Despite broader market volatility and the increased cost of capital, deals are getting done. The question remains: what will the market look like in 2023? HOTELS asks the experts.
In Part 2 of HOTELS series about the outlook for merger and acquisition activity in 2023, we discuss the near-term outlook for debt availability, the potential increase in non-traditional debt sources and just what might the makeup of buyers look like. Read Part 1 here.
HOTELS: Will debt availability improve or worsen in the near term?
Robert Hecker, Horwath HTL, Singapore: Banks have money to lend, and higher interest rates create opportunities for improving margins/spreads. So, I think we’re going to see improving debt availability for the hotel sector.
Charles Human, HVS London: That is the big unknown. The market is already pricing in substantial rate increases, so it is more about availability than cost moving forward. This really all comes down to the extent to which trading becomes affected by the current inflationary pressures and turmoil in the capital markets (i.e. whether or not economies do sink into general economic recession). Right now, trading remains robust, but there is little visibility and lead times are short. If countries do fall into recession, the availability of debt from traditional lenders is more likely to shrink than recover.
Pedro Petiz, Avington Financial, London: Debt availability is likely to be tighter going forward as lenders will be more careful about leverage ratios offered in their borrowers’ business plans. Despite a relatively large pool of liquidity right now at banks and debt funds, we do not believe that lenders will lend ‘for the sake of lending’ and will be prudent allocators of capital assessing transactions on the basis of (i) who is the borrower; (ii) who is the target; and (iii) what is the business plan.
Denny Meikleham, Berkadia, Boston: Unfortunately, it’s very hard to obtain an acquisition loan or construction loan right now. If they’re available, it’s expensive and only getting worse.
Andrew Broad, San Francisco: The cost and availability of debt will continue to be an issue for the next 12-18 months.
H: Will there be an increase in non-traditional debt sources, and what will it look like?
Hecker: With the liquidity in the market and rising interest rates, private equity can potentially be put to use for alternative lending, mezz financing. There’s also increasing “green” lending and the hotel sector has plenty of opportunities for “green” improvements and carbon emission reduction.
Human: The debt funds will step in to take advantage. We may see some of the considerable amounts of dry-powder equity looking at lending.
Petiz: Absolutely. Already we are seeing several new players becoming sources of non-traditional debt (or quasi-debt) capital, including preferred equity, convertible as well as sale and leaseback capital. Although these forms of financing have been available before, there is a new breed of investors with deep pockets entering the space, and able to think about and structure strategies that meet borrowers’ objectives in the face of current macroeconomic conditions.
Meikleham: I assume it will be from the public markets.
Broad: Assumable debt and seller financing will become more common as a way for sellers to maintain pricing and, overall, keep deals flowing.
H: Who are the most active buyers, and why?
Hecker: Private equity seems to be everywhere now and taking an interest in the hospitality sector. Sovereign wealth funds, as well.
Human: Europe is looking pretty interesting for dollar-based buyers, but it’s hard to see the PE funds being particularly active in the near term. That will, of course, change if there is distress. We will probably see the greatest activity from long-standing European investors who do not require significant leverage and see long-term value.
Meikleham: I believe any group with cash is going to be very selective in the coming year. Most of the buyers that I’ve talked to believe there will be more distressed assets to buy and distressed loan sales to buy, as well as rescue capital opportunities in the next two to three years.
Spencer Scott, Berkadia: We anticipate the most active buyers in 2023 will be private cash buyers. The common themes surfacing in Q4 are increased inquiries from family firms, inquiries from 1031 exchange buyers and outreach from entrepreneurial firms with “fundraised” ready to go.
Ryan Lindgren, Berkadia: All cash buyers and/or buyers with deep banking relationships have a material competitive advantage over the rest of the market right now. The advantage of all-cash is obviously the elimination of expensive debt, but it also provides certainty to a seller and could speed up the closing timeline. Buyers with deep banking relationships are getting out-of-market debt terms that are 300-400bps inside of market debt, giving them a clear advantage over groups that don’t have those relationships.
Broad: As always, property fundamentals like asset condition and quality, location, market potential and so on drive the most successful deals. Motivated all-cash buyers or low-leverage buyers may win the day in the present financial environment, as well as those buyers who are creative with their capital structure.
H: Predict transaction volumes in North America versus EMEA versus Asia Pacific?
Hecker: I can’t get quantitative about volume, but North America is typically the biggest market and is expected to remain so. Asia Pac remains limited primarily to Japan and Australia, with smatterings of deals in Thailand, Indonesia, Malaysia and the Maldives. Europe is somewhere in between.
Human: Volume will almost certainly remain highest in North America – it always is and it is the market that sees the quickest correction in a downturn. Then Europe. Middle East will continue to see low levels of transaction activity.
Petiz: North America is expected to continue to lead transactional volume due to its sounder and more stable economic position, especially as it relates to energy and utility prices.
We expect EMEA and Asia Pac to see a natural deceleration mainly due to geopolitical issues. However, there will be regional standouts such as Spain, Portugal and Italy in Europe and India and Australia/New Zealand in Asia Pacific.
H: How much leverage is being required to get deals done?
Hecker: 60% is the norm.
Human: That depends.
Petiz: We expect to see a set of less aggressive, better-equitized buyers succeeding in more auction processes than in prior cycles. High-leverage purchasers will have a blended cost of debt in the high single digits which will require near-flawless business plan execution and leaves little margin for error, making those few and far between.
Meikleham: I’m hearing 60% leverage is the new norm on the few acquisition loans I’ve heard about.
Broad: The least expensive debt will be found on deals with 14+ in place debt yield (likely equating to 50% to 55% LTV). The lower the debt yield, the higher the interest rates. Fixed-rate conservative debt today is in the low 7s. Floating rate debt on “value-add” deals is SOFR +600; we are approaching and exceeding double-digit interest rates for these deals.