Kathy explores options for hotels facing difficult decisions and discusses how lower than normal new construction will assist hotels in the long run.
How are we advising hotels that are faced with selling during a downturn?
The answer to this question depends upon the motivation of the seller, and whether the seller is under duress. If the seller is under no duress, but had planned to exit the investment this year, then the seller needs to hold the asset for another few years in order to achieve the optimal valuation. If exiting the investment now is more important than achieving an optimal sales price, then the seller should anticipate that the best scenario will likely be achieving a price discount between 10% and 20% of the 2019 asset value. Providing some seller financing to the buyer for a few years may help the seller mitigate the percent loss in value from the 2019 evaluation.
If the seller is under duress, what is the source of the duress that is driving the motivation to sell the asset? (1) Is there financial duress, whereby the seller cannot meet loan obligations even after a loan modification or restructuring has been worked out with the existing debt capital position? (2) Or is the seller experiencing operational duress, with poor management and an operating performance below what the property can achieve? Buyers will naturally try to gain more leverage in negotiating a price with a seller who is under duress; in general, with a seller under duress that must sell the hotel in the current period, buyers will attempt to negotiate a sales price at a 20% to 30% discount from the 2019 asset value.
But depending on the source of the duress, there are both creative solutions and more benign forms of rescue capital available to sellers, which can mitigate the ultimate discount to be taken on the 2019 asset value should the owner be able to avoid a sale in the current period. For example, some rescue capital will fund additional money into the equity capital stack and take over the management of the operation; often, this can solve financial and/or operational duress issues. In such a case, the rescue capital may negotiate a “proxy sale” of the owner’s position at a future trigger date; thus, ownership may be able to divorce themselves of overseeing the operation of the asset and exit the asset at a much better payout in the future.
Another solution may be to find additional funding needed for the capital stack during a time of financial duress from CPACE providers, assuming the asset qualifies under the new “look back” provisions.
What is the outlook for new construction?
Debt capital funding for new construction will be more constrained, with senior debt servicers wanting to limit their exposure to a maximum of 60% to 65% LTC. Interest rates will also remain at current levels or increase slightly because of the perceived risk in this asset class and/or the desire of the borrower to avoid loan guarantees. In short, with more constrained financing, the level of new hotel supply arriving to market over the next few years will be lower than normal, which will indirectly help existing hotels working through a recovery of both demand and ADR.
How is the luxury hotel market doing? Is it recovering?
Demand recovery for luxury hotels offering an outdoor experience and located within driving distance of their main source markets has been very strong. This is not surprising as, historically, the drive-to regional markets are the first to recover demand during a downturn in the hotel industry.
For example, within several weeks of reopening, beachfront hotels on both coasts of Florida are reporting weekly occupancies at 90% to 100% of 2019 levels. With the strong demand levels, operators also report continued strengthening in ADR levels to within a striking distance of their 2019 performance. These beachfront hotel operators acknowledge that they are benefiting from the typical period of family summer vacations; however, they believe that catering to an outdoor vacation experience with the ability of the guest to socially distance has attributed to their extraordinarily fast demand recovery. They also report strong onsite F&B sales due to many local restaurants not yet offering dine-in options and to guests not wanting to leave the hotel campus and increase their exposure to additional people. Another luxury hotel, which is focused on a culinary experience within a self-contained campus of hiking trails, has reported both a complete recovery of demand and ADR at 2019 levels; the self-contained campus and outdoor-centric experience are major contributing factors to this performance. Lastly, operators with a group component to their business noted that they are focusing on increasing their proportion of leisure demand over the next several years until group demand fully recovers.