The Impact of Federal Per-Diem Rates on Washington, D.C. Area Hotels

Politics aside,  the D.C. area’s economy remains stable and in many respects poised for moderate growth. This has translated positively to the area’s lodging industry, but how will a reduction in per-diem rates affect D.C. hotels?

By David Fuller (MAI)

October 5, 2010

It is commonly believed that the Washington, D.C. area is largely insulated from traditional economic cycles because of a strong orientation toward the government, education, and healthcare sectors. The federal government employs roughly 320,000 people and spends more of its billions of procurement dollars in the D.C. Metro region than anywhere else in the world. According to the Partnership for Public Service, federal spending represents approximately 33% of the region's economy.

The presence of many major government agencies, including the Department of Defense (DoD), the National Institutes of Health, and the Food and Drug Administration, has led to business development both in the District itself and in the suburbs of northern Virginia and southern Maryland. These businesses include federal contractors (defense and civilian), numerous non-profit organizations, law firms and lobbying firms, catering and administrative services companies, and several other industries that are sustained by the economic wellspring of the federal government.

In mid-year 2010, Defense Secretary Robert Gates announced a plan to cut funding for support contractor personnel by ten percent per year for the next three years. This will undoubtedly have a negative impact on regional employment and procurement. However, while the DoD may be downsizing, the federal government was expected to add over 50,000 new jobs to the area by 2012; according to the Bureau of Labor Statistics, approximately 13,900 new government jobs were added to the Washington, D.C. region from May 2009 to May 2010.

Contingent on these forecasts for job growth over the mid- to long-term, the outlook for the regional economy remains optimistic. Hotels in D.C. and other major metro areas depend on a strong, diverse employment base to fill their rooms, but for D.C. and its outlying suburban markets, another relationship measurably affects hotel performance: government per diem and average rate.

Room Night Demand and Average Rates

Overall government demand, including federal contractors, amounts to approximately 5% to 10% of total room night demand in the D.C. Metro region. The vast majority of the room night demand in the market is driven by tourism, conventions, and business travel.

The city has always been a top destination for both U.S. and international travelers. The region's economy is heavily weighted toward the services sector, with professional and technical services, as well as management and administrative services, representing strong sources of commercial demand. Furthermore, leisure transient demand in the area is primarily generated by Washington, D.C.'s diverse and rich history as a political town, offering a bounty of monuments, museums, memorials, and other tourist attractions. Leisure demand softened somewhat in 2009 given the state of the national and international economic situation; however, visitor levels are reportedly showing signs of slow recovery in 2010.

Thus, while the expected reduction in employment and procurement at DoD will adversely impact hotel room demand, regional occupancy levels are still projected to increase based on improvements in transient and group demand.

Another way to consider the impact of the federal government on the region is to consider the rates paid for the room nights government employees and contractors occupy at area hotels. The following graph illustrates a comparison of per-diem and average rate trends for D.C. and the nation over the past ten years.

The graph shows that, in 2000, the D.C. Metro area’s per diem rates stood almost even with the overall average rate commanded by D.C. Metro hotels. However, from fiscal year 2000 to fiscal year 2010, per-diem rates increased by 6.0% per annum (compounded), while average rate for the region grew by only 3.1% per annum. By mid-year 2010, per-diem rates stood more than $50 higher than the average for the D.C. Metro area and about $100 above the national average.

 

The increase over the past ten years was driven largely by higher room rates demanded by downtown upscale and luxury properties in D.C. As average rate for these hotels exceeded $200, much of the government demand was displaced to the inner suburbs. Based on the trend line presented above, a typical hotel in the D.C. Metro area should therefore have been running after this segment of business, as the rates exceeded what they could otherwise capture on average.

 

It was no surprise therefore, that the recently released per-diem rates for fiscal year 2011 show a 9.4% decrease from the 2010 rates. This decrease coincides with a reported double-digit increase in rates for downtown upscale and luxury hotels in the second quarter of 2010.

 

Conclusion

 

With the per-diem rate decrease for the coming year, we expect that a greater portion of this demand will migrate toward less-expensive hotels in suburban markets. Hence, while the large percentage decrease in the per-diem rate for the region may have a minor negative impact on some downtown hotels, it spells an opportunity for other  hotels in the suburbs to capture additional government demand. Given the respectable premium per-diem rates should continue to maintain over market-wide average rate, these hotels will also have the opportunity to drive their own average rates upward.

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