Markets to monitor
In a previous post, I argued that capitalization rates have essentially been thrown out the window for the last couple of years. However, a strong 2011 will again have us applying cap rates to improved income as we move into 2012.
I recently reviewed a report of hotel transactions from 2005 through September 2011 in which approximately 50 U.S. markets were cited. Through 2011, the average cap rate for reported hotel trades in the United States was 7.5%. By comparison, the average cap rate from the four-year span from 2005 to 2008 was 8.7%. It does not take long to justify the lower aggregate cap rate in 2011 versus that of 2005-2008. Bottom-line income is almost universally down versus peak years, and buyers are optimistic that performance can return to peak.
What stood out were the markets in which the 2011 average cap rates are greater than the 2005-2008 average. Is it a matter of undervaluation, or negative factors influencing market sentiment? Let’s examine each market individually:
(2011 average cap rate: 9%; 2005-2008 average cap rate: 8%)
Chicago has been a case of unappealing hotel product for sale in the downtown market coupled with oversaturation in the outlying areas, keeping investors at bay. Both public and private REITs, and offshore capital accredited with driving low cap rate deals during the downturn, continue to have Chicago on the acquisition short list. Considering in 2010 the Westin River North traded at a rumored sub-5% cap on 2008 income, I don’t believe there is much to worry about with core-branded, well-located assets. In addition, three upper-upscale and luxury downtown hotel sales are either pending or did not report a cap rate at close.
Bottom line, attractive assets with little “hair” on the deal should trade below the 2005-2008 average cap rates through 2012, as an already promising RevPAR recovery continues to move in the right direction. However, it is important to keep in mind that Chicago is limited by a relatively low rate ceiling compared to the top five markets and is one of the most location-sensitive markets in the country.
(2011 average cap rate: 9.9%; 2005-2008 average cap rate: 8.5%)
Of the top 25 U.S. hotel markets, only Detroit, Phoenix and Tampa, Florida, have experienced a greater RevPAR drop over the last five years, with Atlanta RevPAR having fallen 10% since 2006. Also consider that over the last two decades, the number of hotel rooms in metro Atlanta has nearly doubled. There have been several closed or pending transactions in Atlanta this year of core-branded hotels. However, many of these have been portfolio deals with assets in other, more attractive markets.
With November marking the 52nd straight month in which Atlanta unemployment has exceeded the national average and office space vacancy still among the worst in the nation, the macro indicators for Atlanta do not bode well. Lastly, with over 8,000 rooms in the construction pipeline, only New York, San Diego, and Washington, D.C., are expected to add more rooms in the coming years. Proceed with caution.
Charlotte, North Carolina
(2011 average cap rate: 9.5%; 2005-2008 average cap rate: 8.6%)
With the exception of 2007 — when 28 hotels traded hands — Charlotte is not a market with much action, averaging just a half-dozen sales each year. It is a market that is most appealing to regional owner/operators considering the vast majority of institutional capital, and REITs that have entered the market did so via larger portfolios.
Yet if you consider the upward trends versus value, this may be a dark-horse market to hit sizeable investment returns during the next cycle. Through second quarter 2011, Charlotte experienced 18 straight months of RevPAR improvement, its best since 2006-2007. Year-to-date RevPAR was up 10.2% over prior year compared to the 9.7% increase for the top 25 U.S. hotel markets. Passenger enplanements/deplanements at Charlotte Douglas International Airport is up 6% in 2011. Charlotte is on pace to exceed room night target pace by 130% in 2012, 100% in 2013 and 131% in 2014. And despite unemployment levels still above 11%, Charlotte has shown a 0.5% decrease in this figure in 2011.
In a previous blog, I argued that developers should consider secondary markets for boutique hotels … perhaps Charlotte?
(2011 average cap rate: 10%; 2005-2008 average cap rate: 8.9%)
It’s easy to dance around the topic of non-gaming hotel performance in Las Vegas. In fact, many industry publications and reports exclude Las Vegas altogether. This is not an excuse for avoiding great detail here, but with only three reported hotel transactions this year, we don’t have a credible basis to use. In the near future, however, expect a blog tackling the one U.S. hotel market no one seems to get.
San Jose, California
(2011 average cap rate: 8.4%; 2005-2008 average cap rate: 8.2%)
In a region that varies considerably from one market to the next, the greater San Jose/Silicon Valley/South Bay market as a whole continues to flourish. The prize markets of Mountain View, Palo Alto and Cupertino — driven by the ever-growing tech campuses — post some of the highest occupancy marks in the nation. However, many of the outlying resort markets are highly seasonal, lucky to have year-round occupancy percentages north of 50%.
But as a whole, the numbers don’t lie in that San Jose-Santa Cruz has been one of the strongest hotel markets during the recovery, posting a 15% RevPAR increase in 2010 and 14.5% increase through second quarter 2011. With only two properties in the region under construction, what’s keeping investors from paying up? You can bet that Apple Campus 2, a 2.8 million-sq-ft (260,129-sq-m) office complex set to open in 2015, will only continue to lure other tech companies to the area. Barriers to entry will become more of a challenge for hotel development moving forward. Assets that are able to draw business from Silicon Valley should be trading at a greater premium. Perhaps investors are still nursing their wounds from the last tech bubble.