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Investing in Hotels: The Current Market and Upcoming Opportunities

An Overview of This Distinctive and Compelling Asset Class

(iStock)
(iStock)

In this two-part series, LoopNet provides an overview of the lodging/hospitality/hotel — terms that will be applied interchangeably throughout this series — sector. This is one of the most idiosyncratic asset types in real estate, as well as (potentially) one of the most rewarding. It’s also a sector that has been particularly impacted by the coronavirus, which has produced both distress and opportunities. Part one, presented below, focuses on the current and anticipated near-term state of the market, as well as potential investment opportunities. Part two centers around strengths, challenges and unique characteristics of the sector.

It’s probably not hyperbolic to observe that these are dark days for the hotel industry.

“You know the term, ‘reeling’ comes to mind,” said Jared Kelso, executive managing director of C&W Capital Markets, and one of three senior partners in the firm’s national hospitality capital markets practice group. “What’s going on in the sector today, unfortunately, has nothing to do with irresponsible investment or aggressive valuations or purchases. This is not a situation that anyone could control, but the industry broadly is on its knees.”

Sachin Patel, managing principal of Shiv Properties, which is a majority or minority stakeholder in 11 hotel properties in the southeastern United States, described the current circumstances rather succinctly: “I don’t think it could get worse than what it is today. We’re at the bottom of the market.”

According to STR, which provides data benchmarking and analytics for global hospitality sectors (and, like LoopNet, is owned by CoStar Group), U.S. hotel occupancy for the week ending November 28 was down to 36.2%, a 28.5% drop from the same time period in 2019. Meanwhile, RevPAR (revenue per available room) across the U.S. dropped by 41.2% compared to 2019, settling at $33.49 per room.

And, yet, where there is adversity, an intrepid investor may also uncover opportunity. Certainly, that’s what the relatively high volume of hotel sales on Ten-X Commercial (which is owned by CoStar Group) suggests. While hotel sales on the site this year will likely fall below the number of transactions reported in 2019, which totaled more than $585 million, 2020’s year-to-date volume has already exceeded $330 million, which means that there are still a plethora of investors seeking hotel properties.

For investors new to the hospitality space this unique market interval may seem like an ideal moment to enter the sector. As Kellan Florio, managing director and global head of lodging and leisure investment banking for Goldman Sachs, recently told Hotel News Now (a CoStar Group news service covering the hotel industry), “People looked at the hospitality space this year and said, ‘OK this is that time. This is the once-in-a-decade or maybe lifetime opportunity to find discounted deals.’”

That kind of conjecture may very well be accurate — perhaps even more so in 2021 than it was in 2020 — but the hotel sector is not an asset class built for casual investors, even if you are eminently familiar with other types of real estate, such as office or industrial.

As Kelso told LoopNet, “You can’t own a retail strip and go into the hotel sector thinking that they have anything in common … there’s virtually no similarity.” This is why it’s so important for nascent hotel investors to understand critical components such as:

  • The current state of the market.
  • Where the opportunities can be found in the months and years ahead.
  • The unique attributes and detriments of the asset class.
  • The implications of the franchise model.

The State of the Hotel Market

Where It’s At

While the hotel market has been affected across pretty much every subsector by the coronavirus and its attendant recession — from luxury to economy and from business to tourism — the reaction hasn’t necessarily been evenly distributed.

According to Ford Barton, principal of Lodging Partners, a brokerage and advisory firm focused on the hospitality and lodging sector, “Large hotels in urban locations with a lot of meeting and convention space have been impacted by far the most, and the smaller economy interstate-oriented hotels have been impacted the least.” He added that, “There’s more leisure travel today than business travel.”

Patel echoed these sentiments, though his characterization of this dichotomy was blunter. “I think the corporate market has taken a ridiculous beating. And I think the tourism markets are down, but they are able to at least function.” He went on to say that “The Grand Strand market [in Myrtle Beach, South Carolina], where most of my major investments are [located] is down about 50%, but it is doing better than the rest of the corporate markets that we’re invested in, such as Charlotte, North Carolina and Nashville, Tennessee.”

Kelso said that the coronavirus has fostered a nearly unprecedented situation that the industry has struggled to contend with. “You can solve a lot of problems with cash flow, but when there’s no heads in beds, there’s really not much owners can do to change that in this environment.”

Barton did observe that there is one subsector that has performed well during the pandemic. “The one shining star we’ve had throughout 2020 has been extended stay properties; they have actually performed quite well.” He theorized that this was because extended stay units offer in-room kitchen facilities, which allows people to travel, while still minimizing their interactions with others.

Patel agreed that extended stay hotels had performed well in 2020, but he suggested an alternative reason for their success. “I think, locally in the Grand Strand, it’s because people can’t afford the rent on apartments and houses,” Patel said. “And they’re getting an all-in number of 200, 250 [dollars] a week to stay in a hotel that has a kitchen in it.” In other words, extended stay hotels aren’t thriving as hotels, per se, but rather serving as a form of alternative housing.

Where It’s Going

Despite the challenging state of the market currently, everyone that LoopNet spoke with in the industry remained optimistic about its future.

Kelso has worked in the hotel sector since he was 14 years old, starting out as a member of the cleaning staff during summer vacations. As an adult, he served in a management position for Marriot and as an industry consultant before transitioning into his current brokerage role. This long-term perspective may have partially informed his attitude about the future of the hotel industry. “Without question, I am incredibly bullish on the sector,” he said. “Travel is not going anywhere.”

Kelso was particularly optimistic about the outlook for business travel. “We do see a return to corporate travel in the second quarter of 2021 that will likely coincide with early stage distribution of a vaccine. We believe that corporate travel and group travel, in particular, are going to rebound stronger than ever, quite simply because a higher number of people working from home in the future will create a greater need for monthly or quarterly in-person meetings.”

Barton has enjoyed a similarly multi-faceted and extensive career in the hotel industry. Over the course of 37 years, he has worked in positions with Marriot and Choice Hotels, before developing and owning his own hotels. During the Great Recession, when financing for development became scarce, he shifted into his current brokerage and advisory position. Like Kelso, he is hopeful about the long-term future of the industry. “I think there are a lot of people that really like to travel for pleasure, as well as [for] work, and I think that the industry will start to recover once a vaccine becomes available.”

However, unlike Kelso, Barton is somewhat dubious about a swift recovery in the business travel segment of the market. “I think it would be very difficult for companies to accurately forecast their expenditures for lodging in 2021. Consequently, I just don’t think there will be very large budgets for corporate travel in 2021, but I think that will change significantly in 2022,” he said.

Patel concurred with Barton’s assessment. “I think the first quarter [of 2021] is going to be just like the fourth quarter and the third quarter of this year. But I think we’ll see the uptick start in the second and third quarter, on the tourism side. I think corporate travel is going to take a lot longer.”

A Moment of Opportunity for Hotel Investors?

So, is this the moment of opportunity potential hotel investors have been waiting for? Perhaps not just yet, but we’re getting there.

“There’s no guarantee that distress results in immediate product flow. So, what we generally advise people [to do] is to simply be patient. The deals will come,” Kelso observed. He went on to say that “the deals under 10 to 15 million dollars in size will largely be transacted on the online auction markets. And they are coming. But even situations where the borrower wants to give keys back to the lender, and the lender is willing to take them, that process takes time.”

While Patel noted that he has received some confidential offers from banks recently, he also felt that the market was in a bit of a holding pattern. “We don’t see many assets for sale currently, because people are robbing Peter to pay Paul and trying to make it work,” he said.

But Barton said that this dynamic couldn’t be sustained indefinitely. “I think that once 2020 financials are turned over to lenders, there’s going to be a lot of pressure on these lenders from their regulators to no longer ‘extend and pretend’ and force the lenders to deal with some of these troubled assets,” he noted.

Barton also observed that a lack of financing options has slowed the pace of transactions in the hotel sector. “Right now, the lodging transaction market has declined significantly, and there’s a big spread between the buy and the ask for these properties. But the biggest reason for the decline in transactions is the lack of debt and funding options. Lenders often have a herd mentality and they have red-lined the entire hospitality sector.”

Nonetheless, Barton expects that transactions will accelerate in 2021, even if that means investors will have to supply more equity than usual. “Make sure you have plenty of equity available; line up your friends, family and partners and put your equity together,” he said.

In terms of evaluating potential investments, Kelso said that investors should realize that cap rates, one of the most fundamental tools that investors utilize to analyze most real estate transactions, can be less relevant to hotel properties. “I hate to quote cap rates in the hotel sector,” he said. “It’s a very misleading statistic. Because two similar assets that sit next to each other and look and appear the same to the user, may have vastly different profiles with regard to their cash flow. In the best of times cap rate is not a great indicator; it’s not an indicator at all in 2020.”

Instead, Kelso suggested that investors should “be looking at the stability of the demand for that particular hotel, and the likely speed of recovery of that demand by sector — when you think about leisure travel, versus corporate travel, versus group travel — and the capital needs that the property has.”

Patel’s perspective coincided with both Kelso’s advice regarding carefully evaluating potential investments, as well as Barton’s guidance concerning equity. “There’s going to be a bunch of opportunity in the next 24 months for anybody that wants to get into the business. It’s about choosing wisely, timing it correctly and making sure you have the equity to put into a deal.”

In part two of this series, we’ll dissect the advantages and disadvantages of hotels relative to other real estate assets and consider some of the unique aspects of hotels that investors need to be aware of, including franchises and operational challenges.

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