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 Rampant Optimism in U.S. Hotel Investment Arena

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By Scott Smith, MAI, June 20, 2005

Atlanta, June 20, 2005: U.S. hotel investors and lenders are the most optimistic they have been since the mid-1990s, according to a recent study published by a leading hospitality consultant. The purchase and lending criteria used in this year’s lodging transactions indicate a community of buyers willing to pay higher prices and financiers offering liberal lending requirements. Virtually all investment measures are equal to, or more positive than, those used to purchase properties during the early stages of the 1990s growth cycle. These observations come from an analysis of the data collected for the recently released 2005 edition of Hospitality Investment Survey published by PKF Hospitality Research (PKF-HR), an affiliate of PKF Consulting.

“The survey data certainly matches what we hear from our clients,” said Scott Smith MAI, vice president in the Atlanta office of PKF Consulting. “We’ve got buyers willing to pay higher prices, owners wanting to sell, and lenders needing to make loans. It is the ‘perfect storm’ for hotel investment activity.”

“Fortunately, all this optimism is based on sound industry fundamentals, as opposed to artificial factors that have hurt the industry in the past,” Smith noted.  Hotel Outlook, a lodging industry forecast model designed by PKF Hospitality Research and Torto Wheaton Research, projects a continuation of strong growth for the U.S. lodging industry in 2005. By year-end, hotel RevPAR in the 51 largest U.S. markets is forecast to rise 9.0 percent, the result of a 3.4 percent gain in occupancy and a 5.5 percent bump in average daily rates. This level of revenue growth should generate double-digit increases in profits for the typical U.S. property.

The 2005 Hospitality Investment Survey presents the results of research conducted during the first five months of 2005. Active hotel owners, equity investors, and debt providers were survey about the investment criteria used for transactions that have, or will occur during the year. The eight-page report contains tables that show the current and historical averages of a dozen critical investment measurements. Data is broken out for full-service and limited-service properties. In addition, the report contains topical essays that address the current investment and development climates.

Very Active Marketplace

Several respondents to the 2005 Hospitality Investment Survey indicated that there continues to be plenty of money available for hotel lending and equity investment. “The combination of low interest rates, rising cash flows, and sluggish markets for corporate securities keeps real estate in the spotlight.

Without the friction of lease contracts, many investors view hotels as a very favorable asset class in this environment,” Smith explained.

Added to the mix is a sizeable population of hotel owners now willing to sell properties. These investors held hotel properties beyond their expected holding periods and find the current pricing of hotel property very satisfactory for meeting their yield requirements. “With both buyers and sellers being motivated to execute transactions, and both debt and equity being readily available, we expect that 2005 (like 2004) will be another banner year for hotel transactions,” Smith concluded.

Low Risk Leads To Liberal Criteria

Given the bullish performance forecasts for U.S. hotels, all parties involved perceive less risk in hotel investments, compared to both historical measures and other forms of real estate. This optimism has resulted in a relaxation of both investment return requirements and lending restrictions.

“Yield rates, or IRRs, for hotels have come down to within 25 basis points of the historical low from this survey in 1998,” Smith noted. “More importantly, the spread between the overall capitalization rate and the discount rate continues to hover in the 4 to 6 percent range, suggesting that owner expectations for growth in net operating income are exceeding recent historical performance.”
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Despite fears of rising interest rates and Federal Reserve actions, the cost of financing continues to fall, thereby decreasing investor’s rate of return requirements as compared to 2004. “Loan-to-value ratios crept up to more than 70 percent -- territory not visited since our surveys of the 1980s. In addition, debt coverage ratios continue to move in favor of borrowers as they seek more leverage. These terms indicate that lenders feel adequately protected from a recurrence of delinquency and default risk experienced in 2002 and 2003,” Smith observed.

Full Is Favored

Investors continue to price the cash flows of hotels in the full-service segment higher than limited-service hotels. ”With higher barriers to entry for full-service hotel development, investors see greater profit potential for this segment, going forward,” Smith said. “Well-branded, full-service hotels in good condition located in major metropolitan or resort locations get the undivided attention of investors.”

Lenders also are showing a preference for full-service hotels. “Differences in default risk are shown by the higher interest rates assessed to limited-service mortgages, as opposed to full-service loans,” Smith noted. “Somewhat surprisingly, longer loan terms can be obtained for limited-service properties.”

Other loan terms are nearly identical for the two hotel types, and all terms appear quite favorable to borrowers by historical standards.

Copies of the 2005 Hospitality Investment Survey are available for purchase in PKF’s online store at www.pkfc.com/store, or by calling Claude Vargo toll free at
(866) 842-8754.

PKF Hospitality Research (PKF-HR), headquartered in Atlanta, is the research affiliate of PKF Consulting, a consulting and real estate firm specializing in the hospitality industry. PKF Consulting has offices in New York, Philadelphia, Washington DC, Atlanta, Indianapolis, Houston, Dallas, Los Angeles, and San Francisco.

Contact:

Scott Smith MAI 
Vice President
PKF Consulting, Inc. 
3340 Peachtree Road, Suite 580
Atlanta, GA 30326
(404) 842-1150, ext 233

Also See: Hotel Real Estate is Alive in 2005 / Scott Smith, MAI / June 2005
Room Rates Across the Top 50 Hotel Markets in the U.S. Will Increase by 3.7% in 2004; Five Highest and Five Lowest Average Daily Room Rate Hotel Markets in 2005 / PKF Consulting / December 2004
Hotel Forecasting Methodology Improves Accuracy of Projections; Hotel Outlook's 2004 RevPAR Estimates for Top MSAs Were 99.9% on Target / June 2005

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