Austin-based real estate investment manager Palladius has its hands in a lot of different commercial real estate verticals, from student housing to multifamily residential. As it stands, Palladius manages and operates approximately $600 million of real estate across the U.S. Hospitality investment has also always been a focus for the company, a vertical that was part of the overall strategic plan, Afshin Kateb, CFO and head of hospitality investments told HOTELS, further stating that timing has been an issue; namely, COVID. “At the outset, everyone thought there was going to be this surfeit of products hitting the market,” he said, noting that no other asset class has been as hit hard as hotels. In this Q&A, Kateb discusses the current macroeconomic environment and its impact on hotel transactions, the lending environment and why hotels, even in the face of threats, show more resiliency than any other asset class.
HOTELS: How has the current macroeconomic picture impacted hotel transactions and development?
Kateb: On the transaction front, a continued rise in inflationary indicators coupled with the Fed’s response to them has put material upward pressure on rates and impacted buyers’ ability to find optimally sized and priced financing. Additionally, the lender rate cap purchase requirement has laid yet another layer of pricing complexity on an already expensive debt market, which means that both lenders and borrowers have become very cautious and selective. There was also a general expectation that there will be a surfeit of impaired hotels hitting the market during COVID, but that expectation never materialized. The to-date bid-ask gap between the borrower and seller continues to hold. However, the borrower’s inability to hit the required lender going-in debt yield may force some borrowers to rethink their position and reverse course.
On the development and construction front, the steep rise in material costs, shortage of labor and heightened cost of debt have resulted in a perfect storm, creating an interim lender apathy and selectiveness toward hotels. A positive impact of this trend is a reduction in supply pipeline, thus enabling existing hotels to benefit from the continued demand growth and regain values.
HOTELS: Do you expect transaction volumes to be higher or lower than 2022?
Kateb: We believe transaction volume will pick up, primarily because the rising cost of debt leaves borrowers with maturing debt with few options but to transact. By the end of 2023, approximately 40,000 CMBS hotel loans totaling $30 billion will be maturing. This maturity is further ballooned by bank and debt fund loans, thus adding additional pressure to an already tight debt market. This transaction volume will come from properties with maturing debt with inherit valuation issues whereby their current valuation cannot support the outstanding debt and their trailing NOI will make them ineligible for a refinance under current constrained debt environment and terms.
HOTELS: What segments are most appealing to investors?
Kateb: Select-service and limited-service hotels will remain industry darlings because of their operating cost model and operational efficiency. Interestingly, the extended-stay and limited-service segments have much fewer maturities than full-service hotels, so for investors searching for dislocation, the full-service sector appears to be the biggest target. However, I should qualify that not all markets have been able to recover their COVID demand losses. In the case of the still-recovering markets, all segments may see diminished value and refinancing difficulties, which means opportunity and appeal for some bargain hunters.
HOTELS: What does the lending picture look like vis-à-vis acquisitions and ground-up?
Kateb: Our debt fund is very well positioned to offer targeted ground-up, acquisition and existing debt refinancing at a fixed rate. Our underwriting looks at a range of quantitative and qualitative criteria, taking into account the sponsor experience as well as market performance and management quality. So long as the demand continues to grow, business travel green shoots continue to flourish and the group sector burgeons, there will be a lender ready to do business with a qualified sponsor. The main issue lenders are grappling with nowadays is debt pricing.
HOTELS: Where does LTV stand in the wake of COVID, et al.?
Kateb: It’s a mixed bag. Assets in markets such as Florida have seen material value enhancement while assets in Chicago and New York continue to struggle to get their lost values back. Assets in pockets of Los Angeles and San Diego, for instance, are beginning to surpass 2019 values. In general, we will likely not see the values drop to the same level as the GFC, but instead will see a 10% to 15% value adjustment, which, in light of the state of debt markets and demand recovery, is very reasonable. Clearly, there are outliers; certain assets were badly impaired and will trade for material discount (20%-40%) to 2019 pricing. However, those will likely be rare and highly competitive. We will also see assets that have reached their utility obsolescence and must seek alternative use. However, the above presumes that we see no major recession and that the Fed achieves a semi-soft landing.
HOTELS: Where are cap rates headed in major urban markets?
Kateb: Resort and select destination markets, such as San Diego and Orange County, continue to lead in recovery, compared to 2019 levels. Assuming leisure demand continues its growth trajectory, these markets should maintain their recovery lead. For urban markets, we’re seeing a dichotomous story of “haves” and “have-nots.” In some urban markets, such as New York, Boston and Atlanta, the impact from the pandemic has proven ephemeral, as these markets have seen accelerated demand and relatively rapid recovery. However, their ability to completely recover back to 2019 levels will continue to depend on a combination of office visitation, citywide conventions and events and continuation of leisure demand. On the other hand, for other urban markets, such as such as Chicago, Minneapolis and Philadelphia, COVID’s impact is proving more permanent due to a lag across all demand segments. Accordingly, we should expect to see a bigger value deterioration and rate cap expansion of possibly 100 to 150 points in these still-recovering markets.
HOTELS: What’s your overall outlook?
Kateb: We are optimistic about the future of the industry. No other sector, not even multifamily, saw such a devastating blow to its core but showed such immense resiliency. Hospitality has made a remarkable comeback; many markets are continuing on their recovery journey to the top. People want to travel, people want to meet face to face in groups to exchange ideas and people want to do business and close deals in person. Hotels are hubs for all such activities.