By Art Gering

Lodging & Resorts
# of REITs	19
Market Cap. (in thousands)	$18,208,637
Industry Market Cap. (in thousands)	$333,935,637
% of industry	5.5%
Yield	4.1%
YTD Total Return	5.9%
One-Year Return	15.8%
Three-Year Return	35.1%
Five-Year Return	12.7%
Average Daily Trading Volume (Shares)	6,867,133
Source: NAREIT. Data as of Nov. 30, 2005

The lodging industry has faced its share of challenges in recent years. However, the sector is showing signs of strength as both business and leisure travelers are coming back. With the economy continuing to improve and new supply remaining limited, lodging REITs are seeing an increase in room demand which analysts say bodes well for improved performance in 2006. In addition, demographic trends over the long term should continue to boost demand in the sector's favor.

PricewaterhouseCoopers forecasts lodging occupancy rates to advance 100 basis points to 64.2 percent in 2006. The average daily rate (ADR) is forecast to climb 5.1 percent, resulting in a 6.7 percent gain in revenue per available room (RevPAR). The firm also expects industry profits to rise from $21 billion in 2005 to $25.3 billion this year.

Last year, ADR increased 5.2 percent, accounting for most of an 8.3 percent jump in RevPAR. "ADR will continue to drive gains in RevPAR in 2006," says Maria Maslovsky, an analyst with Moody's Investors Service. "Gains in ADR are possible when competition is fairly limited, and in a strong demand environment."

Jan Freitag, vice president of Smith Travel Research, agrees, noting that significant ADR gains occur on the heels of the type of occupancy increases posted in the past two years. Smith Travel Research forecasts a 5.5 percent increase in ADR this year, citing steady demand from business and leisure travelers. In fact, demand growth is expected to offset supply growth by a fairly wide margin this year and beyond.

WHAT TO WATCH FOR: LODGING As 2006 unfolds, investors in lodging REITs should be mindful of the following issues that could impact the sector’s performance: Pros: 1. While more rooms are expected to be added to supply this year compared with 2005, supply growth remains very restrained. 2. Current expectations for a robust rate of GDP growth have favorable implications for lodging demand. 3. Leisure travel is expected to continue expanding at a healthy rate. Cons: 1. The lodging sector tends to overbuild. Monitoring the pipeline of planned projects can provide an early warning of future overbuilding. 2. Greater inflation, driven partly by rising energy costs, could diminish leisure and business travel. 3. The diminished ability of consumers to extract wealth from their homes could significantly curtail consumer spending, especially on discretionary items such as travel and vacations.

Lodging Econometrics reported that the construction pipeline at the end of the third quarter of 2005 consisted of approximately 2,800 hotels containing more than 377,000 rooms. According to the firm, the project pipeline is 30 percent smaller than it was at its peak in 1998. What's more, new projects added to the pipeline in the third quarter marked the smallest quarterly increase in 2005, while project cancellations and postponements were at the highest level since 2003. Rising construction costs are one of the reasons given for a thinner pipeline.

Smith Travel Research also has been tracking the decline in new construction of hotels, and adds that the number of projects in the pre-planning, or "rumor," stage dropped 40 percent last year. "There is not even that much to talk about," Freitag says.

As if the decrease in the project pipeline were not enough, the existing stock of hotel rooms fell throughout 2005. Many rooms were removed either for conversion to residential use, or were simply demolished. At one point during the year, Smith Travel Research reported that inventory was reduced in 12 of the nation's top 25 markets, including New York City. A slowdown in new construction and the reduction of existing stock are drawing attention.

"You don't see supply ahead of the demand trend line until 2008 and 2009," observes Rod Petrik, a REIT analyst with Stifel, Nicolaus & Company.

Freitag concurs, but adds a note of caution. "The hotel industry has always overbuilt, and that will probably happen again because the industry has a short memory," he says.

Demographics and Inflation

Besides the supply trend tilting in favor of lodging property owners, leisure travel room demand during the next several years will likely be augmented by changing demographics. Room demand from leisure travelers surpassed business travel demand for the first time in 2004, according to D.K. Shifflet & Associates, and continues to expand. Leisure demand will be increasingly supported by the aging baby boomer generation, an age cohort that has accumulated wealth for years and will soon have the free time to spend it on leisure pursuits. The population of individuals aged 35 years to 64 years, a segment that includes baby boomers, is projected to expand 1.2 percent annually through 2010, compared with 0.9 percent for the entire population, according to data compiled by Marcus & Millichap Research Services.

Despite favorable supply and demand trends, an area of immediate concern for lodging property operators is the effect of inflation on travel. The yearlong rise in energy prices last year fanned talk of inflation. The consumer and producer price indexes, in addition to the bond market, were giving mixed signals late in the year, lending greater uncertainty to the inflation outlook.

The impact of higher inflation on consumer spending and travel could adversely impact the lodging business, cautions Daniel Michles, an analyst with Moody's. In fact, higher fuel costs are projected to raise business travel costs 12 percent this year, according to management consulting firm Runzheimer International.

As for the leisure travel segment, "there is a perception that the consumer is in a declining position to spend on discretionary items" such as travel, says William Crow, a senior vice president with Raymond James & Associates. "The perception is this will have a negative impact on lodging fundamentals."

Another potential risk for the lodging sector is an unforeseen downturn in the economy, Crow adds, and the sector's higher risk profile than other property types. "Occupancy goes to zero every morning," he says.

Lodging Stats
	2002	2003	2004	2005*	2006*
Occupancy	59.0%	59.2%	61.3%	63.1%	64.3%
Average Daily Rate	$82.80	$82.91	$86.24	$90.70	$95.21
RevPAR	$48.86	$49.07	$52.90	$57.20	$61.25
Average Daily Rooms Sold (000s)	2,576	2,612	2,726	2,821	2,907
*Estimate ** Forecast Source: PricewaterhouseCoopers