Total revenues for the average American hotel returned to 2019 levels in 2022, but profit recovery won’t be seen until later this year, the latest study has found.
According to CBRE’s February ‘Investment Performance’ forecast, ongoing revenue recovery has helped hotel franchise and management companies benefit the most because the fees they receive are often earned as a portion of revenue.
However, for most hotel owners, their lenders and investors, the lagging return to profits has become a challenge since the profits from hotel operations help them pay any debts and offer returns to their investors.
Based on a study of EBITDA and interest expense data from CBRE’s ‘Trends in the Hotel Industry’ database, rising profits and reduced interest payments have helped an increasing number of hotels to cover their interest obligations in 2022. This, however, is becoming more difficult given the increasing interest rates.
To help analyze the ability of American hoteliers to pay their interest expenses, CBRE surveyed a sample of 575 hotels that reported interest payments in their operating statements from 2019 to 2022. In 2022, the hotels averaged 167 rooms in size, occupancy of 67.8%, ADR of $168.6 and RevPAR of $114.31 compared to the $113.71 of RevPAR recorded in 2019.
Hotels that failed to make any interest payments in 2020, 2021 and 2022 were not included in the analysis.
INTEREST COVERAGE
In 2019, 93% of these hotels achieved EBITDA levels higher than their yearly interest expense. In 2019, the hotels achieved an average interest coverage ratio (EBITDA divided by interest expense) of 2.32x. Limited-service hotels registered the highest interest coverage ratios (2.52x), while resorts recorded the lowest (1.7x).
In 2020, the pandemic-resultant recession saw the average interest coverage ratio falling to 0.23x. Only 37.4% of the hotels generated enough cash from operations to cover their interest litigations, with extended-stay hotels faring the highest.
Among the rest of the hotels, owners had to call equity, utilize their operating or capital improvement reserves or negotiate a loan modification with their lender. On average, full-service and all-suite hotels saw the highest levels of distress in this period.
By 2022, 89.2% of the hotels achieved EBITDA higher than their interest expense, and the coverage ratio jumped to 2.72x, aided by better performance and a favorable interest rate environment. While the average coverage ratio surpassed that of 2019, the percentage of properties able to meet their interest payment obligations was less than in 2019. This meant some of the properties posted robust recoveries and were more secure in their interest coverage than before the pandemic.
However, not all properties which covered their interest expense in 2019 could improve their profits in 2022.
Leisure travel and remote work helped drive the performance of resorts. In 2022, the relatively robust rebound in both revenues and profitability enabled 92.9% of resorts to earn EBITDA greater than interest expense. The average interest coverage ratio for resorts in 2022 was 3.7x.
The metrics among resorts were not only higher than in 2019 but also higher than the respective metrics for limited-service, full-service, all-suite, convention and extended-stay hotels in 2022.
INTEREST EXPENSE
Along with the rising profits, the study noted lowered average interest payments by hotels.
Average interest expense fell 4.4% in 2022, $5,921 in 2022 per available room from $6,192 in 2019, while other property types reported an increase in their interest expense.
The decline in relative interest expense can be attributed to a significant dip in prevailing interest rates in this period. From the beginning of 2019 to March 20220, the Federal Reserve dropped the Federal Funds Rate (FFR) from 240 bps to 5bps and held FFR close to zero until March 2022.
From March 2022 to the end of the year, the Federal Reserve reversed its course and raised FFR by 425bps, which saw a rapid rise in debt service for properties that are leveraged with floating-rate debt.
FUTURE REQUIREMENTS
CBRE’s February 2023 ‘Investment Performance’ has predicted average hotels in the U.S. to return to 2019 EBITDA levels this year. CBRE then predicts an average 4.8% annual EBITDA growth rate till 2027. This is higher than the expected pace of inflation, a net positive for hotel owners.
If one wonders when the interest rate will be moderate, the CBRE study said all eyes would be on the Federal Reserve, given the recent unrest from the bank failures in March and indications regarding when they will start lowering the FFR amid tightening financial conditions both in the country and abroad.
For hotel owners, what comes as welcome news is that there is substantial liquidity in the debt capital markets as lenders continue to favor hotels as an asset class, considering the relative outperformance compared to other property types.