|February, 2006 - US Realty Consultants, a national
real estate appraisal and consulting firm specializing in the hotel industry,
has released its Winter 2006 hotel investor survey. The survey has historically
been released annually, but will now be released every six months.
According to Jeffrey Walker, MAI, CHME, Principal and Managing Director
of US Realty Consultants, “We recognize that rapid changes in investment
parameters within the industry require us to be even more timely and pro-active
in assessing capitalization and yield trends. Moving forward, we will be
releasing results in the Second and Fourth Quarters of each year.” USRC’s
next survey will therefore take place during the second quarter, and will
be released in June.
In the current survey released January 30, the Winter 2006 USRC Hotel Investment Survey indicates that discount rates and capitalization rates for both limited-service and full-service hotels have continued to become more aggressive, following decreasing trends demonstrated annually since our Winter 2002 survey. Lower overall capitalization rates are not only the result of a healthy investment environment, but antecedents of continued anticipated growth in the industry, forcing down implied capitalization rates as lower yield requirements are coupled with above-inflationary NOI expectations.
Several key factors have come together to create an almost unprecedented investment environment. First, despite some recent modest increases, interest rates remain low. The short-term U.S. Treasury Rate at the beginning of 2006 of 4.4% is an increase of 160 basis points from 2.8% at the same time in 2005. However, low interest rates are not only a factor of historically low treasuries in 2005 and into 2006, but of much lower spreads over those treasuries in the hotel lending arena, a segment which traditionally required a higher spread compared to more traditional real estate segments. This has led to very attractive leverage opportunities for hotels, particularly among some securitized lenders for better quality assets.
Secondly, with several years of solid income growth, the industry is perceived today as a lower risk, higher growth segment, virtually a 180-degree reversal from the sentiment in 2001/2002. Based upon our respondents, the industry seems to be more concerned about energy prices and other economic factors than about the risks of a travel disruption from terrorists attacks, concerns that dominated investment thought just a few years ago. Finally, the industry’s investment parameters have been influenced by the increased participation of institutional investors, who have recently seen hotel yields as an attractive alternative to even more aggressive investment parameters in other real estate segments. It is important to recognize, however, that these institutional investors may apply their more aggressive yield requirements to often more conservative cashflow underwriting as compared to the traditional hotel owner/operator. Therefore, caution must be used in applying these investment parameters to cashflows which reflect the corresponding risk of the yield. Having said that, cashflow projection parameters still continue to be optimistic, as evidenced by our survey results which demonstrate ADR growth well in excess of expense growth.
Full-service hotels recorded larger decreases in direct capitalization rates, terminal capitalization rates and discount rates as compared to those of limited-service hotels. Investors see greater profit potential in full-service hotels as there are higher barriers to entry for full-service hotels than for limited-service hotels. Also, our research indicates that default risks are higher in loans for limited-service hotels than for full-service hotels. Accordingly, lenders are willing to take lower returns on full-service hotels than on limited-service hotels, which again drives down yield requirements for the sub-segment, even on an unleveraged basis.
The total impact of these changes has led to a steady 220 to 390 basis points decrease in the overall direct capitalization and discount rates over the past four years. The steadily decreasing capitalization rates since 2002, as evidenced in charts contained in the full report, reflect that buyers are paying more for underlying net operating income and are expecting lower yields. The increase in the number of hotel buyers and lenders is causing increased competition and lower rates for hotels.
The full report analyzes and provides numerous charts and tables depicting historical and current trends of the following for limited and full service hotels:
US Realty Consultants