A summer filled with wildcards
Rich Warnick?s initial blog entry and subsequent responses touched upon several questions that are still much debated today. Is there too much money on the sidelines? Have both asset and bond pricing recovered too aggressively? Is hotel debt financing back? Will fundamentals support these technical investment trends? Obviously, the jury is still out.
Investment opportunity is increasing, though we are coming off a two-year period where transaction volume was nill. Most of us anticipated significantly greater opportunities by now given the extreme performance pressures and default spikes experienced since 2008. Critics suggest that lenders need to more aggressively perfect their security interests. Proponents respond that more accommodating lenders and steadfast owners avoided selling at the least favorable moment, and extentions have thus far allowed greater value recovery. Note that several of the announced sale transactions during 2009 and 2010 include what many would define as a foreclosure rather than an arm?s length transaction. Moreover, a very robust secondary hotel debt and bond market exists; it just is not as well publicized as real estate sales.
While we and many other groups have substantial equity capital to invest in the hotel sector, an equal challenge remains the relative dearth of quality investment opportunities. We are either seeing the ?worst first? or are witnessing pricing premiums being paid for the few high quality offerings that have become available. Quality assets located in barrier markets with existing EBITDA in place are fiercely sought after by public companies, as accretive investments are possible when multiples still are at 14X levels despite recent pullbacks.
Private investors are also lowering return requirements as our most uncertain moments are behind us and a bottom seems to have formed. Despite potential concerns over a mini-bubble, it is normal to experience low cap rates on trough income (as opposed to say low caps on peak income as in 2007). Regardless, firm pricing trends will lead to increased product availability — both asset and loan sales.
Loan originations also seem to have rebounded a bit, though it is still challenging to underwrite proceeds above $75 million, or transitional assets needing capital improvements. A good portion of new hotel financing capacity also seems to be relegated to existing borrower restructures. Fixed rate financing is more common lately, particularly as the CMBS market attempts to regain traction, though many hotels are better suited to floating rate structures given current depressed cash flows and the ability to price inventory daily. Construction debt is virtually non-existent despite declining costs (not necessarily a bad thing). Loan covenants are back.
Underlying these trends are a few critical wildcards: macro economy, interest rates and hotel profit fundamentals. Will we experience a confluence of monetary defaults and increased maturity defaults thereby causing further distress, or will income recovery be vigorous enough to provide a solution?
This blog will explore these additional questions in later entries. Meanwhile, enjoy the rest of the summer.