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When will the party end for the hospitality sector?

Nick Villa — Wed, 01 Nov 2023 08:00:00 +0000

It’s the same old song and dance: Pent-up demand from people wanting to travel in the post-pandemic era will be a boon for the hospitality industry and hotel owners for years to come. And while that’s certainly been the case thus far in terms of revenue per available room (RevPAR) — a function of a hotel’s average daily rate multiplied by its occupancy level, which more than doubled in 2021 — how much longer should the good times for the hotel sector be expected to last?

First, let’s be clear that the good times being referred to should be viewed through the lens of leisure and hospitality operators, since consumers will undoubtedly have a thing or two to say about the price of their last hotel stay. But the reality is, higher prices for accommodations have been a wide-spread consequence of the post-pandemic recovery and consumers are justified in voicing their concerns. (After all, try speaking with a potential homebuyer who missed the boat on sub-3% mortgage rates and has seen property values only continue to climb.)

Nevertheless, inflation has remained above the Federal Reserve’s 2% target since November 2019. And while the Consumer Price Index has fallen considerably from its peak of 8.9% in June 2022, the headline increase this past August was still above target at 3.7%. There are several other concerns on the horizon that have the propensity to adversely impact consumers, with the most imminent being the recent resumption of student loan interest accruals and repayments.

Additionally, gasoline prices have increased by nearly 20% during the first eight months of this year, and a somewhat weaker dollar has tended to dampen international travel (albeit the conversions to euros or pounds are still more favorable than in 2019, while the dollar-to-yen exchange rate is near a multidecade high). These factors have resulted in U.S. consumers seeing their budgets squeezed as their excess savings continue to fall.

Consequently, as consumers reevaluate their discretionary budgets, a pullback in travel demand should be anticipated. This is especially true for leisure travel rather than business travel, as the price elasticity of demand for business travel is usually lower.

So, back to the question at hand: How long does Moody’s Analytics expect the good times to last for the U.S. hotel sector? While performance was exceptional in the first half of 2023, we expect a deceleration to occur in the latter half of the year. Specifically, national RevPAR increased by approximately 20% in the first six months of the year and is projected to rise an additional 7% by year’s end — hence, we forecast an annualized increase of roughly 27% relative to 2022.

Looking ahead to 2024, which becomes even less clear, we estimate an additional bump in RevPAR of about 6%. For perspective, the average year-over-year increase in RevPAR from 2001 to 2019, based on Moody’s Analytics data, was about 2%. Importantly, this long-term average omits the immediate post-pandemic data, given the extreme fluctuations experienced in 2020 and 2021 (which included a 65% decline and a 123% increase in RevPAR, respectively).

Visibility beyond 2024 in terms of financial and economic conditions is even more cloudy, but our current projections fall short of the aforementioned 2% long-term average. In summary, growth has already started to decelerate and it’s possible that the cyclical nature of the hotel industry moves in the other direction within the next 18 months.

It’s best to wait and see, but as illustrated on the accompanying chart, hospitality property owners can let the good times roll. RevPAR is projected to end this year 11.3% higher than its pre-pandemic level after three straight years below this threshold. ●

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Q&A: Jason J. DeJonker, Bryan Cave Leighton Paisner

Jeff Bond — Sat, 01 Jul 2023 08:00:00 +0000

Although the regional banking troubles that engulfed the commercial real estate sector this past March appear to be calming down, attorney Jason J. DeJonker said he doesn’t believe the problems are over just yet and that another bank failure isn’t out of the question.

“Office is still incredibly different. We are seeing decreases in value, even in major cities, that range from 25% to 75%.”

DeJonker, a partner at the global law firm Bryan Cave Leighton Paisner, also said he still sees lingering valuation problems in the office sector and he worries about these financial difficulties spreading to other areas of commercial real estate. Scotsman Guide recently spoke with DeJonker about his outlook for the banking sector and where commercial real estate is headed in the near term.

What is the current state of bank lending for commercial real estate projects?

I have never seen banks so unwilling to lend, frankly. And it’s not just banks — it’s all financial institutions. Both banks and nonbank financiers have been very cautious in advancing funds. At this point, the only transactions we see with any degree of regularity are in two categories: either rare and very high interest rate construction and development deals, or insurance company transactions where the loan-to-value (ratios) are so low and the asset classes are the types that even insurance companies are willing to advance funds on a loan.

In general, we are just not seeing a lot of activity, whether it’s retail, hospitality, office or multifamily. We also are seeing an unwillingness for banks and other financial institutions to lend in the health care space, whether it’s skilled nursing, acute care or assisted-living facilities. Those types of loans are very difficult to refinance right now.

What is the status of the banking crisis, and do you expect more regional banks to face financial problems or a possible collapse?

I think it is definitely a possibility. At this point, all it takes to create a run on a bank is a few bad articles and a decrease in stock price. The depositors will move their money out very quickly. I can tell you just from speaking with banks that there has been significant damage done to the number of accounts and the amount of money that is being held in those accounts in many regional banks. So, we are not out of the woods by any stretch of the imagination.

We also have not had any rightsizing of real estate values as it relates to some commercial real estate loans originated by regional banks. If there are any dramatic adjustments in values resulting in significant write-downs by some of these banks, it could get messy. It really will depend on whether certain banks have trouble maintaining their account bases and have significant exposure to nonperforming loans.

What valuation changes are you seeing?

It depends on the asset class. For the most part, hospitality has largely bounced back, although “work-travel” hotels continue to see difficulty versus vacation hotels. There are some outliers, but the value of hotel properties has stabilized. Office is still incredibly different. We are seeing decreases in value, even in major cities, that range from 25% to 75%. Everything is getting hit to some extent. It really depends on the city and the type of office property you are talking about. For instance, if you are looking at a Class B property or lower, you are seeing significant drops in value because there isn’t the market for new tenancies in office space. For those owning B- and C-level properties, it’s very difficult.

The last thing I would add is, people are talking about converting these buildings to multifamily properties. Those conversions are ridiculously expensive and many of the building floor plans won’t work. One major impediment is that some of these buildings have only one washroom on each floor. They don’t have water systems running everywhere and many of the buildings have low ceilings. You might be better off tearing some of these properties down and building something else there.

Is there something that will potentially signal the market reaching the bottom for the office and banking sectors?

I don’t know what the sign will be. But I don’t think we’ve gotten to the bottom yet as it relates to some of the valuation issues that we’ve talked about. I am concerned that we are going to see more softness in other asset classes that we haven’t seen yet. For instance, we haven’t seen the amount of turnover in the multifamily properties. In secondary markets, the rents on newer construction, in certain instances, have gone up considerably in recent years. People are paying rents based on a COVID-19-inspired economy with very low unemployment. I don’t know if the market can support such high rents because I don’t know if the incomes and rents match up any longer. ●

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The end of ‘revenge travel’ has arrived for hotels

Thomas LaSalvia — Thu, 01 Jun 2023 08:00:00 +0000

The U.S. hotel sector has been on a roller-coaster ride for the past three years. After fears of Armageddon became paramount for much of 2020, COVID-19 vaccines and pent-up demand quickly brought the phrase “revenge travel” into our lexicon as people sought experiences they missed during the early stages of the pandemic.

Hotel occupancy rates rebounded and average daily room rates soared as households looked to spread their wings and spend their excess savings. But as we know too well, nothing lasts forever. Stimulus funds have dried up, home price appreciation is stagnant or declining, and equities are currently on their own bumpy ride. And while a national recession is far from guaranteed at this point, an economic softening is upon us.

The overall labor market will remain relatively tight over the next couple of years, given an imbalance in skill and a general shortage of workers, but companies have already been conducting layoffs, particularly in middle-management positions. Elevated uncertainty for these middle-class workers will surely dampen their plans for lavish travel this summer.

This is not to say that the bottom is about to fall out for the hospitality sector, but the reaction of hotel performance metrics to lower leisure demand will be an intriguing summer story. To gauge the impact of economic changes upon the hotel industry, let’s sift through some of the most relevant demand drivers.

Positives: Excess savings is declining but still in the black. As of February 2023, excess savings (or the extra money consumers saved beyond the level they would have without the pandemic) was approximately $1.5 trillion. This is well below the September 2021 peak of $2.5 trillion but is nothing to scoff at. Some cushion remains for those who have lost jobs, or fear a job loss, but these funds will most likely be saved or used for necessities.

Negatives: Retail sales growth has weakened over the past year. March 2023 spending levels were roughly level with their October 2022 reading. Service-sector performance is still outpacing that of goods, but consumers have been tightening their purse strings across the board. In fact, with annualized inflation still running well above normal, spending levels declined throughout much of the winter and spring. It’s likely that this will turn around a bit as lagging tax returns make it into consumers’ hands, but as previously mentioned, fear and uncertainty tend to lead to more conservative spending habits.

Neutrals: The labor market is softening — and will soften further — but it won’t fall off a cliff. This is not the same situation as the Great Recession and its 10% unemployment rates, but rates of 5% to 6% by this time next year are not out of the question. What is a wild card here (and what may keep unemployment down and wage growth positive) is a high ratio of job openings to unemployed persons. Entering the two other recessionary periods of this millennium, this ratio was considerably below 1.0. As of this past February, the ratio was falling but still above 1.5.

Neutral but leaning positive: Corporate and event travel is not part of the “revenge” definition, but it is still quite important to the health of hotels. Placer Labs recently utilized cell phone data to track visits and usage for a variety of locations and transit types. Using measurements such as the timing and frequency of air travel, as well as visits to convention centers, they concluded that business travel is seeing a resurgence but has yet to return to pre-pandemic levels. Will this type of travel fully return? It may not happen in the exact same fashion, but a full recovery is possible in the next few years with a realization that education, networking and sales are more effective in person.

As the chart on this page illustrates, the hotel-sector roller coaster is forecast to come to an end, with occupancy and room rates above pre-pandemic levels. A continued resurgence of business and event travel, along with a resilient labor market, will outweigh a pullback in revenge travel. ●

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The Key to Success

Jay Litt — Sat, 01 Apr 2023 08:00:00 +0000

To say that the COVID-19 pandemic was a financial disaster for the hospitality industry would be an understatement. The impact of the global health crisis on hotels and other hospitality sectors was extensive. But these bad times appear to be over.

As the nation puts the pandemic in the past, U.S. hotels, restaurants and travel destinations are finding new life as they approach pre-pandemic levels of revenue and activity. At the same time, the recovery has been uneven and many properties may end up going bankrupt if the economy continues to cool this year. Commercial mortgage brokers must learn from the difficulties of the pandemic so they can evaluate properties and identify their underlying values without being misled by tough economic circumstances that may cloud their true worth.

The years from 2011 to 2019 were favorable to the hospitality sector and good times appeared to lie ahead. By 2019, the U.S. travel and tourism industry had reached annual sales of about $1.1 trillion. International and domestic travel was booming. Forecasters saw continued expansion and construction of many new projects. The industry’s future appeared to be, in a word, rosy.

Then the pandemic hit. Few observers could have imagined the devastating effects it would have on the global economy and more specifically on the hospitality sector.

Travel and tourism sales fell by nearly half in 2020. While the actual number of hotel closings is hard to ascertain, it is estimated that half of all U.S. hotels were in danger of closing. More than 110,000 eating and drinking establishments closed in 2020. About 670,000 jobs in hotel operations and nearly 4 million jobs in the broader hospitality sector were lost that year due to the pandemic, according to the American Hotel and Lodging Association.

Before the pandemic, the nation’s 5.4 million guest rooms generated more than $169 billion in annual revenue. A year later, room revenues had been cut in half, causing disruptions for major hoteliers. Marriott, for example, reported that it temporarily closed about 25% of its 7,300 hotels around the world. In the first few months of the pandemic, Marriott’s North American occupancy rates fell to 10%.

Industry comeback

Despite this gloom and doom, the hospitality sector has since bounced back with unexpected strength. The U.S. hotel room occupancy rate reached 62.7% in 2022, not too far below the 67.6% level seen in 2019.

The industry’s workforce was expected to return to pre-pandemic job levels this year. Hotel revenues and profits reached record levels in 2022 due to strong demand and pricing power. Unfortunately, so did labor costs, and economic headwinds in 2023 may threaten the pace of further recovery and expansion.

“The picture of the hospitality industry is somewhat disjointed. Mortgage brokers need to take the time to research current industry trends to see which properties are worth buying and which should be avoided.”

The hotel sector is rebounding, as it always does, but in slightly different ways. Here are a series of U.S. hospitality industry statistics to keep in mind:

The average daily rate (ADR) has now surpassed pre-pandemic levels. As of early February 2023, the ADR was $145.35, an increase of nearly 14% from the same week in 2019, according to data analytics company STR.
Revenue per available room (RevPar) also has topped pre-pandemic levels. STR reported that RevPar was at $80.45 as of the first week of February, up 5.6% from the same week in 2019.
Pent-up travel demand is sweeping the U.S. and the rest of the world as leisure travel exceeds pre-pandemic levels.
New construction projects are growing and hotels in major cities are running at high occupancy rates.
Deloitte, a leader in corporate accounting, estimates that by the end of 2023, spending on business travel will reach 68% of 2019 levels.

Changing market

These statistics sound encouraging, right? They should. Still, the picture of the hospitality industry is somewhat disjointed. Mortgage brokers need to take the time to research current industry trends to see which properties are worth buying and which should be avoided.

The market has changed. Leisure travel is now king; business travel is returning but more slowly. The result is that hotels and resorts in select metro areas are seeing excellent returns. But many other properties, used to relying on business travelers week after week, are not recovering as fast. The industry’s full recovery may not arrive until 2024 or 2025. It may even be influenced by the next presidential election.

While still lagging, business travel has had a surprising comeback. The number of business travelers declined drastically early in the pandemic. But group travel and convention traffic has been returning. The Center for Exhibition Industry Research reports that convention center business activity has steadily improved and is expected to reach pre-pandemic levels in 2024.

But the performance of hotels in individual markets (especially smaller ones) is varied and depends on many factors, including location and surrounding activities. The market for small-group business travel remains slow to recover. This is due to many reasons, including the growth in home offices and changing attitudes about travel. Small-group travel should change somewhat. The hospitality industry may never fully recover this market segment, which could be a damaging future trend for hotels with meeting spaces.

Higher costs

The post-pandemic recovery has also resulted in soaring labor costs. The job market is tight, which has created a major upswing in hourly wages for hospitality employees. In many markets, the increase in hourly pay rates has grown by 25% to 50%.

Many of the major hotel chains were providing limited services to guests (such as fewer housekeeping and meal offerings) coming out of the pandemic. Some of these services are returning and this trend is growing. But the costs to provide these services is well above previous levels.

Added to this are today’s widespread inflation issues, creating an environment where hotel profit margins have been severely disrupted. Costs for all items used in hotels, including food and beverage outlets, are creating challenges.

At the same time, lending rules are changing. Early in the pandemic, banks gave some borrowers forbearance on their loans, but these policies have ended. Banks are not looking at debt-service-coverage ratios and borrowers are being required to pay interest. Profit margins have eroded, however, putting borrowers in a jam.

A perfect-storm scenario has arrived. In the past, borrowers could use short-term loans to cover their positions until the economy stabilized. But inflation has driven up interest rates considerably. As such, there appears to be a crisis looming for existing owners who are in debt.

Looking forward

With recessionary alarm bells ringing a bit softer of late, the final three quarters of 2023 should show growth throughout the hotel industry. Many new hotels will be added to the current inventory while some existing hotels may close or be adapted for new uses.

There are a few other trends to look for this year. The Airbnb model of home rentals will continue to expand. The “hybrid hotel” — a building that includes hotel rooms and a combination of transient facilities, extended-stay rooms and offices — will grow in popularity. Despite brisk business, foreclosures may increase due to the decline in profit margins. But there is a significant amount of equity ready to step in as investors look to buy value-add assets.

Renovations will play a big part in this transition. During the pandemic, many hotels did not receive tender loving care. Major brands, quiet for the past few years, are now becoming aggressive and demanding improvements to their facilities. And as assets change hands, new owners will need capital to complete upgrades.

The leisure travel market is expected to stay strong. Workweeks are being shortened, and the amount of leisure travel is expected to continue growing this summer and beyond. Staycations (vacations near home where work is often part of daily activities) should become more common. Due to the remote-work policies of many companies, employees have more freedom to choose where they want to be while working. Why not at a resort with their family by their side?

The food and beverage sector will continue to change. Along with the traditional restaurant experience, hotels will include expanded pantry areas where guests can purchase food and drinks. Takeout and “grab-and-go” facilities, such as DoubleTree by Hilton’s Made Market, will become more popular. And as always, hotels will continue to refine their service offerings to find new revenue streams that offset the additional costs of labor.

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What’s important for the mortgage broker to remember is that the hotel asset that’s in foreclosure today may simply be the victim of the pandemic and its effects on profits. The physical asset is the same as it was before the arrival of COVID-19. And a new owner will have a value-add investment opportunity that, in many cases, could be as little as 30% of the replacement cost of the hotel.

A new cycle has started and new owners are finding ways to offset increased costs. They have smaller investments in hotels that can compete due to their low-cost basis. Keep searching for these borrowers. The low basis in these assets should give lending committees a degree of security that the mortgage will be secure and protected. ●

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International Investments: United Arab Emirates

Neil Pierson — Wed, 01 Mar 2023 09:00:00 +0000

When it comes to the global economy, think of the United Arab Emirates as a nation that punches well above its weight. The Middle Eastern country with a population approaching 10 million covers an area slightly smaller than the state of Maine, but it ranks as one of the world’s wealthiest nations on a per capita basis.

At the start of this year, the UAE slotted in at No. 7 on this list with a per capita income of $78,255 — a higher rate than Norway and the United States, according to Global Finance Magazine. An economy centered on farming, fishing and pearl trading was remade after the discovery of oil there in the 1950s. Today it has two world-renowned cities in Dubai (3 million residents) and the capital of Abu Dhabi (1.6 million residents). For more than a decade, Dubai has been home to the world’s tallest building, the Burj Khalifa, a 163-story tower that stands more than 2,700 feet high.

The UAE also has emerged as a notable player in commercial real estate investments. As recently as 2020, it barely cracked the top 20 of the largest cross-border funding sources into the U.S., according to MSCI Real Assets. But for the year ending in third-quarter 2022, the UAE ranked No. 13 on this list. Although its $1.1 billion investment total represented less than 2% of all foreign capital placed into U.S. commercial properties during these 12 months, the UAE upped its capital-infusion level by 162% on a year-over-year basis, MSCI reported.

Gulf Islamic Investments, based in Dubai, made a splash on American soil in December 2021 when it acquired a portfolio of 11 office buildings in Richmond, Virginia, for $87 million. The seller was Brookfield Properties, a subsidiary of Canadian-based Brookfield Asset Management — one of the largest foreign investment companies in the U.S. Richmond has been a recent hot spot for cross-border activity: According to CBRE data, international investors placed $445 million into the city from January 2021 through June 2022, accounting for 38% of all investment sales during this period.

In a much larger deal that also occurred at the end of 2021, AGC Equity Partners (which is based in London and Dubai) paid $780 million for three office buildings in San Jose. The transaction represented the largest of the year in Silicon Valley, according to The Mercury News. Yahoo is leasing the space, which cost AGC a pretty penny of $1,185 per square foot at the time of purchase. Yahoo, which was allowing many of its employees to work from home, then subleased two of the buildings this past September to Chinese tech firm ByteDance (TikTok’s parent company).

Damac Properties, which recently opened a 70-story luxury apartment building in Dubai, acquired a South Florida parcel last year for its first stateside development project. The property is infamous as the former site of Champlain Towers South, the condominium tower that collapsed in June 2021 and killed 98 people. Survivors of the condo collapse will receive $33 million of Damac’s $120 million purchase price, the Miami Herald reported.

Another Dubai-based investment company, Safanad, purchased a pair of U.S. hotels in 2022. It partnered with The LCP Group on an $83 million purchase of a 196-room beachfront resort south of Tampa. CBRE brokered the deal with a $72 million loan. A few months later, Safanad acquired a Hilton-branded property near Los Angeles International Airport. The deal for the 162-room property was valued at $37.5 million, MSCI reported. ●

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Is the hotel-sector roller coaster coming to an end?

Thomas LaSalvia — Tue, 01 Nov 2022 08:00:00 +0000

From a historic perspective, national-level performance metrics for the hotel sector have been surprisingly steady. In a given year, opposing patterns of peak business, event and leisure travel have typically provided balance to occupancy rates, average daily rates (ADR) and revenue per available room (RevPAR).

Summer leisure travel is replaced by robust autumn business travel, which then makes way for holiday and conference travel, and finally, spring break and another round of business and event travel to round out a 12-month period. Tracking the data between 2000 and 2019 validates this narrative. In fact, when excluding the two recessionary periods in this time frame, Moody’s Analytics found that occupancy rates have consistently hovered in a tight range of 60% to 65%.

All of this, however, was before the COVID-19 pandemic put a sudden end to nonessential travel. Hotels suffered mightily in the early stages of the health crisis. By March 2020, national-level occupancy declined to only 36.7% while ADR followed suite and dropped from a steady average of $127 to $108, a level not seen since shortly after financial crisis of 2007-08.

Unfortunately for the hospitality sector, the first month of the pandemic was far from the trough. A slight uptick in travel during the summer months of 2020 was followed by a second wave of infections that fall. Occupancy further dipped to 34.6%. Meanwhile, at only $88, ADR plummeted to its lowest level since the 1990s. At this point, hotel owners were having difficulty keeping up with debt payments. Moody’s data shows that the share of hotel assets tied to commercial mortgage-backed securities (CMBS) that were at least 60 days delinquent increased to about 15%.

Over the course of 2021, vaccination rates increased and various metrics of travel rebounded. The prevailing trend for hotel performance turned quite positive as occupancy and ADR quickly rose while CMBS delinquency rates began to drop. By late spring of 2022, occupancy rates had fully recovered and ADR jumped to record highs. By the end of second-quarter 2022, ADR was about 15% above its pre-pandemic peak.

Two questions remain. First, does this record performance have staying power? Second, will a lack of large-scale seasonality again reign supreme for the hotel sector? The answer to both questions lies in the analysis of the current situation.

To fully evaluate conditions, both supply and demand changes must be accounted for. On the supply side, while inventory declined substantially though the early portions of the pandemic, it has since fully rebounded. The number of available rooms is now 2.4% higher than its level at year-end 2019.

Consequently, fully recovered occupancy rates must require robust demand. On this side of the equation, much of the data and anecdotal evidence support leisure travel as the primary driver. During this year’s Labor Day weekend, the numbers of travelers passing through security checkpoints at U.S. airports slightly exceeded their 2019 levels. In subsequent weeks, however, numbers receded back toward 90% of pre-pandemic levels. This is likely due to a lack of business travel, which typically would pick up the slack for seasonal leisure travel declines.

So, if business travel has not fully returned, will ADR and occupancy be able to maintain their current pace? Not likely. Without strong business travel, occupancy in the latter half of 2022 is likely to recede a bit. Furthermore, ADR has been at least partially inflated due to shorter booking windows. Travelers were often waiting until the last minute to book, which typically resulted in fewer available lodging options and less price sensitivity.

As COVID-related health concerns subside, booking windows will likely increase again and travelers will be more likely to have the time to search and/or wait for lower room rates. Additionally, corporate and event travel will continue to rebound. While this is a boon for hotel demand, these mass bookings often come with significant discounts and will cause ADR to revert to its long-run average. As for the lack of seasonality, a full return of business travel is likely to be a slow process. Thus, at least for the near future, mild seasonality will be the new normal. ●

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The New Trend of Hybrid Hotels

Jay Litt — Sat, 01 Oct 2022 08:00:00 +0000

The hospitality and travel industry is one of the largest business sectors in the world, generating an estimated $3 trillion per year across the globe and about $600 billion in direct spending in the U.S. Of the total U.S. revenue, nearly $200 billion is funneled into the hotel industry.

Due to the COVID-19 pandemic, hotels have had to reinvent themselves in different ways in recent years. This includes new cleaning protocols, fewer amenities and a greater introduction of digital technologies. Another trend that appears to be gaining traction — and one for the commercial mortgage industry to watch — is the move toward hybrid hotels.

A hybrid is defined as the creation of something new by combining two different elements — a mixture. When it comes to hotels, a hybrid version can take various forms. A common model is a property where a certain number of rooms remain as traditional hotel accommodations while the rest are reconfigured into office spaces. Another popular trend includes properties that offer hotel rooms on some floors and multifamily housing on others. Both models offer hotel owners new cash streams while diversifying the tenant base.

Commercial real estate services company Colliers, for one, advises hotel operators to harness the remote-working trend and adapt their properties to provide office space as an added amenity for guests. “Hotels creating a place not only to sleep and eat but also to rent out space to meet, collaborate, socialize and work is a key way that underperforming areas within the building can be optimized from a revenue and income perspective,” said Dirk Bakker, head of hotels for the company’s Europe, Middle East and Africa region.

The Airbnb effect

The hybrid hotel model comprised of short-term lodging and apartments is a natural fit. After all, longtime hotel residents are nothing new. In recent years, another version of mixing private and public residences has been popularized by companies such as Airbnb that allow people to rent private accommodations. This movement has been phenomenally successful, and it continues to grow and mature on other platforms, such as VRBO, which is generally geared toward vacation-home rentals.

Home-rental services are quite different from a general hotel format. The location could be a detached home or an apartment building. There is no front desk, limited amenities and few, if any, employees. These alternative lodging options are proving to be a successful trend that has momentum and is posing a growing challenge to the conventional hotel format.

The alternative lodging industry, led by Airbnb, typically does not get involved with the real estate lending community, with the exception of some larger businesses. Sometime soon, as this alternative lodging format becomes more institutionalized, this is likely to change and commercial mortgage originators will have to take the time to decide how to evaluate such operations.

Hybrid hotels that include a multifamily component may be a way for hotel chains to compete with the Airbnbs of the world. These changes also may play a role in addressing the lack of housing supply that is currently impacting the country.

Successful conversion

Mortgage brokers should be prepared to talk with clients about how the hybrid option could potentially turn around poorly performing hotel assets. Here is an example: A 250-room hotel goes on the market. The hotel has a restaurant and 10,000 square feet of meeting space. The hotel suffers from a low occupancy rate and is losing money on its operation. The property seems destined for foreclosure.

Five years earlier, the real estate was valued at $10 million, based on its net operating income (NOI) of $1 million and a cap rate of 10%. The cost to replace the building and its contents is a minimum of $175,000 per room for a total cost of $43.75 million. A buyer can purchase the hotel at the discounted price of $45,000 per room or $11.25 million.

The buyer decides to use a hybrid hotel format, opting to split the hotel up into typical hotel rooms and a multifamily component. The buyer closes the hotel’s restaurant and builds a large deli-style eatery. The hotel’s meeting space is transformed into alternative uses.

For 100 of the rooms, the buyer finds a hotel brand franchise that does not require extensive conversion costs. The other 150 rooms are converted into studio apartments and one-bedroom suites. The studio conversions include a pullman-style spare kitchen, eating area, bed and television. The one-bedroom units require the conversion of two hotel rooms to provide a living room, full kitchen and an adjoining bedroom.

So, 25 one-bedroom suites would utilize 50 rooms. As such, the finished property now has 225 rooms and apartments for rent. A rough estimate on the conversion costs is about $35,000 per room, depending on the building and configuration.

Increasing profits

What does this mean for the broker and lender? Using the same example, the hotel pro forma calls for a market rate of $85 per night at 68% occupancy for a revenue of roughly $2 million. The NOI is 35% or $700,000. Using a cap rate of 10%, the hotel’s value is $7 million.

The apartment pro forma projects 65% occupancy with a blended monthly rate of $1,000. Revenues would be roughly $1 million and the NOI at 75% would be $750,000. Using a cap rate of 4.5%, the apartment component could be valued at $16.6 million. In this example, the combination of the hotel value and the apartment value would be $23.6 million.

The hybrid model also saves money by allowing property owners to reduce labor costs for housekeeping and other staffing issues. The new delicatessen would cost less to run while potentially increasing revenue and profits. The 125 apartments also would help stabilize the property’s pricing and cash flow. Location is one of the most important aspects of this hybrid model. There needs to be demand for rental housing. Since the demand for multifamily housing is so strong, however, this shouldn’t be much of a problem.

Major hotel brands have successfully embraced the hybrid concept in Europe. Ace Hotels, Accor and Zoku, to name a few, have ventured into the hotel-office model to offer guests flexible workspaces. It may only be a matter of time before this hybrid property finds a larger audience in the U.S.

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Commercial mortgage brokers and lenders now have a different hotel model to consider. The traditional hotel was often considered a risky type of real estate, with its daily turnover and lack of stabilized rents. But in the hybrid model, a multifamily component or an office space option offers more stability and can help ground the transaction.

The added value of the hybrid asset should give the lender more room and comfort for a given loan request. Mortgage professionals should be on the lookout for these types of hotel conversions in the coming years. Many projects are already converting hotels and other forms of real estate into apartments. Lenders and investors should find excellent opportunities to support these projects, and they should understand that this trend will likely continue into the next economic cycle. ●

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The recovering hospitality sector is full of surprises

Jeff Bond — Mon, 01 Aug 2022 09:00:00 +0000

Anyone who has waded into the throngs of travelers at the airport or fought to find a reservation near Disneyland this summer knows that the hospitality sector is back and almost as crowded ever. At the end of June 2022, the hospitality sector had survived the depths of the COVID-19 pandemic era and was within reach of the heights seen in 2019, according to Cushman & Wakefield’s Jeffrey Brown.

“We use 2019 as our baseline numbers,” says Brown, a senior managing director and national practice leader of Cushman & Wakefield’s hospitality and gaming valuation and advisory group. “If you go back to March 2020, hotel occupancy was 65% below that baseline. Now it’s about 3% below.

“In the past 18 months, we’ve passed the 2019 baseline in some ways. The average room rate actually exceeded the 2019 baseline beginning at about the midpoint of last year and is now significantly higher than in 2019.”

We are seeing a much stronger Monday through Wednesday travel period, which indicates it is business related.

– Jeffrey Brown, senior managing director, Cushman & Wakefield

Brown estimates that room rates averaged about $130 in 2019 but have risen to near $150 this summer. The change began last year when leisure travel came back stronger and faster than many experts anticipated.

“People call it ‘revenge travel,’ where everyone said, ‘I’ve got to get out of this house,’” Brown says. “That really drove last summer’s surge. Now everyone is expecting very strong leisure travel this summer.”

The speed of this comeback, however, may be only one of a number of surprises that have developed as the hospitality sector appears to be taking flight. Business travel, in general, was expected to take years to recover to pre-pandemic levels, and renowned business experts such as Bill Gates predicted that 50% of business travel would disappear permanently. These dire predictions haven’t happened yet. Industry analysis is showing that both business and business-related group travel, such as conventions and events, are on the road to recovery, Brown says.

“We are seeing a much stronger Monday through Wednesday travel period, which indicates it is business related,” Brown says. “And some of the urban centers such as San Francisco, Boston and New York City have gone from being about as bad as it gets for hotel occupancy, and lagging the nation as a whole, to being some of the strongest performers.”

Biran Patel, a senior vice president and national hospitality director for Marcus & Millichap, agrees that business travel is recovering. Recent surveys, he says, show that 70% of meeting planners forecast an increase in the number of bookings for the remainder of the year — an optimistic sign.

Another surprising aspect of the healing hospitality sector is that smaller submarkets have recovered faster than major metros. Through the first five months of 2022, Patel says that smaller metro areas are reporting higher occupancy rates, average daily rates and revenue per available room compared to 2019.

“If it’s Knoxville, Tennessee, or Sarasota, Florida, or Tulsa, Oklahoma, maybe you are traveling to see family or taking a short vacation by car, or even a staycation,” Patel says. “Whatever the reason, you are going to stay in a hotel. I think that has improved some of these secondary or tertiary markets.”

A third revelation for hospitality is that the consolidation that many observers expected during the pandemic never really materialized. Over the past two years, there had been warnings that a wave of hotel bankruptcies were on the horizon and that the industry would go through a phase of upheaval. But the doom-and-gloom prognosis didn’t come to pass.

Sure, there have been some acquisitions, such as the megadeal this past June in which Choice Hotels International bought Radisson Hotel Group Americas. The $675 million acquisition involved more than 600 properties. But that was a unique and complex deal. According to reports, one reason for the sale was that Radisson (which is owned by a Chinese conglomerate) was trying to disentangle itself from political conflicts.

“My opinion is that there has been some consolidation,” Patel says. “Maybe it is not at the level we envisioned or anticipated, but it is happening.”

Brown believes a combination of factors — including the return of leisure travel, as well as federal government support such as enhanced unemployment payments and the Paycheck Protection Program — kept the sector from heavy consolidation. Brown estimates that hotel transaction volumes are back to 2019 levels on a dollar-volume basis.

Looking to the future, there are many headwinds for the sector, including labor shortages. This past May, U.S. labor statistics revealed that jobs in the leisure and hospitality sector were down 8% from February 2020. That is 1.3 million fewer workers. Patel says that hotel costs are increasing as the industry competes with restaurants and other businesses for labor. Still, the long-term outlook is bright.

“It’s a very interesting time from an investment standpoint,” Brown says. “The takeaway is that the health of the underlying hotel business is continuing to improve. … At the same time, higher capitalization rates mean lower values, and higher debt costs because of rising interest rates means more difficulty in making deals work.” ●

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The Welcome Sign Is Back On

Jay Litt — Tue, 31 May 2022 17:00:00 +0000

The past two years have been brutal for the hospitality sector. The COVID-19 pandemic also decimated the restaurant industry. The National Restaurant Association estimated that by the end of 2020, about 110,000 restaurants had been forced into a long-term or permanent closure. And even today, restaurants are still struggling to find their way.

Hotels have not fared much better. The year 2020 ranked as the worst on record for U.S. hotels, with the industry experiencing all-time lows in occupancy rates and revenue per available room (RevPAR), according to hotel industry research company STR. That year, hotels experienced an aggregate of more than 1 billion unsold room nights.

Some facilities closed or drastically cut back their services, and hotel room revenue was cut in half to about $84.6 billion, the American Hotel and Lodging Association (AHLA) reported. More than 670,000 direct hotel-industry jobs and nearly 4 million jobs in the broader hospitality sector were lost due to the pandemic.

But as Maureen McGovern sang in the film, “The Poseidon Adventure,” there’s got to be a morning after. And sure enough, that is happening. The hotel sector is making a comeback, just not as quickly as everyone would like. Here is a roundup of the recent history of the U.S. hotel industry, which commercial mortgage brokers should keep in mind as they work with investors and lenders on these types of projects.

Downturn and recovery

Amid worries about the spread of the novel coronavirus, tourism across the globe slowed to a crawl in the spring of 2020. A series of restrictions were put in place for many foreign travelers visiting the U.S. On Jan. 14, 2020, Transportation Security Administration checkpoints nationwide counted more than 2.3 million daily passengers. By April 5, this number had fallen to 97,130.

The impact of the slowdown hit hotels hard. The situation was bleak until the government rolled out the $2 trillion-plus Coronavirus Aid, Relief and Economic Security Act. Even with hotels and restaurants receiving a slice of this capital, however, many businesses and properties in the hospitality sector failed.

By 2021, circumstances began to improve for the hotel sector. Some states began to ease their COVID restrictions as the pandemic seemed to be more under control. Tourism and leisure travel, which typically occurs from Thursday to Sunday, began to grow. Hotel room revenues came back strongly, jumping to $141.6 billion, about $56 billion above 2020 levels. But business travel continued to trend below the levels seen prior to the pandemic.

This year, the AHLA expects room revenues to reach $168.4 billion, just slightly behind the $169.6 billion recorded in 2019. Hotel loan delinquencies continue to decline, even in the commercial mortgage-backed securities realm. And while business travel is still recovering, an analysis from hotel research firm Kalibri Labs projects that it will reach 80% of 2019 levels by the third quarter of this year.

Even with its recovery, the hospitality sector has changed. Since the beginning of the pandemic, hotels have been cutting back on services, a shift that may continue well into the future. One example is that many hotels won’t provide housekeeping unless it’s requested by a guest.

Future headwinds

Looking forward, the hotel industry is going to experience some headwinds in the recovery process. The return of top-line revenue during the first half of 2022 is encouraging, but owners are seeing a decline in profit margins due to increased wages, inflation and other post-pandemic cost increases.

The erosion of these margins is concerning and will continue with the resumption of more services, such as housekeeping. Alternative lodging options, such as Airbnb and Vrbo, will continue to thrive. Major hotel brands have yet to acknowledge the ill effects of these additional competitors, but time will tell.

Increased operating costs, regardless of the growth in top-line revenue, will create stress on debt coverage. Declining profits will impact the capitalization rate, devalue the asset and place stress on bank balance sheets. Lending institutions may require hotel owners who lost value to add equity to their investment and lower the stress on existing debt.

Owners may not want to go this direction, and the industry could see a similar scenario to 2009 when RevPAR dropped by nearly 20% year over year. During the same period, profitability as measured by net operating income (NOI) fell by nearly 37%.

Actual values

A hotel is real estate. It’s true that economic changes can create a sudden loss of value, as described above, but does the hotel actually lose value? No. The hard asset, or the brick and mortar of the building, doesn’t change. Its value may decrease due to reduced NOI, but the building is still the same.

Knowing this, a lender should consider the conditions that created a loss of value. The culprits usually include some combination of poor management and deteriorating property conditions. The hotel might be losing its guest base, or the market where the hotel is located collapsed or had an increase in supply. It’s also possible that a hotel lost its brand name due to certain conditions and that the related economic stress affected the property’s ownership.

If these reasons are not the cause of a sudden decline in value, and the only reason is tied to the pandemic, then a lender should take certain actions. They should review the asset’s best years prior to the drop-off, then consider that adverse conditions may dissipate, thereby allowing the property to regain its footing. In other words, concentrate on what could be rather than what is.

There is talk of many hotels being sold during the latter half of 2022 and into 2023. Such transactions may take place due to foreclosures, bankruptcies or the dissolution of equity partnerships. Lenders shouldn’t throw the baby out with the bathwater. They should look at a hotel’s financial history to understand its potential. The market is now in a bubble, due in large part to the pandemic, but this is going to dissipate. Mortgage financing should have an eye for the future. And that future could produce ramped-up profits, much like what occurred following the previous industry recession in 2009.

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No doubt, this is a difficult place to be as commercial mortgage lenders, brokers and borrowers will be looking at present results to forecast future financial performance. But it is more important to look at the past as a means to predict a hotel’s future.

The pandemic can be categorized as a one-time disaster. The world and the hospitality sector are recovering. Lenders and investors need to be cognizant of what is happening now as well as what could happen over the next two years. They can be part of putting capital into a future growth scenario. Bubbles happen, but so do recoveries. Brokers can get a piece of the action. ●

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A Vital Step in Hotel Lending

Jay Litt — Thu, 30 Dec 2021 21:36:56 +0000

The COVID-19 pandemic has been highly destructive to the world — and more specifically, to the hospitality industry and hotel business. According to the American Hotel & Lodging Association, hotel room revenue fell by nearly 50% across the U.S. in 2020. Room revenues for 2021 were expected to remain 34% below 2019 levels. This has resulted in the closures of many hotels as well as major layoffs across the industry.

While there are new hotels being built, many industry experts suggest that there still is a bumpy road to navigate. Of the hotels that closed or remain in economic gridlock today, many have mortgage debt in place. Often, banks are the recipients of these financial failures and receivers oversee the damaged assets.

Considering the state of the hospitality industry, there are inevitably going to be a lot of new owners of hotels. These investors will need debt. Commercial mortgage brokers and lenders need to know what to look for — and what to ask about — with these properties as the new owners request loans to renovate and refurbish.

Heart of the deal

When it comes to hotel financing, commercial mortgage brokers and lenders should realize that there are many factors to consider. One of the most important, however, is that many new hotel owners will want to become affiliated with a brand — such as Marriott or Hilton, to name two well-known franchises.

To qualify for a franchise license, newly minted hotel owners are going to need a property improvement plans (PIP). These are mandated plans that allow owners to bring their properties into compliance with a brand’s requirements. The PIP may involve updates on everything from plumbing and electrical systems to food-and-drink facilities and fitness centers.

One thing that new hotel owners and their mortgage brokers need to keep in mind is that, over the past two years, there has generally been little capital spent to keep hotels fresh and competitive. To acquire a property and have a brand, borrowers are going to have to complete repairs and update work included in the brand-mandated PIP.

One crucial aspect of a PIP is a “comfort letter,” which is a document signed by the lender and the hotel brand. This letter is a guarantee that if the borrower does not continue making payments for any reason and the property is foreclosed upon, the brand will allow the lender to continue using the brand affiliation under various contingencies — one of which is to complete the PIP.

Due diligence

Commercial mortgage lenders need to be sure that borrowers have the capital to complete the PIP. Because the money to complete the PIP is typically part of the loan, lenders may need to include funds to ensure the borrower is covered and can complete any needed improvements. If not, and the borrower fails, the lender may wind up in a position to have to spend the money anyway to keep the franchise in place.

As such, lenders that make hotel loans need to be in a defensive state of mind when considering these transactions. It is critical that they find out whether a PIP exists and what requirements are detailed in these documents.

When reviewing hotel loan requests that include a PIP, lenders should work with experts in the PIP sector. They must understand what is being asked of the hotel owner by the brand and whether it will suffice in making the property competitive. After all, the hotel is the lender’s collateral.

The lender needs to have the PIP priced by an expert in this field and consider their next steps, such as engaging a capital project coordination firm to put the PIP package together. And, of course, lenders need to be sure they have a comfort letter from the brand.

Sizing the loan

Usually, a PIP is only written during a change in ownership. Otherwise, ownership follows brand-mandated dates for spending capital on the hotel. The PIP can be detailed and costly. It’s the brand’s name on the building. They want the property to look great, and for the guests to feel comfortable and willing to use other hotels that brandish the same name.

It’s useful to remember that lenders consider the property they are loaning money on as collateral. And to some extent, so do hotel franchises. These companies are strict in their inspections of properties. Brands require owners to spend money at regular intervals and cycles. To pay for these renovations, hotels usually accrue money in reserves. These reserves — often amounting to about 4% of gross revenue — are used for normal capital expenditures.

The debt that is sought for the acquisition of a hotel includes the PIP as part of the cost to buy the asset. This is why it’s critical for the mortgage broker to know whether the borrower is asking for enough money to complete the PIP. If the plan is not completed, the franchise has the right to walk away.

The next year or two will be a volatile time in the hotel industry and many hospitality properties are expected to trade hands. There will be losers and there will be winners. There will be a lot of loans and, as such, a lot of PIPs. Commercial mortgage lenders need to protect themselves by seeking out third-party partners that are familiar with PIP programs so that they are covered no matter what may come. ●

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