How outsized supply growth is affecting Chinese hotels

HENDERSONVILLE, Tennessee—The Chinese hotel industry fluctuates with the general economy and as the years of hyper growth make way to more moderate, but still healthy, GDP growth, the hotel industry feels the impact.

For the first time since 2016, STR data shows mainland China supply growth outpacing demand growth, leading to occupancy declines. Annualized occupancy growth has now slowed for four of the five months through May, which is remarkable given the healthy demand increases of more than 3% this year, 4.6% in 2018 and 7.9% on 2017. At the same time, supply growth, which topped 5% in 2014 and 2015, slowed somewhat to 3.9% in May. (STR is the parent company of Hotel News Now.)

This slowing in new supply was not enough to keep occupancy growth positive, and it will be imperative for developers to watch the general economic trends to make sure their new products meet customer demand. Currently, the lack of occupancy growth coupled with new supply has negative implications for average daily rate increases. Through May, ADR decreased 0.1% to 522 Chinese yuan ($76).
The declines in occupancy and lack of ADR growth then led to RevPAR deterioration. The above chart shows, however, that the RevPAR increases of the years 2017 and 2018 seem to have been the exception as pricing power lagged and RevPAR deteriorated in consecutive years starting in 2013.

China class performance varies
Since the country-level data covers some 16,000 hotels with just under 3 million room nights, is it worth parsing the data by subgroupings to understand what drives the overall performance. Our data shows clearly that Chinese hotel developers had a strong appetite for higher-end hotels, and combined supply growth for these classes was well above the national average, topping 7% in the years prior to 2017.

Lower-end hotel growth was steady as well, but the overall growth rates were at or below 5% after 2014. In the most recent past, starting in late 2018, a trend seems to emerge where developers once again prefer to build full-service hotels. It is too early to say with certainty if this is a long-run trend, but our data seems to point at a clear demarcation between the two hotel types.

Of course, room supply growth is only sustainable if it is matched with equal or stronger demand growth, and our data seems to point to high-end demand growth slowing rapidly, leading to occupancy deterioration.

The trajectory of demand growth seems to be pointing at much slower growth across the board, a fact that may not inflict much pain on the lower-end hoteliers since their supply increases are much more manageable. But the higher-end hotels will have to contend with rapidly developing new competition. This does not bode well for the future of high-end hotels in China.

City supply growth varies widely
A slightly different way to slice Chinese hotel development activity is to follow the common approach of breaking out the cities by tier. This is not an official government designation but is widely accepted to be a sensible way to delineate markets and opportunities in them. The following table lays out the Tier 1 and New Tier 1 metro areas, as designated by Chinese financial magazine Yicai Global. There are a total of 338 cities ranked between tiers 1 and 5.

The four Tier 1 and fifteen New Tier 1 cities that had traditionally been the focus of local and international developers are now still reporting healthy supply growth, but their supply changes are only half as strong in the Tier 2 to 5 cities.
Tier 2-5 supply has increased well above 7% for a prolonged period. Small absolute supply figures make the percent changes seem a bit disproportionate. But it likely also points at the underlying trend of domestic investors wanting to capitalize on the nascent travel desires of the emerging middle class.

That said, the demand patterns that seemed to justify the strong supply increases over the last few years are rapidly slowing.

Tier 1 and New Tier 1 market demand is still growing, currently 2.8% through May, but this is a long shot from the prior hyper-growth of 8% in late 2018. Demand in the Tier 2-5 markets is slowing as well, currently at just over 5% from more than 12% in 2017. If the trajectories are an indication of things to come, it is not unreasonable to estimate a further slowing. The big question then remains whether the slowing supply growth will be rapid enough to cushion the slowing demand growth and will therefore not impact the occupancies in the major markets.

We will continue to monitor the supply and demand balances by class and market tier and report on the rapidly changing Chinese lodging environment.