Notwithstanding a persistent jittery economic environment and rising global geopolitical concerns, market conditions in the U.S. appear simultaneously shaky and resilient, and lodging sector metrics particularly average room rates and RevPAR, continue to achieve exceptional results as demand for travel and lodging remains robust. Although overall leisure patronage is trailing off from pandemic highs, due in part to Americans opting for international travel, domestic corporate individual and group meeting business continues to rebound to pre Covid-19 levels. Additionally, inbound international travel to the U.S. continues to recover.
Raised levels of inflation continue to fuel rising prices, particularly for groceries and gasoline, are challenging consumer confidence although Americans continue to voraciously spend on material goods and experiences including travel. Low unemployment rates and high job growth render the nation’s employment market strong. However, many major companies are struggling to adapt to the changing economy and have implemented significant layoffs. Examples include Cisco Systems, Inc., CVS Health, Epic Games, Inc., Farmers Insurance Group, Geico, General Motors Company, Google, Juniper Networks, Inc., LinkedIn, Qualcomm, Qualtrics, T-Mobile, Tyson Foods, Inc., Washington Post, Wells Fargo & Co., and Yellow Corporation.
Labor shortages, rising cost of debt, continued supply chain constraints, and increased inflation of operating costs are challenging the U.S. lodging sector. In addition to the need to replenish FF&E reserve accounts, many owners are being forced to execute deferred capital expenditure refurbishments to remain in brand PIP compliance. On the flip side, the nation’s net lodging supply growth remains well-below the long run average.
Recent rising debt costs and tightening lending standards have exerted negative pressures on commercial real estate values. While obviously a risk for existing property owners, investment opportunities will evolve as trillions of dollars of commercial real estate debt matures over the next several years. The bulk of this debt originated when base interest rates were near zero and will need to be refinanced in an environment where rates are much higher and in a market with much less liquidity. Existing debt facilities scheduled to mature over the next 12 to 18 months will create new venture opportunities while challenging numerous existing investments. Many owners will need to provide or source additional capital to bridge unavoidable financing gaps when dealing with maturing loans, while some sponsors will be forced to sell asset(s).
In addition to the recent elevated cost of debt, wide bid-ask spreads have resulted in subdued transaction volume thus far this year. Continued strong sector metrics are anticipated to backdrop large amounts of impending debt maturities on the horizon and billions of dollars reaching the end of underwritten holding periods, all of which will catalyze transaction activity. Significant amounts of sidelined capital chasing yield will be deployed into a variety of hotel investment opportunities that currently have compromised financial structures however offer upside through vigorous asset management. Furthermore, with Covid-19 rapidly becoming a distant memory inbound foreign investment into the U.S. is now approaching pre-pandemic levels.
Despite recent increases, interest rates are still low by historical standards, yet borrowers have been hamstrung due in part to the historical capitalization rate compression that has occurred over the past decade, combined with a widening spread from lenders. The pullback in overall leverage that debt providers are willing to lend at is tied directly to capitalization rate inflation concerns.
Although credit markets are volatile, there is no shortage of available financing for hotel assets as institutional and private investment funds are backfilling a void left by banks. Knowledgeable sector investors who comprehend market nuances and can leverage relationships with multiple types of capital partners can secure investment funds regardless of market conditions. Lenders make money deploying debt capital, not sitting on the sidelines with cash.
Sophisticated investors will utilize a prudent balance of debt and equity to avoid overleverage. Furthermore, they will make use of interim debt and not lock in long term fixed commitments only to end up with large prepayment obligations when interest rates decline in 2026-27. Property values in 2027 will no doubt exceed the peak of 2021-22 as recoveries always exceed previous all-time highs. Those who buy now at market pricing, particularly in major U.S urban markets, and are smart about capital stack structure and coverage with stress tests will prevail.
Author: Daniel H. Lesser, Co-Founder, President, and CEO for LW Hospitality Advisors
Daniel H. Lesser has more than forty years of specialized experience worldwide in hospitality related: real estate appraisals, economic feasibility evaluations, investment counseling, asset management, receivership, and transactional services of hotels, resorts, conference centers, casinos, mixed-use facilities, spa & wellness properties, and timeshare/fractional ownership properties.
Daniel Lesser offers a 360-degree, cross-functional and multi-disciplinary lodging industry perspective. Proffering innovation and strategy, he serves as a third-party advisor and independent expert witness, neutral arbitrator, business model canvasser, asset manager, property/business receiver, and as a principal investor, borrower, guarantor, and franchisee. Daniel Lesser provides services to corporate, institutional, municipalities, and individual clients on all facets of hospitality real estate including site evaluation, highest and best use analysis, appraisals for mortgage, acquisition and portfolio management, workout strategies, operational analysis, property tax assessment appeal evaluations, economic impact studies, market and feasibility analysis, strategic planning, management and/or franchise company selection and contract negotiation, deal structuring, and fairness opinions. Daniel Lesser has served as a Court Appointed Receiver in connection with dozens of hotels throughout the U.S.
