While some subsectors of the US hotel market have rebounded since the covid-19 pandemic, others – notably those focused on corporate hospitality – are struggling to recover.
Overall, the hospitality sector is a growing proportion of investors’ total real estate exposure – and there is a huge amount of potential liquidity waiting to be deployed in the space, according to participants in Real Estate Capital USA’s most recent roundtable discussion.
The panel comprises a quartet of real estate professionals with extensive experience of the hotel sector: Jeffrey Brown, senior managing director and head of the US hotel valuation and advisory group at Cushman & Wakefield; Sean Hehir, president and chief executive of Trinity Investments; Matt Mering, executive vice-president of hospitality at Waterton; and Daniel Peek, president and chief operating officer at Hodges Ward Elliott.
Leisure v business
Hehir acknowledges that corporate-focused hotels are struggling, and in his view will continue to do so, but destination resort properties are ascendant, as are the leisure travelers who frequent them.
“Last summer we saw the group traveler coming back with a vengeance, competing for the same type of hotels in the Smile States [running a U-shape from California to the East Coast]: these bigger-box assets,” Hehir says. “And that’s caused compression, with both room rates and occupancies rising. We’re seeing RevPAR at record levels month-on-month, compared with the prior peak of 2019.
“It is starting to come back quite strong in many markets, but an issue is that pricing for the corporate traveler – which was usually a bright spot for a suburban hotel – is now falling behind weekend leisure”
Cushman & Wakefield
“But there’s a lot of concern. How much longer will the consumer continue to keep spending in this manner?”
Hehir is bullish on the prospect of a continuing upward trend for destination hotels, particularly as many office workers continue to work from home during the week and their weekend activities adjust accordingly.
“I was joking, walking down Park Avenue last Monday, that I felt like Will Smith in I Am Legend,” Hehir says. “I mean, there’s nobody around, right? People are working from home and every weekend is now a three-day weekend. So that’s helping these resort-style properties. In addition, because people are working from home more frequently, companies are forced to have more offsites, and that’s really driving group demand in these assets.”
The midweek corporate traveler space is performing better than it has in certain other market conditions since the start of the pandemic, says Cushman & Wakefield’s Brown. “It’s starting to come back quite strong in many markets, but an issue is that pricing for the corporate traveler – which was usually a bright spot for a suburban hotel – is now falling behind weekend leisure.”
“We’re going through a significant correction,” says Hodges Ward Elliott’s Peek. “We’re seeing a little bit of softness, but very positive overall fundamental perspective – both in terms of supply and demand [and] pricing. It’s rare to have that kind of a pricing-led recovery.”
Valuing hotel assets
Panelists went on to discuss valuations and transaction activity. The challenge of predicting income from hotel and hospitality assets is another hot discussion point.
“We have a technique that fell out of favor for a while, called ‘the band of investment,’ which basically measures the equity yield requirements and the debt cost, and blends them together to come up with a capitalization rate,” says Brown. “Applying that technique, as the debt increases then the cap rates also increase, which would drive down the value of the property.”
The hotel space is “a very dynamic, business-oriented real estate operation, rather than an office building where you sign 10-year leases and you have surety in your cash flow,” adds Brown. “[With hotels] the better you can do to project next year — or the next five years’ business — the simpler your job is to valuation.
“We put primary focus on the income approach when we’re valuing hotels, because the buyers are doing the same. They’re putting together a pro forma, and they’re out there in the market looking at debt and equity. Hotel sales are occurring that we keep track of, but they’re a guidance for our metrics of valuation, more than comparable sales. The hotel market’s always been much thinner and less consistent than other real estate types, so comparable sales have always been secondary – more of a check – for valuations which focus on income.”
The resort play is very interesting to panelists. “We’re pretty laser-focused on this drive-to-resort play, and I can tell you our space has been very robust,” says Waterton’s Mering. “Everyone has been reading the headlines over the last three years, and these kinds of domestic resort markets, the leisure traveler, have been really resilient.
“When we look at our properties that are open, looking at forward bookings for the summer, we’re running about 30 percent higher than we were at the same time last year. So we’re expecting another big summer.”
Waterton owns some legacy assets that are more suburban and full-service branded, Mering says. “And it’s been a tale of two cities – I mean, that’s been a very rough place to play,” he acknowledges. “People aren’t coming back to the office as much as you’d like in some of these markets, so that’s been tough sledding. But the resort markets have been really strong; I think the challenge is that it’s very, very difficult to finance properties right now. You have to be creative.”
Mering cites a current project for which Waterton is putting in 55 percent equity. “I’ve never done that in the past. But the yields are there at those numbers, and the deal still makes sense. But we’ve got a strong balance sheet, we’re an experienced sponsor, putting 55 percent equity in a deal – and it’s still tough to get lenders to jump. So that’s the real challenge from our perspective: the debt markets,” Mering says.
“Because people are working from home more frequently, companies are forced to have more off sites, and that’s really driving group demand in these assets”
Peek highlights a slowing in transaction activity, with deal volume in the hotel sector down by around 55 percent in the first quarter of 2023 compared with the same period last year. But he also pointed out that Q1 2022 was a particularly strong quarter – up around 200 percent compared with Q1 2021.
“Talking to market participants, there’s still a big spread between the bid – what someone’s willing to pay and the ask – what the seller is expecting,” Brown says. “The sellers are expecting 2021 prices, before interest rates started to increase, and buyers are facing cost of capital that is so much higher than it was. So if you don’t have agreement on price, you tend to push back from the table, and that’s why you’re seeing transaction [volume] down.”
Hehir highlights the importance of lenders for market participants to be able to transact.
“We can’t transact if we don’t have lenders that are willing to lend, and that brings transaction activity to a complete halt,” Hehir says. “Then you’re in the world of relationship loans; we’re doing more CMBS loans than we normally would.”
Trinity is currently working on the acquisition of an asset with in-place cashflow. Hehir believes, however, that “whereas before we would have had 15 lenders looking at it, today you may only have three or four. And I know that one or two of them are going to really act because we’ve dealt with them before – but it’s just different.
“It’s all about market, asset type, in-place cashflow, and the sponsor – more than ever.”
Hehir also notes that he has seen no cash-out refinancing. “They’re not allowing that, and I think we’re going to be in a situation later this year. I could be wrong, because during covid I was convinced we were going to have this wall of debt maturities, but that never happened; the lenders cooperated with the borrowers.
“I think patience has run out for lenders this time around. We’re going to see situations where private equity will be stepping in to fill that gap when loans start coming through.”
The CMBS market is also coming back, says Peek. He points out that “better cashflow [and] double-digit debt yields mean you’re going to get a good quality CMBS quote with a good sponsor and a good asset.”
“It’s interesting on the CMBS side that they’re not taking any risk, though,” says Hehir. “Before, you’d see them take principal risk and backstop with their balance sheet and so forth. They’re doing none of that.”
Debt funds continue to be a significant part of the market, notes Peek, highlighting that some of them are impacted by the balance sheet lenders that provide their senior leverage.
“[Those lenders are] not there. It’s very hard for them to principal the loan unless it’s a really wide spread. That’s where you’ll see the quotes from some of the newer debt funds – double-digit interest rates – because they don’t have the back leverage in order to generate the return on the incremental capital,” he says.
The regional bank market is another uncertain area, with recent downgrades for about a dozen institutions, Peek adds.
“That raises a concern and raises questions,” he says. “They do have a lot of real estate exposure – much more exposure on a relative basis than the big lenders. And again, big lenders are back in the market to a degree but are being very conservative.”
“I agree the regional banking issue is still playing out,” says Hehir. “Some of the public mortgage REITs are more inactive just because of where they’re trading and the ability to raise money.”
Creative deal structuring
Mering described Waterton as philosophically lower leverage than the typical investor, with the thinking that hotels are high beta investments. “Any way we can de-risk them, we like to do that,” he says.
The firm will usually put in around 50 percent equity as standard. “That being said, our projects are heavy – even if they’re a value-add project, they’re big and hairy repositions typically. We’re buying older assets and putting a lot of capital into them,” Mering says.
Over the past year, Waterton has been looking into programs that would not have been considered four or five years ago, including Commercial Property Assessed Clean Energy (C-PACE).
“I think the challenge is that it’s very, very difficult to finance properties right now. You have to be creative”
“We’re doing C-PACE financing on our California projects [and] looking into USDA programs, because a lot of these resort markets qualify for USDA — which is federally-guaranteed and kind of like the Fannie or Freddie for hotels. You have to get very crafty,” says Mering.
With housing in high demand, the panel discussed a current trend for hotel assets to undergo conversion.
“There are groups that have their origins in multifamily that are focusing on identifying hotels that would work for them,” says Brown, adding that Cushman & Wakefield works with a group that is taking large suburban hotels and converting them for workforce housing. “In that way you don’t lose any keys. You have to get over the municipal hurdles – but with the housing shortages that are out there, in most markets the municipalities are being more flexible in terms of change of use.”
Brown acknowledges that parking with redevelopments can present a challenge, but adds: “I’m always a big fan of adaptive reuse, because with hotels and any other real estate type, the physical life of the property extends well beyond the economic life. If you can repurpose to workforce housing, you can extend the useful life of the asset out 20 or 30 years.”
Mering says he has seen most conversions among older generation, extended-stay product, “which are kind of natural B- or C-housing, particularly if you’re near universities or other [densely populated] places that have a shortage of housing.
“We’re spending a lot of time across our portfolio, trying to understand what we have from an excess-land perspective – what we have and what we can be doing better. What additional offerings can we have?”
As an example, he points to his firm’s acquisition of the Hyatt Regency in Greenwich, Connecticut last year. “It’s got a massive parking lot; should we be putting serviced townhouses there, or something like that? Should we be putting a destination sports club [that] residents can be coming and using? So we’re trying to think outside the traditional box with what we can do with concepts of space and better used space and so forth, outside of the traditional hotel,” he says.
Turning up the volume
Peek says that based on first-quarter activity, transaction volumes across the hotel space this year could be half that of 2021 or 2022, when deals totaled close to $50 billion. “There’s a lot of capital that will be competing,” he says, “and I think that will start to turn it around.”
“We’ve deployed more resources in the southern US, and into select service, because those are two pockets where there’s activity today”
Hodges Ward Elliott
When it comes to managing a firm, Hodges Ward Elliot is in the return-on-time business, with Peek highlighting the importance of engaging in situations – and with other parties – that can end up at a transaction.
“We’ve deployed more resources in the southern US, and into select service, because those are two pockets where there’s activity today,” he says. “When it comes back, we still have our teams that are focused on the DCs, the New Yorks, the Chicagos, the LAs; you need those markets to recover to really bear fruit. So it’s a challenging time for everybody in our sector, because there’s capital out there that wants to be put to work. There are great fundamentals, which is rare.
“Bob [Webster, president of CBRE Hotels Institutional Group] and I have been in the business a long time; we were working on a project together and trying to work out: when was the last time that we had fundamentals as great as they are, and equity liquidity as significant as it is, and had such a bad capital market in terms of debt markets. And we agreed, it’s happened once in 30 years of our career, and it’s happened for about 24 months.
“We’re hopeful that if that piece comes around – the cresting, the compressing, all of that – and the fundamentals hold up, it can be a very active time. But that’s a question to be answered.”
“For once, hotels aren’t a four-letter word as an asset class,” Hehir quips. “You walk around the office and people – the retail people and the multifamily – are sort of looking up at us. For once, we’re a more favored asset class.”
Dry powder to deploy
There is a sense that private equity funds and other managers are biding their time for investments, with firms like Blackstone Group recently completing fundraising efforts for a $30 billion fund.
“I’ve never seen as much potential liquidity in the hospitality space as we see today,” says Hodges Ward Elliott’s Daniel Peek.
He namechecked Brookfield, Blackstone and Starwood – pointing to the “shockingly large” pools of capital managed by these sector giants. “I remember one time when Blackstone said it had raised $5 billion for real estate equity, and we all were sort of shocked,” he says. “Well, of course the new fund is $30 billion.”
Meanwhile, hospitality assets as a proportion of investors’ total real estate exposure is also growing, says Peek. “So, as you think about people being more selective about office, more selective about retail and more selective about some of the other product types that have had more challenges than hospitality over the last few years, hospitality is just getting more of the allocation. And there’s a lot of liquidity in the REITs but not a lot of activity. I would say there’s plenty of liquidity; conviction is the question.”
Trinity Investments’ Sean Hehir also referenced mega-funds but notes these were only one side of the story. “On the other side, you’ve got private equity funds who are having a very hard time raising money in this environment,” he says.
“I’m hearing both stories, and you’ve got a lot of large private equity groups that are between funds, and so aren’t deploying because they might have had a first closing, but it’s critical that they buy the right type of asset in the right type of market to demonstrate that they’re executing on their business plan. I think, the headline from Blackstone – it’s brilliant, but it’s not what’s going on with all the other private equity funds. I think they’re having a rough time raising capital right now.”
Meet the roundtable
President and chief operating officer, Hodges Ward Elliott
Peek joined HWE in June 2019 and oversees a team executing institutional-grade commercial real estate transactions globally. During his career, Peek has completed nearly $40 billion in investment sales, debt and structured finance transactions. He has held senior posts at firms that include HFF, and co-founded hotel boutique Regent Street, an affiliate of The Plasencia Group.
Senior managing director, US hotel valuation and advisory group head, Cushman and Wakefield
Brown has more than 35 years of experience in all facets of hospitality real estate, including brokerage, development, appraisal/valuation, feasibility consulting, management and operations, and strategic planning.
Executive vice-president hospitality, Waterton
Mering joined Waterton in 2019 and is responsible for the formulation and execution of the firm’s investment strategy. He also oversees asset management and development of investment relationships. Prior to Waterton, Mering held posts at firms that include Graves Hospitality and Salita Development.
Managing partner, president and chief executive,
Hehir oversees the firm’s investment activities, including sourcing and executing investment opportunities, formulating investment strategies, and structuring acquisitions and dispositions. Prior to joining Trinity, Hehir worked for HVS International.