for the expected slowdown.

“The combination of an aging business cycle, looming uncertainty over the trade war between the two largest economies, rising U.S. interest rates, and a geopolitical pot that is already at full boil are the main factors that will hinder growth,” Baumohl said.

If the president hadn’t imposed the series of tariffs on China and other countries during the course of his presidency, the economic outlook for this year would’ve improved slightly: increasing from 2.4% to 2.7%.

Of course, not immune to the administration’s tariffs is the lodging industry. “The hotel industry is also feeling the effects,” he said. “The trade war and the nationalistic, if not xenophobic, tone of this administration will slow foreign travel into the U.S. Moreover, the cost of furnishing rooms with TVs, refrigerators, microwaves and mattresses becomes more expensive due to higher tariffs.”

In addition to the hotel industry, there are other industries within the United States seeing effects from the tariffs.

“Many critical U.S. industries are already hurting because of the tariffs Trump imposed,” Baumohl said. “The sectors include semiconductor, agriculture, construction, chemical and automotive. It’s important to keep in mind that it’s not just the tariffs that are hurting the U.S. economy by raising the price of imports. It’s also U.S. exporters that are victims as other countries retaliate against Trump’s trade policy. Since $1 out of every $3 in U.S. GDP is linked to international trade, the impact of this trade war will be felt by virtually every American.”

A chain reaction is set off when tariffs impact an industry. Everything within the industry’s businesses undergo shifts, including employees, vendors, suppliers and customers. “All of this may cause a general slowdown in business and leisure travel,” said John S. Fareed, chairman, North America, Horwath HTL. “Companies may no longer be able to afford to send their employees on sales trips or to attend conferences, and Americans may take fewer leisure trips with friends and family.”

Other hospitality executives are concerned whether the pending trade war will impact the future of tourism.

“We worry about a trade war, we worry about the approach our administration is taking toward welcoming others into our country,” said Jon E. Bortz, chairman, president and CEO of Pebblebrook Hotel Trust. “Tourism is our biggest export, so the more people who come here and spend money on hotels, airlines, retail experiences, the better it is for the economy, and the more people it employs. We’ve not had a welcoming message in the last couple of years. We’re making it difficult for people to come here, and we’re adding onto that the negatives that surround trade. Part of that fits into this unwelcome message, but part will have an impact on the economy at the end of the day.

“Maybe the end will justify the means,” he acknowledged. “That’s not my area of expertise, but we worry about the impact in the near term and how that could—I don’t know if it would—drive us to a recession. Certainly, though, it could slow down economic growth.”

Industry opinions
Some industry executives haven’t seen much of an impact from the administration’s imposed tariffs—at least not yet. “So far, the effect of the Trump tariffs have been mild and indirect; however, that could change dramatically depending on the ultimate resolution of the trade disputes and the reaction to them,” said Steve Van, president and CEO of Prism Hotels & Resorts. “The hotel industry rises and falls very quickly in response to GDP growth, and while there has not yet been a meaningful drop, the effects of negative anticipation are growing. Business spending decisions are directly based on predictions about the future, and the more uncertain the future, the less businesses invest capital and spend on travel.”

Some hospitality companies are taking direct hits from the tariffs. “Owners are being impacted on a number of levels, but most concerning is the increased risk in relation to new-construction and renovations,” Fareed said. “The uncertainty associated with rising costs for construction materials, casegoods, electronics, etc., combined with unexpected delays in deliveries, has caused ownership to put off necessary property improvements. It has also made underwriting a challenge.”

Then, there’s the potential blow to overall renovation costs.

“Owners are specifically affected by tariffs during the renovation process,” said Jay Litt, principal at The Litt Group. “Increased product costs and difficulty procuring projects are forcing owners to incur longer wait times and higher budgets than anticipated.”

Oftentimes, hoteliers make note of these additional construction costs, however, so some believe tariff impacts are just expected. “At the end of the day, these are just built into the cost of doing business, and a hotelier just accepts that,” said Chip Rogers, president/CEO of AAHOA. [Editor’s note: It was recently announced that Rogers was appointed to president/CEO of AHLA.] “This is short-term pain for a broader economic policy that seeks to address the massive trade imbalance between the United States and China. The Trump administration’s plan to apply pressure to industries not directly related to the big issues they want China to address, such as intellectual property theft, causes short-term pain for certain industries domestically, like hoteliers with projects in the pipeline.”

In addition to construction costs, procurement firms are sourcing products elsewhere to avoid additional expenses.

“The U.S. hospitality industry imports a significant amount of key products from China, such as machinery, TVs and appliances (washers, dryers, dishwashers, etc.),” said Robert Cole, president and CEO of Hospitality Ventures Management Group (HVMG). “Tariffs could potentially drive up the cost of these items. Additionally, there is the potential of an impact on the cost of construction, making deals more difficult to pencil. We’ll be paying attention to the outcome of the 90-day halt on tariffs between the U.S. and China.”

Construction materials
Due to the administration’s tariffs, construction costs are rising. “One of the more noticeable impacts the tariffs are having is on construction materials,” Rogers said. “In hotel construction, brands mandate that some materials meet a certain standard. For example, for most of the major brands, bathroom vanities must be made of quartz. Currently, there is a 10% tariff on quartz.” Used for countertops, backsplashes and tile, granite—made up of quartz—is popular for many hotel projects.

“One of the biggest areas in which tariffs are impacting the hospitality industry is in hotel renovations,” said Peter Nichols, national director of national hospitality group at Marcus & Millichap. “Granite used for renovating bathrooms and vanities is now more expensive, along with other casegoods like tile, which we typically buy from China or overseas. These tariffs affect the buying cost, and subsequently affect the value of the hotel, which isn’t driven by how much money you put into it, but by the performance of the hotel based on the marketplace.”

If tariffs continue, renovation costs are expected to continue to increase. “Due to these tariffs, renovations are more expensive and these extra expenses either come out of the seller’s pocket or buyer’s pocket: If the seller does the renovation but doesn’t get the expenses they were looking for upon selling the property, the buyer will absorb the renovation cost if they need to do the renovation,” he said. “A positive aspect to this is sourcing renovation material opens more doors than just to China, whether it’s manufacturing in the United States or sourcing elsewhere overseas.”

The instability the tariffs are creating is making it difficult for hoteliers to estimate budget costs for their projects.

“Everyone wants to know what they will need to build into their budgets for projects,” Rogers said. “While a 10% tariff can be absorbed into construction budgets, hoteliers are concerned with the prospect of anti-dumping penalties being assessed to core construction materials that could increase tariffs by a couple hundred percent. This could slow project production and cause hoteliers to go to the brands to call for different brand-standard materials, since the cost of obtaining what was once accessible is no longer tenable from a cost perspective.”

He continued: “A more extreme scenario is if an importer decided that they’ll only deal with freight on board ships, then a hotelier might be entering an entirely new and unfamiliar role as an importer on record and, in addition to handling all the duties, they’ll have to pick up the domestic responsibilities typically handled by importers. Most hoteliers don’t have the experience or the bandwidth to take on that responsibility or financial obligation.”

Within the lodging industry, the aluminum and steel tariffs are the ones most talked about and feared. “The immediate worry is the uncertainty of higher steel and aluminum prices making it difficult to predict what it will cost to build a new hotel and slowing development,” Van said. “But, constrained supply is good for hotels—especially this late in the business cycle. Development does appear to be slowing compared to the last few years, but the long-term worry is that a full-blown tariff-induced trade war would slow global growth and reduce both business and leisure travel.”

The administration’s imposed tariffs on steel and aluminum have increased prices on both commodities. Steel tariffs alone have cost American companies $2.3 billion, including $446 million in October 2018, according to government data compiled by The Trade Partnership. Aluminum tariffs cost companies about $124 million during the same month. Costs jumped significantly after May 2018, which is when the president imposed tariffs on the European Union, Canada and Mexico.

“The administration’s tariffs have translated into significantly higher prices for steel and aluminum, which has, in turn, caused a slowdown in the pace of new hotel construction,” Fareed said. “Most of us in the industry are keenly aware of this. However, we must also understand how the tariffs on steel and aluminum are driving up the costs of everything from HVAC systems to commercial kitchen equipment. It’s affecting more than just new-construction.”

In total, U.S. businesses paid $6.2 billion in tariffs in October 2018 (a figure more than double what businesses paid in tariffs in October last year), according to the same report.

“Domestic and other sources have filled in the hole left by the less-expensive Chinese products,” said Ciro Gambone, director of preconstruction services at High Construction. “The commodities market, a leading indicator, is showing a yearly trend reduction of 11% for steel and 6.2% decrease for aluminum. Infrastructure work with government funding has historically had stipulations to utilize domestic products and prevailing wages that impact on price would only be any premium that resulted from increases in domestic products due to lack of competition from abroad, and not the difference between the two.”

“No one really wants to pay additional tariffs on imported goods, nor do they want to see their project development slowed, so, to a certain extent, the tariffs are a cost of doing business,” Rogers said. “The question is, how do hoteliers benefit from the broader objectives a tariff-heavy trade strategy looks to accomplish? That’s what many are still working to determine. The ultimate goal, which has been articulated by the president, Democrats and Republicans, is to make tariffs as low as possible so long as there is a level playing field.”

Procurement of goods, FF&E
“The administration’s tariff policy has created a new shift in the way the hospitality industry sources and procures products,” Litt said. “This is true for both cost and timing. The cost of products typically procured from China is increasing and lead times are getting much longer, so we are searching for and finding alternative products in other markets—specifically, the U.S. This has created a positive impact on U.S. companies, especially those involved with furniture, but a painful exercise for procurement groups and costly for ownership.”

To get around the additional costs from the tariffs, some companies are simply sourcing products from other Asian and South American countries at a slight premium. These companies are working hand-in-hand with architects by requesting more leniency on substitutions for property products.

“We can expect brands to source goods from different locations, perhaps changing imports from China to Mexico or another country, for example, or manufacturing goods in the U.S. Regardless, brands will continue to source and negotiate the best possible price that hoteliers expect,” Nichols said.

Developers have been adjusting the way they’ve been doing business to adapt to the status quo. “The usual list of vendors does not fit anymore,” said Blair D. Hildahl, CMO and president at Base4. “All of this adjustment to find new suppliers, vendors, etc., takes time. It is not that a developer cannot find a deal and keep prices relatively stable. The challenge is that finding the right deals is now much more time-consuming. Time is a commodity, and time is the top commodity at risk during this time of uncertainty.”

To avoid additional costs, there’s a lot of geographic movement, especially in Asia.  “As many Chinese suppliers work quickly and hastily (in my opinion) to move operations out of China and into Vietnam, my concern is that Vietnam will become overloaded as factory owners take advantage of this new flow of projects and income,” said Ted Carroll, one of the founding partners and current president of The Carroll Adams Group. “It is important to understand that China has a population of 1.4 billion, while Vietnam has a population of 93 million. There is no way that Vietnam can handle this large influx of orders. The result of this increase in Vietnam product is [this]: longer lead times; decreased quality; and increased price. In addition to new hospitality orders, there is already an increase in retail orders moving to Vietnam. The end result will likely be pricing that is higher than the current tariff, longer lead time and poor quality. It’s time to slow down, don’t panic and abandon China too quickly. We made it through the bedroom anti-dumping issue long ago.”

Moving factory operations out of China and into Vietnam, for example, might be a hasty solution that backfires, according to some hotel industry professionals.

Waiting game
While many leaders in the industry believe more tariffs will be imposed in the future, there are varying opinions on how additional tariffs will impact the markets. “It is certainly possible,” Rogers said. “From what we’ve seen, there is a broader method to the so-called ‘madness’ that is pressuring the Chinese to address the big trade issues, but where and when the next round of tariffs may be levied, we’re all guessing.” In his opinion, the uncertainty created by the tariffs will force trade partners to the table, and to avoid further instability, they’ll negotiate on terms more favorable to the U.S.

“They all want certainty and stability, and without purchasing power, we’re in a position to provide that—on our terms,” he said.

Others don’t hold the economic and political instability in the same high regard. “If the current administration’s erratic approach to international economic policy continues into the new year, I don’t think anyone can predict what we’ll see in 2019,” Fareed said. “I am hopeful, however, things will improve.”

What instability also does is make it difficult for experts to forecast the impact of the tariffs.

“At this time, the impact is uncertain,” Cole said. “Part of this may be because of a lack of knowledge of how tariffs will extend. We could see an increase in expenses as buyers seek out domestic products and suppliers to fulfill orders.”

While the industry has seen years of active growth, change is inevitable—just in time to cushion the impact of the administration’s tariffs, some believe. “The industry is starting to cool after many active years of growth, so that tariffs will have less of an effect,” Litt said. “Brands will have to rethink their property improvement plans to accommodate increases in costs. During the past few years, brands have been aggressive in requiring extensive renovations. These costs in 2019 will be higher than planned, and owners will need assistance.” Eventually, someone or something is going to give.

“We can’t predict the future, but at some point the negative impact on domestic exports will get a voice, and pressure to resolve will get traction,” Gambone said.

“I don’t believe that 2019 will be as good as 2018, given the fact that costs are already increasing and there is a strong chance that cooler leadership heads will not prevail,” Van said.

Some industry executives believe 2019 isn’t the year to be worried about. “I see it as a buffer to prepare ourselves for a probable downturn,” Hildahl said. “Despite the tariffs increasing construction costs, and other adversities the industry is facing, we still have projects rolling and getting off the ground. I see the trend continuing into the next year as well, but after two years of ongoing confidence, 2020 may have a stumbling block in store.” Instead of hitting the gas, developers, awaiting to see how the political landscape pans out, could pump the brakes before the 2020 election.

“What happens after that remains a matter of time, but we believe that with efficient models and value engineering practices, our clients have little to worry about,” he said. HB

To see content in magazine format, click here.