By Daniel Lesser
Defying the expectations of many, the U.S. economy has demonstrated resilience driven in part by a solid employment report with stronger-than-expected wage growth during June, along with continued healthy levels of consumer spending. With this said, the U.S. economy has been slowed by the Federal Reserve’s aggressive drive to tame inflation through a series of interest rate hikes that began early last year. Although trending downward, with inflation remaining above its two percent target, the Federal Reserve is on track to raise interest rates again this month and mull another hike as soon as September. Despite elevated inflation, which is now easing, and ongoing fears of impending economic recession, unemployment rates remain low, and Americans continue to spend money on goods, services, and experiences.
Stress in the U.S. banking system and financial market volatility continue to slow commercial real estate lending activity and rising numbers of failing commercial real estate loans are beginning to weigh down the nation’s banks. The recent collapse of several regional banks has resulted in tightening credit and relatively high borrowing costs which has driven down prices of all types of commercial real estate assets particularly in downtown urban cores. Upon loan maturities, numerous sponsors, many of whom are highly respected large well-capitalized investors, are refusing to “throw good money after bad,” and considering surrendering properties to lenders. Within the decimated office and retail sectors BentallGreenOak, Brookfield Asset Management, Blackstone, Columbia Property Trust, Related Fund Management, RXR Realty, Vornado Realty Trust (NYSE: VNO), and Westfield Group are examples of institutional investment platforms that have defaulted on high profile assets across the nation. Although U.S. hotel sector operating fundamentals remain strong, lodging-centric institutional investors including Ashford Hospitality Trust (NYSE: AHT) and Park Hotels & Resorts Inc. (NYSE: PK) have announced plans to “hand back the keys” on assets whose loans have matured. Time will tell if these maneuvers are a positioning tactic to negotiate workouts with lenders who may very well not be interested in foreclosure of any of the assets.
During the current inflationary environment, the U.S. hotel industry has proven to be a defensive sector, exhibiting strength and the ability to weather economic challenges. Robust leisure demand and the resurgence of group and corporate travel have fueled Average Daily Rate (ADR) growth that is outpacing the rise of overall U.S. inflation. This recent phenomenon, which like long-term averages, further reinforces the notion that investment in lodging is a hedge against inflation.
The LWHA Q2 2023 Major U.S. Hotel Sales Survey includes 84 single sale transactions over $10 million which totaled roughly $3.1 billion and included approximately 12,100 hotel rooms with an average sale price per room of $257,000.
• In comparison, the LWHA Q1 2023 Major U.S. Hotel Sales Survey included 83 single sale transactions over $10 million which totaled nearly $3.5 billion and included approximately 12,500 hotel rooms with an average sale price per room of $279,000. Comparing Q2 2023 with Q1 2023, the number of trades decreased slightly by one percent while total dollar volume decreased roughly 11 percent and sale price per room diminished roughly 8.5 percent.
• By further comparison, the LWHA Q2 2022 Major U.S. Hotel Sales Survey included 133 single sale transactions over $10 million which totaled roughly $5.3 billion and included approximately 21,200 hotel rooms with an average sale price per room of $248,000. Comparing Q2 2023 with Q2 2022, the number of trades decreased by approximately 37 percent while total dollar volume declined roughly 41 percent, however sale price per room increased slightly by 3.4 percent.
Contrasting the first half of 2023 with the same time frame in 2022, the LWHA Major U.S. Hotel Sales Survey indicated a 36 percent decrease in the number of sale transactions, a 50 percent decline of total dollar volume, and a diminishment in sale price per room of 4 percent.
The current relatively high cost of debt has widened bid/ask spreads and clearly slowed investment volume. Additional noteworthy Q2 2023 observations include:
• Fourteen trades or roughly 17 percent of the national quarter total occurred in the State of Florida, followed by nine sales or 11 percent of the national quarter in California, and Arizona with eight sales, or 10 percent of the national quarter. Combined, thirty-one trades or 37 percent of the national quarter occurred in Florida, California, and Arizona.
• Ryman Hospitality Properties, Inc. (NYSE: RHP) acquired from Blackstone the 1000-room JW Marriott San Antonio Hill Country Resort & Spa in San Antonio, TX for $800 million or $800,000 per unit.
• Five Q1 2023 sales were consummated for between $100 million and $199 million each.
• The 250-key Nautilus Hotel in Miami Beach, FL was acquired by Service Properties Trust (Nasdaq: SVC) for $164.5 million or $661,000 per unit from Quadrum Global. The property, which is now managed by Sonesta International Hotels Corporation and subsequent to a major renovation to be completed in early 2025 is slated to be rechristened under Sonesta’s The James brand.
• Ohana Real Estate Investors acquired from Blum Capital Partners the 276-room Claremont Club & Spa – A Fairmont Hotel in Berkeley, CA for $163.3 million or approximately $592,000 per unit.
• A joint venture between Gencom and GD Holdings, LLC acquired from Magellan Development Group, Ltd. the 192-room St. Regis Chicago for $133.5 million of $695,000 per unit. The trade represented the closing of a forward sale of a new hotel agreed upon in late 2020.
• Norwich Partners sold the 144 key AC Hotel by Marriott Clearwater Beach and the 139 key Courtyard by Marriott Clearwater Beach for $113.7 million or $402,000 per unit to Mission Hill Hospitality.
• Southwest Value Partners acquired from Fortress Investment Group the 575-room JW Marriott Tucson Starr Pass Resort & Spa in Tucson, AZ for $112 million or $195,000 per unit.
Institutional investment platforms, many of whom are lodging-centric, dominated the Q1 2023 hotel transaction arena.
• Examples of buyers include ARA US Hospitality Trust, Dauntless Capital Partners, Gencom, Hersha Hospitality Management, Ohana Real Estate Investors, Pyramid Global Hospitality, Magna Hospitality, McWhinney, Mission Hill Hospitality, Peachtree Hotel Group, Procaccianti Companies, Ryman Hospitality Properties, Service Properties Trust, Shaner Hotel Group, Southwest Value Partners, and Summit Hotel Properties, Inc.
• Examples of sellers include American Hotel Income Properties REIT LP, Blackstone, Blum Capital Partners, Buccini/Pollin Group Inc., Chartwell Hospitality, Donohoe Hospitality Services, Pebblebrook Hotel Trust, Fortress Investment Group, Highgate, KKR & Co. Inc., Lam Generation, McSam Hotel Group, Norwich Partners, Peachtree Hotel Group, Quadrum Global, and Waterton Associates
Although U.S. hotel sale transactions continue to be consummated, activity is tepid due to the current disconnect between operating fundamentals and capital markets. Many trades are being made at opposite ends of the spectrum including trophy properties located in high-barrier markets with strong cash flow, or assets that are underperforming and require immediate and meaningful capital investment. Generally, the pricing of U.S. hotels remains steady and continues to offer favorable discounts to replacement costs which during the recent past have dramatically risen.
Commercial real estate investors now perceive U.S. lodging as a darling sector and preferred asset class. Unlike prior downturns including the 1990/91 Gulf War recession, 9/11, and the Great Recession of 2008, during the COVID-19 recession the hotel industry for the most part avoided competing by lowering room rates. The past has proven the lengthy challenges associated with recovery from slashing prices.
While credit markets remain open for high-quality borrowers and/or lodging properties, all-in financing costs of +/- 9 percent make little sense relative to overall capitalization rates of 8 to 8.5% for many hotel assets. Bid-ask spreads remain wide, and few sellers have yet to be forced to transact. Relative high debt costs have created new opportunities for alternative debt platforms and funds. Additionally, substantial sums of liquid equity remain on the sidelines which, when coupled with strong in-place cash flows, will likely prevent widespread distress. Currently, given the limited number of acquisition opportunities, buyers with the ability to consummate transactions quickly with all cash/equity have an advantage.
Despite a slowing economy and possible recession, continued strong demand for transient lodging accommodations, coupled with relatively low increases of net new hotel supply are anticipated to bolster sector performance. Bleisure travel has taken root and is increasing the length of stay in many markets, most notably well-defined leisure markets. Although in the post-COVID-19 pandemic era, as Americans have returned to traveling overseas, inbound foreign visitation to the U.S. continues to rebound, although somewhat hindered by the federal government’s slow processing of visa applications.
Labor shortages and supply chain issues continue to challenge the sector as do rapidly rising insurance costs and property taxes. Furthermore, scores of lodging assets are capital-starved and dramatic increases in renovation costs will affect investment underwriting and decision-making.
Effects of the COVID-19 pandemic hallowed out many U.S. downtown central business districts, and numerous urban cores are no longer considered bustling centers of activity. Much has been written relative to the negative consequences of the continued work-from-home phenomenon, resulting in empty offices which have led to a perception of “doom loops” and the death of downtowns affecting numerous major U.S. cities. Walking around New York and in particular San Francisco looks and feels starkly different compared to pre-COVID times as reduced levels of business travel, retail store closings, homelessness, and elevated levels of crime are taking their toll. While there is little doubt that many U.S. urban markets, including San Francisco’s, path to recovery remains clouded and elongated by major challenges, commercial real estate including hotel investment opportunities in these cities will offer tremendous upside for patient money willing, if need be, to hold assets for upwards of ten years. Now is the time for long-term investors to acquire assets in these locales as history proves that one cannot precisely predict the bottom and invariably only know when it occurred six to nine months after the low point was hit, and the opportunity is mostly lost.
In addition to courage and patience, savvy investors will utilize a prudent balance of debt and equity to avoid overleverage. Furthermore, they will make use of interim debt and not lock in long-term fixed commitments only to end up with large prepayment obligations when interest rates decline in 2026-27. Property values in 2026-2027 will no doubt exceed the peak of 2021-22 as recoveries always exceed previous all-time highs. Those who buy now at market pricing in major U.S urban markets and are smart about capital stack structure and coverage with stress tests will win big.