Hospitality Consulting Services
400 Spear Street, Suite 106
San Francisco, CA 94105
|by Rick Swig, October 2001
Understatement: Financing new hotel construction or acquisitions has risen to a new level of difficulty in 2001. Remember the good old days with loan to value ratios of 70% to 80%, or even within the last 24 months, when 60% was achievable? Today, lenders, when providing opportunities, may even be below the 50% LTV line!
These strenuous and, some would say, unrealistic terms are all a result of a business atmosphere of uncertainty. For some markets 2001 was a continuation of the 2000 parade of high occupancies and average daily rates. The continuation of the parade did not last into the second quarter for most, however.
As Spring, 2001 began to warm the country, the hotel business climate became more frigid with the beginning of declining market segment demand. In a valiant effort to protect earnings many corporations began to reduce or forbid business travel. In some markets the individual business traveler segment has reduced by upwards of fifty per cent or more with coincidental reductions in the corporate meetings business. Additionally, consumer confidence has wavered and joined the travel reduction cycle.
These travel declines have created occupancy reductions of between 5% and 15% in most major markets. Those markets with the most explosive gains in the last two years are coincidentally the markets with the greatest percentage downturns. Market examples, like San Francisco and New York, will still retain over 70% occupancies in 2001, which, although painful, is not cause for critical alarm.
So, if you’re a lender, how should this situation be analyzed? Certainly, current and immediate past performance may not be the test. Much like a yo-yo, this market, which has quickly slumped down, will return up the string, but also like a yo-yo, it may be in a sleeping position at the bottom of the string before it returns upward. The yo-yo analogy fails, however, because unlike the yo-yo in sleeping position, demand is most likely not to return to peak 2000 levels with a simple flick of the wrist.
Corporate travel budgets will be renewed in 2002, but direction will be given to corporate travelers and their travel managers to be circumspect with regard to spending. In the same vein corporate meetings scheduling will most likely reappear, although with less frequency and more austerity by comparison to recent annual periods. Trade show attendance and participation will mirror business meeting trends.
Finally, consumer confidence will drive the leisure markets. Corporate layoffs and unemployment rates may not have stabilized, so discretionary leisure travel will be impacted. The extent of vacations, whether week long or long weekend, should reflect more personal spending conservatism.
Although some recovery is probable in 2002, a lender would be fooled, if looking either to 2000 or 2001 for some reflection of ultimate market occupancy stabilization. This determination may be a significant challenge for lenders, principals, and consultants alike.
The fluctuating market tendencies of the last ten years have offered varying clues about what or where stabilization is. Changing business environments from “old” to “new” economy plus hotel development patterns have continued to provide changing views for the stabilization target. As the macro-business environment continues to find its normalized position once again, hotel business seers should also be pulling out their Ouija boards to seek some clarification of market occupancy stabilization trends.
Lenders clearly do not want to place risk on an unforeseeable environment. Market valuation of hotels is not clear, as the business patterns of the last two years have gone from boom to slump after reversing from certain bust only four or five years ago.
The reduced volume of 2001 hotel sales transactions would indicate that sellers and buyers are finding it difficult to reach consensus on hotel property values, so why should lenders be so forthcoming on giving away money, when their value benchmarks may be hazy and uncertain?
Lenders are abstaining from the market by providing challenging loan terms to force more equity contribution. It is clearly their way of communicating that buyers and developers are free to put their equity where their passions are. Obviously, with more equity the lenders have more surety of getting reimbursed. Another view is that lower loan to value ratios might be a polite way to communicate disinterest in the hotel real estate segment as a whole.
Looking forward, the 2001 downward trends in occupancy should be viewed truly as a correction to find some reality with regard to market stabilization. The return to stabilization will not be a quick snap back action. Although there will be some recovery in 2002, it should come far more slowly than the surge to the peak or slide of the downturn to the cycle’s bottom.
When reviewing financing opportunities for existing properties, lenders should not limit themselves to reviewing current market trends or those of the recent past. Markets should also be analyzed in an historical context of five to ten years, while taking into consideration existing hotel activity, new hotel supply, and specific business trends within any given market for the purpose of clarifying individual geographic market shifts and where those shifts might take place looking forward.
New development presents different challenges. Differing product segments; barriers to entry or not; construction timetables; fluctuations in the current business environment of high risk; and forecasting for the future each impact business assumptions dramatically plus force lenders to have a multiple standards for financing approvals.
So why shouldn’t lenders be conservative. The historical past is checkered with success and failure, the current view is one of flux, and the predictability of stabilization is narrow. Investment in the hotel segment can and will be lucrative, as demand in multiple segments will ultimately rebound and grow. Until that path of growth is clarified, however, lending opportunities will be challenging.
RSBA & Associates
400 Spear Street, Suite 106
San Francisco, CA 94105
Tel: (415) 541-7722
Fax: (415) 541-5333