Lower interest rates, revenues that are outpacing expense growth and below average supply additions are combining to give lenders and investors a greater comfort level with the U.S. lodging investment market, according to the 2012 edition of Hospitality Investment Survey, published by PKF Hospitality Research.
“Investors acknowledge the existence of all the economic uncertainties, but the industry fundamentals are strong enough to overcome these concerns,” said Scott Smith MAI, vice president in the Atlanta office of PKFC.
Smith noted that the optimistic attitude appears to be somewhat bifurcated. “Institutional investors and private equity funds are showing a bias toward full-service and resort hotels in the major markets, where profit growth has been the greatest,” Smith added.
On the other end of the lodging spectrum, transaction activity involving limited-service assets outside the major markets is extremely slow. Survey results show that there currently is a significant gap between the price a buyer is willing to pay and what a seller is willing to accept. However, as market conditions start to improve in secondary and tertiary cities, Smith said he anticipates that investors will look more favorably at those markets and property types for higher yielding opportunities.
Investment criteria eases
Lenders report a year-over-year easing of investment criteria, with the overall capitalization rate (OAR) dipping 15 basis points from 8.73%, the lowest in the past 15 years.
“Historically low interest rates and the expected improvement in property level net operating income (NOI) are causing capitalization rates to contract in all segments,” said Bill Morton, associate in the Indianapolis office of PKFC. “In fact, cap rates for recent transactions in high barrier-to-entry markets have sunk as low as 5%.”
The survey also revealed that discount rates, or un-leveraged internal rates of return (IRR), declined by 33 basis points to 11.42%. “This further demonstrates investor expectations of improved market fundamentals and less risk,” Morton noted.
Hospitality bankers and mortgage companies responding to the Hospitality Investment Survey reported that mortgage terms have remained virtually the same from 2011 to 2012. During this period, the loan-to-value ratio declined by 80 basis points, while interest rates, on average, fell just 0.1 percentage point, and little change was reported for the average loan term (year of balloon) and amortization period.
“Lenders remain cautious,” Smith stated. “The loan-to-value ratio appears to be stabilized in the mid-60% range. This is lower than the level experienced during the prosperous period from 2005 through 2007, but similar to the long range average.”
The 2012 Hospitality Investment Survey also identified the increasing use of Small Business Association 504 loans, a program most frequently offered by local and regional banks to investors purchasing limited-service properties in secondary markets. The availability of financing for the construction of any type of new hotel remains very scarce.
PKF concluded that investments in the hospitality industry will continue to become more attractive due to the expected continued improvement in industry performance and the continued availability of cheap capital.
With capitalization rates hovering near record low levels, current owners will eventually benefit from a rise in property values.