WASHINGTON, D.C. — Higher interest rates make it tougher to buy or build hotels, but as the Federal Reserve signals that it could remove its heavy foot from the pedal, buyers and developers could be in a position to have their checkbooks ready.
The Fed since March 2022 has raised rates in succession in order to curb inflation—it’s currently to a range between 4.75% and 5%—but there are signs that it could start to back off. “We are much closer to the end of the tightening journey than the beginning,” said Loretta Mester, president of the Cleveland Fed, on April 20.
Any signal that interest rates will abate is soothing for investors on the lookout for assets. It was a topic of discussion at the recent Bisnow Lodging Investment Summit, where leaders of the hospitality industry converged at the Hilton Washington DC Capitol Hill.
Inflation is a two-way street for hoteliers. On the one hand, daily leases allow operators to change hotel rates on a nightly basis. This dynamic pricing gives hoteliers the ability to keep up with both supply and demand changes, but also fluctuations within the broader economy.
“Right now, hospitality is the best bet against inflation,” said Marc Magazine, executive managing director at Savills Hospitality Group. “Daily rates can change every day to keep up with inflation.”
Unlike 2020, when no one was traveling, the past two years have been gangbusters for hotels, specifically resorts, extended-stay properties and others in so-called “drive-to” markets, benefitting from pent-up leisure travel demand. Concurrently, there has been a smaller amount of new supply entering markets, giving operators further cover to raise rates.
Magazine pointed out that people are traveling right now, but does that mean hotels are an investment opportunity?
Part of hospitality’s allure is it benefits as an inflation hedge, said Adi Bhoopathy, managing director of Noble Investment Group. It’s one reason why investing in hotels is attractive. “Hotels are yielding assets,” he said, “and it’s why there are new entrants coming into the space, buying into the yield, but you need to have a strong capital market to execute.”
The capital markets are anything but stable now, with investors playing the wait-and-see approach. “The tick up of interest rates has slowed down sales, but people have cash to spend,” said Magazine. He believes that interest rates are poised to move up 25 basis points again, but abate by the fourth quarter. “There may be slower transactions over next few months but could then pick up into Q4 and into the next year.”
He further added that’s not taking into account the extraordinary amount of loans coming due, which will force owners to refinance at likely higher rates or sell. Beginning at the start of 2022 and through the end of 2023, nearly 45,000 CMBS hotel loans totaling about $30 billion in value were set to mature, according to analytics provider Trepp.
Higher interest rates increase the cost of capital; they also impact cap rates and have a knock-on effect on profitability. “Higher interest rates are impacting our bottom line as much as deal flow,” said Dana English, CFO of Excel Group, a private equity shop focused on the hotel space, particularly limited-service assets.
For now Excel Group, which owns 42 assets in the U.S., is biding its time, English said, which means a combination of acquiring assets and “sitting and waiting.” In the interim, English said that her firm is making sure that its bank partnerships are on solid footing for when they become more earnest buyers.
SIZING UP OPPORTUNITY
The murky macro-economic climate is hard to navigate, but advantageous for both specialist hospitality investors and thematic investors who have a finite understanding of the operating landscape. Though panelists acknowledged the investment space becoming more crowded, Bhoopathy noted the advantage to be had over what he called “generalists,” or those investors without the background. “You have to have conviction when things are unclear,” he said. “With current the capital markets as they are, it’s not one size fits all; being a specialist allows you to access debt easier.”
Tapping into debt is more expensive, but available. All-cash buyers have an advantage, but not everyone has the juice to do that. Meanwhile, recent regional bank upheaval has made it harder, but could bolster debt diversity. According to a recent Moody’s report, 135 U.S. regional banks with between $10 billion and $160 billion of assets hold 13.8% of commercial real estate debt, far lower than what was initially believed. Though there is no underestimating the stress on the debt markets caused by regional bank failure, Moody’s also noted that commercial real estate could benefit from a larger pool of lenders, from life insurance companies to bridge lenders.
“Debt is available and a basis of optimism,” said Bhoopathy, but noting the pressure on middle-market banks that has opened up the door to more private lenders, including mezzanine and rescue.
For traditional loans, more equity is required to secure debt compared to last year, said Magazine. Whereas debt could be financed at 65% loan top cost compared to prior years, now, according to Magazine, debt seekers now are looking at 50% to 55% LTV. “The equity is higher, it’s not easy and it is taking longer,” Magazine said.
Expectations were that the pandemic and attendant impact of it would create a distressed asset environment; to now, it hasn’t come to fruition. Yet. “There is not a lot of distressed assets on the market,” Magazine said. The amount of CMBS loans coming do could change that. “There is some anticipation of that,” Magazine said. “Lenders are working with owners, but there is still a [wide] spread between sellers and buyers is still there. The job is to try and get them closer together.”
It’s not just loans coming due that could force transactions. In the wake of the pandemic, property improvement plans (PIPs) were avoided by owners and accepted by the brands. The latter, now, are restless and less compromising. “Stress is building,” Bhoopathy said. “PIPs are coming after three to four years when hotels needed to renovate.”
WHERE TO BUY
Every buyer is looking for diamonds in the rough, like English’s Excel Group, but also being able to understand the market and not pull the trigger on a deal that might not produce the return down the road. Excel Group, for example, pulled out on a deal in Long Island City because of what it deemed too much supply coming into the market.
Capital is still going into where the recovery has been: leisure, resort, drive-to space, extended-stay and economy, which is where more of the brands are going, too. (New brands, such as Hilton’s Spark and Hyatt Studios fit the bill.)
The markets that haven’t yet returned are the downtown core markets that are still awaiting corporate and group business to return with gusto. According to the data, the worm is turning: CoStar expects business travel to bounce back in full by the end of 2023.
“Downtown hotels and big boxes will come back in favor because their prices will fall,” Magazine said. “Conferences and conventions will pick up.”
Bhoopathy said part of his investment strategy is to “follow net migration,” meaning where populations are moving to. The south, currently, is having a renaissance. “Florida, Nashville those core markets are where to be,” he said. “There is no shortage of buyer pool.”
“The south is getting a lot of play,” Magazine said, ticking off cities including Nashville, Austin and Tampa.