By Robert Mandelbaum, Mark K. Owens
The decline in the operating performance of U.S. hotels during 2020 has been well documented. According to the results of CBRE’s 2021 edition of Trends® in the Hotel Industry, total operating revenue during the year declined by 62.2 percent, which resulted in an 82.6 percent drop in gross operating profits (GOP). Similar to the decline in total operating revenues, the 30-day average annual LIBOR rate declined by 68.9 percent. 30-day LIBOR is historically the benchmark rate used by lenders for floating-rate loans, which are a preferred loan type of most institutional hospitality investors.
Declines in revenue and gross operating profits had an impact on hotel management and operating personnel. The need to reduce staffing resulted in a 48.0 percent drop in total labor costs. Concurrently, the fees paid to hotel management companies fell by 64.0 percent.
In addition to the negative impact on the day-to-day operating employees, the owners of U.S. hotels suffered significantly during 2020. Of the 7,000 hotels that participated in CBRE’s Trends®, nearly half (46.8%) were unable to achieve positive earnings before interest, taxes, depreciation, and amortization (EBITDA). EBITDA represents the cash flows available for debt service payments and ownership/investor distributions.
To analyze the impact that declining EBITDA levels had on the ability of hotel owners to pay their interest expense, CBRE studied a sample of 1,121 hotels that reported interest payments in their operating statements for the years 2019 and 2020. In 2020 these hotels averaged 168 rooms in size, at an occupancy of 40.3 percent, an average daily rate (ADR) of $124.08, and a RevPAR of $49.97. This is down from the 73.3 percent occupancy, $155.22 ADR, and $113.72 RevPAR levels achieved in 2019.
Before 2020, hotels in the study sample achieved EBITDA levels more than double the required interest payment, or a ratio greater than 2.0. In 2019, the interest coverage ratios were greatest at convention hotels (2.56), and lowest at full-service properties (1.93).
In 2019, interest payments for the study sample averaged $6,992 per available (PAR) room. Fortunately for hoteliers who suffered declines in revenue during 2020, the interest payments reported during the year also declined 6.4 percent to $6,528 PAR during the year.
The decline in interest payments is one of the myriad reasons of investors select floating-rate loans. Typically, periods of dislocation result in declining indexes. Floating-rate loan payments often adjust monthly or quarterly, therefore a decline in the benchmark results in lower interest payments for the corresponding period. As an example, a loan with a spread of 350 basis points (3.5 percent) over the 30-day LIBOR rate would have equated to an interest rate of 5.52 percent in 2018 (2018’s 30-day LIBOR average of 2.02 percent plus 3.5 percent). That same loan’s average interest rate at year-end 2020 would have been 24 percent lower, at a rate of 4.19 percent (3.5 percent plus 2020’s 30-day LIBOR average of 0.69 percent).
Despite the decline in the average interest payment, the average coverage ratio dropped well below 1.0 in 2020. This is because the typical hotel in the study sample suffered a decline in EBITDA of 96.4 percent. Given the considerable decline in profits, the typical hotel in the study sample was only able to generate eight cents in EBITDA to contribute to every dollar in interest obligation, or a coverage ratio of just 0.8. 34.5 percent of properties in the sample were able to meet their interest obligation in 2020, versus 89.0 percent in 2019.
During 2020, the interest coverage ratio was greatest at extended-stay hotels (0.88), but even they were only able to earn 88 cents in profit to cover one dollar of interest payment. Resort properties achieved the second-highest interest coverage ratio at 0.68. Unfortunately, the owners of two other property types had to come out of their pockets to pay their interest and operating expenses, as evidenced by their negative coverage ratios. The 2020 EBITDA to interest multiple for full-service properties was -0.31 and -0.11 for convention hotels.
COVID-19, as illustrated by the data herein, presented the lodging industry with an unprecedented challenge. Uncertainty existed across all sides of a transaction; debt, equity, management and franchise companies, municipalities, etc. The speed at which the Federal Government and the lending community reacted is commendable. Companies, industry groups, and industry leaders worked with the aforementioned institutions to help create proposals and solutions. The knowledge gained through the Global Financial Crisis was applied to the pandemic, and by creating liquidity market fluctuations were moderated. Value impairment was minimized through thoughtful implementation of government assistance programs, forbearance, deferrals, and brand relief. CBRE contributed to the process by providing thought leadership, commercial real estate data, and forecasts.
Despite the extreme hardships, the vast majority of owners and lenders have been able to manage their portfolios through this pandemic. CBRE and other advisors have assisted owners and lenders in raising liquidity for financial institutions, and both public and private investors through recapitalizations, dispositions, and restructuring activity to assist those that need additional resources. We continue to assist all industry participants by actively monitoring the potential impacts of the Delta variant.
Assuming interest payments remain the same in the future as they were in 2020, hotels will need to increase their EBITDA levels by 1,165 percent just to match their interest obligations. This equals growth of more than 10 times their 2020 profit levels. While these growth figures sound daunting, it should be noted that through May of 2021, EBITDA levels have already increased more than 2.5 times what they were through the first five months of 2019. Further, through June of 2021, the 30-Day LIBOR averaged 0.10%, which is 87.94 percent below the same period 2019’s 0.89% average, thus indicating continued reductions in interest payments.
The need to grow profits just to “break-even” is the least for extended-stay, limited-service, and resort hotels, which are favored by lenders and equity investors in today’s market. The burden to grow profits to cover interest is greatest for all-suite and convention properties.
Per the first quarter 2021 edition of CBRE’s Hotel Horizons®, hotel revenues will not return to 2019 levels until the latter part of 2024. That is too long a period for owners to wait to be able to pay their debt, so the pressure is on operators to increase revenues and control expenses.