Contributed by Anayat Durrani
Evan Weiss serves as co-founder, chief operating officer and principal of LW Hospitality Advisors, a company that offers a range of services geared toward hospitality and gaming real estate around the world.
Some of his responsibilities in his role include working on client and vendor relationship management, business development, designing and implementing business strategies, plans and procedures, daily operations and leading employees toward maximum performance. Weiss also serves as co-founder and managing partner of Lodging Analytics Research & Consulting (LARC), which focuses on highly correlated predictive analytics for the lodging industry.
As someone who has his finger on the pulse of the hotel industry, Weiss has a front seat to the current market conditions. And a lot has been happening. The U.S. Federal Reserve is raising interest rates again, which for investors means paying more to acquire assets. But, how are interest rates affecting current hotel market values?
“Interest rates are quite interesting right now. We have seen a nearly 350 bps rise, depending on the week, in the base rate, SOFR in most cases, and in Treasuries which have reached the 4%+ level over the past few weeks,” says Weiss. “These benchmark rates have been met with a widening of spreads by most lenders, which include banks, private lenders, mortgage REITS, CMBS and others.”
What factors impact hotel values and pricing?
He notes that increasingly lenders have slowly, and in some instances, wholly backed off from commercial real estate lending. In particular, he says hotel debt is more difficult to come by, considering the variability of their cash flows, and the daily re-leasing of inventory (rooms) with highly dynamic pricing models.
“As would be expected, this should be impacting hotel values and pricing to the downside,” says Weiss. “However, the interesting thing is that while sales volumes have certainly slowed, and voluntary refinancing is all but halted, and portfolio activity, after a busy 2021/22 has all but evaporated, certain types of lodging assets are selling well, and achieving record or near record pricing.”
He says three hotels that were part of the former Strategic Hotels & Resorts Inc. portfolio—which most recently were controlled by the Chinese Insurance firm Dajia Insurance Group Co.—sold for “significant pricing both on a pure dollars basis and a price per key metric.”
Weiss says BofA Securities Inc. and real estate banking and brokerage firm Eastdil Secured LLC marketed and sold the assets on behalf of ownership. The Four Seasons Resort in Scottsdale, Arizona sold for some $267M, or $1.3M per key; the Four Seasons Jackson Hotel, Wyoming sold for $315M, or $2.52M per key; and Montage Laguna, California is said to have sold for more than $2.5M per key, or $660M, says Weiss.
“This is not to mention the consummating of a forward sale of the Four Seasons Nashville, Tennessee, a brand new recently opened hotel which sold on a pre-construction basis for $700,000/key, or $165M,” says Weiss. “It is rumored that if this hotel were to be sold today, it would sell for a significantly higher price per key than the recently completed W Hotel Nashville, Tennessee, which traded at $950,000 per key at its opening.”
Weiss says not surprisingly the buyers of the three Strategic assets were two publicly traded REITs, along with a high net worth individual and that “all three entities are lower-leverage, well-capitalized, somewhat impervious to the debt capital markets, and all ostensibly long-term holders.”
Therefore, he says the pricing for the assets appears to have been relatively unaffected by the increase in borrowing costs, which he says have ballooned in recent months by in some cases 600 bps over where they used to be only a year ago or less.
“We also saw Apple Hospitality REIT, Inc., a publicly traded hotel-focused REIT acquire two AC by Marriotts, one in Pittsburgh, the other in Louisville for over $254,000 and over $326,000 per key, also reflecting what many deem to be “full pricing,” given the buyer’s desire to acquire high-quality real estate in good locations that is relatively newly constructed or renovated. The buyer’s access to public market capital, and a lower or lack of reliance on debt capital markets furthered the transactions,” says Weiss.
He says Apple is known as a medium-long-term holder of its real estate.
Transactions are re-traded due to capital markets costs and financings issues
“With all that as a backdrop, if you spend a few minutes, or as we do, hours, with investment sales and debt capital markets intermediaries, along with owners and active market buyers, especially those that focus on the lodging sector, they will tell you story after story, deal after deal, of transactions being re-traded due to capital markets costs, and financings and ultimately transactions falling through given the cost and availability of capital,” says Weiss.
From a high level, he says, increased costs in financing, particularly as broad as they have become in recent months, affect the Return On Investment but also the Internal Rate of Return that a sponsor of a deal can project.
“At the same time, in light of and due to the volatility, investors still expect similar returns to their previous expectations prior to the rate increases, thus leading to many sponsors lowering their offered pricing, and creating a sometimes wide bid/ask spread between buyer and seller,” says Weiss.
The impact of the pandemic on the hospitality industry
However, he says hotel operations, in general, have recovered or are recovering well from pandemic lows, “and owners, unless they are forced to due to a debt maturity, investor pressure, fund-life ending, or other factors, prefer not to sell for a higher cap rate/lower proceeds, as their cash flows are quite good.”
Therefore, he says, much of the deals happening today are being done at full pricing or possibly with seller or in-place/assumable financing, which he says may not necessarily reflect a discount to today’s capital markets, and further obscures whether today’s relatively expensive debt has led to lower asset pricing.
Weiss says, ultimately, if the debt markets continue the same way through early-mid 2023, there may be a decline in pricing as the factors previously mentioned will become more common, assets will have to trade, and lower pricing is expected.
“However, in the event that there is significant equity capital available for lodging sector investment when the assets finally do come to market, the sponsors could very well bid them up to “full pricing” in order to place capital that is sitting on their books ear-marked for lodging or commercial real estate investment. This could create a very competitive buying environment. Time will tell,” says Weiss. “It should be an interesting end of 2022 and start to 2023.”
How would a rate increase impact the hotel market?
By how much cap rates are affected by interest rates, and how much interest rates are expected to increase, Weiss says it is challenging to tie any increase in cap rates directly to interest rate increases this cycle.
“Historically, the relationship obviously makes sense that as borrowing rates increase, all things being equal, even in a market with an upward trajectory on revenues, operations, cash flows and Net Operating Income, in order for rates of return and IRR’s to remain similar to or the same as previously expected, cap rates must increase,” says Weiss.
However, he says considering the slowdown in both refinancings and transactions volume, he says seller’s “refusal to take lower prices driven by high cap rates, still higher construction and labor costs, along with certain assets, such as luxury, trophy, good quality real estate maintaining their values and even showing substantive increases in price per key and even cap rate metrics, it is hard to tie the interest rate increase to a cap rate increase.”
He says a rate increase can be tied to a slowdown in the volume of both financing and transactions. It can be tied to an increase in negative sector sentiment for the entire real estate market. It can also be tied to a challenging Q1 and Q2 of 2023 when fixed-rate financing expires for many assets. But, he notes, all things being equal, it is a more challenging task to tie the rate increase to a cap rate increase, which would indicate a decline in value.
“If I knew how much and when interest rates were going to increase, stabilize or decline, I would be investing heavily right now!” says Weiss.