by Joel Ross, HotelNewsNow Columnist
September 27, 2011

I love going to hotel conferences. One can escape reality by sitting in the early sessions and listening to the data people report what was and extrapolate that into dreamy forecasts. It was like revisiting (the Americas Lodging Investment Conference) and (the New York University Hotel Industry Investment Conference) in 2008. During this year’s Lodging Conference, the early speakers were talking about how wonderful July was and how bookings are going to be strong in 2012. Life in the rearview mirror is great.

At ALIS 2008, I was saying the capital markets had collapsed and revenue per available room for 2008 would be negative—and for 2009, very negative. The speakers were predicting 5.7% RevPAR increases and then telling me I just did not understand, RevPAR was doing great, so therefore it would continue getting even better. At NYU 2008, a speaker from the appraisal world said the worst was over, values would be increasing, and it was time to buy. The just-completed Lodging Conference was a reminder that those same people apparently did not learn that when the capital markets get into trouble it is not good for the hotel industry.

While the initial lodging industry speakers were predicting a rosy future in 2012, the finance ministers of the G-20 were gathering in Washington. The head of the World Bank said we are in dangerous territory. The head of the World Trade Organization said we are in the red zone. The head of the IMF said European banks need US$500 billion of additional capital, and the IMF cut its growth projection for the world for 2012. The CEO of PIMCO said the world could be on the verge of another financial crisis. The stock market plunged to the sixth worst loss in its history. Chairman of the Fed Ben Bernanke said there is a “significant risk.” The Fed has said there will be almost no GDP growth for two more years. It appears the data people who are trying to be forecasters are forgetting the correlation of RevPAR to GDP. You can’t have 6%-7% RevPAR increases when GDP is only up 1.5% or less.

I think I was the only person out of about 1,000 at the opening session who raised my hand when asked who was not optimistic. Apparently I forgot to take my whiff of happy gas that morning.

The beginning of a decline
Bookings will start to show cancellations and declines next year. Companies already are reducing their event schedules for 2012, and some are telling their branches that any internal meeting must now be held in company facilities, not at a hotel. Even luncheons. This cutback will not show up for a while, so if you are sitting there saying this is not happening, you have blinders on. It is coming to your hotel.

2012 is not going to be 2008, or anything like it. U.S. banks and corporations are in the best balance-sheet shape they have ever been. Consumers are in far better shape than in 2008. There is more than US$2 trillion of liquid assets—cash—on the sidelines waiting to invest. Huge cash deposits are coming to the U.S. for safe haven, which is why treasuries are yielding essentially zero. Leverage is gone from Wall Street. The stock market is probably undervalued now. Regulators are, if anything, overzealous. And hotel and real-estate values remain well below 2007 values. Loan underwriting is once again tough and proper, so there is no insanity where anybody can get a loan.

In short, the U.S. is not going to collapse as it was days away from doing in 2008. We do not need TARP to save the world again. As a result, RevPAR is not going to collapse and might even rise by 2% or so if we are lucky. Lenders are in strong shape, so they will be in a position to work out maturing loans, or they will just foreclose and sell off the assets. Transaction volume should be much better next year, just at lower values.

The squeeze is on
The REITs are dead for the moment. Besides Innkeepers, many other pending deals blew up over the past couple of weeks. You just have not heard about it. More will die in the next few weeks. REIT-driven values of 7%-8% cap rates are over and done. Cap rates will now rise by 50 basis points or more. Values are resetting downward. The forecasts of giant value increases by 2015 are going to get reset. Values in 2015 will be higher than today, but not by the absurd numbers some have predicted. PIPs are now going to be required to get done. Many owners will have maturities, and big PIPs and will simply lose their properties to foreclosure, rescue capital or other restructuring, which will squeeze their equity to nil, and hope certificates will become more common.

Banks are not allowed by the regulators to just keep rolling over loans. You probably already had your one extension. CMBS does not permit perpetual rolling over. There are contractual and legal limits set by bondholders. The squeeze is on now. Cash is king. Values are not going to be what some dreamed. You missed the window.

There are loans available even though there is minimal capacity in CMBS. CMBS was shut since August, but is trying this week to come back slowly. If it does, there is very limited hotel capacity, and what there is will only be for good solid cash-flowing, well-branded assets in major markets, or very good secondary markets with good strong sponsors.

A CMBS pool can only have maximum 15% hotel paper, and the pools will only amount to around US$1.25 billion each. That is only US$187.5 million hotel paper. A couple of major big city deals or portfolios, and that is used up. There is non-CMBS lending available, but it is sized at 12% debt yield and it needs to be well-branded, cash-flowing assets. Appraised value is not even considered. Sponsors need liquidity and good track records. With local banks you need a guarantee. Construction loans are only available in rare situations, like Manhattan and some other very good markets where supply is really crimped, and if the sponsor has lots of cash and lots of liquidity and a personal guarantee.

The good news: Little will get built for two to three years. If you can renovate your asset, now is the time to do it, or buy one below replacement cost and renovate it. In either case your all-in cost will be less than a new-build, and you can outperform the new-build if the renovation is very good. Why build when you can buy below replacement and renovate and still have a lower cost basis?

Hunkering down
The U.S. hotel industry is not going to collapse, but it is not going to be as the data people predict. There is no 6%-7% RevPAR increase in 2012 other than in some markets and for some assets that might be new or recently renovated and well-managed that will take share from its competitors.

Conserve cash. Hunker down. Pull out the cost-saving plans from two years ago and see where you can save now. Market hard. Don’t cut ADR.

If you do the right things now and you refinance now, then in five years you will have a very strong asset, and you will be able to sell it for a lot of profit since there will have been little built, and the economy will be coming back strong by then.

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Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that is available through his website, www.citadelrealty.com.

This article was reprinted with permission by HotelNewsNow.