By: Justin Laub
I recently returned from the Urban Land Institute’s national conference on hotels and resorts. The last time ULI held this event was in 2008. Amongst the attendees, there were conflicting opinions as to whether the hotel industry had a few good years left to run or whether the industry was on shaky ground and headed for a downturn. It was interesting that the event was the first one since February 2008, which – as most would recognize – was the bottom of the 9th inning of the last real estate boom in the US. The Great Recession soon followed, with both the real estate markets and the global economy falling off the cliff. Was this year’s ULI hotel conference the canary in the coal mine signaling the peak of our current cycle, or is it a sign that the market is finally back on solid footing?
The prevailing concerns regarding hotels mirror much of the rest of the commercial real estate industry: i) today’s pricing is above the previous cycle’s peak in most major markets, ii) there is a fairly significant pipeline of new supply in addition to what has been built over the past couple of years, iii) revenue growth has slowed from its torrid pace over the past few years, and iv) political and economic uncertainty in the US. These concerns have already manifested themselves in the market. The sales brokers at the ULI conference acknowledged that hotel pricing has come down and that for certain assets, namely full-service resorts, the sales market has almost completely dried up. On the capital markets side, CMBS lenders have dialed back their leverage on hotels, and banks and debt funds have done the same on ground-up development projects.
So what is there to be optimistic about in the current market? For starters, the trends in the capital markets noted above are likely a positive for the industry in both the near and long term. Debt fuels commercial real estate and the pullback in the lending markets is more precautionary than reactive. Contrary to the market environment during the real estate bubble 10 years ago, lenders today are showing restraint in the wake of softening performance in the hotel and broader commercial real estate markets. Secondly, while revenue growth in the hotel sector has slowed, RevPAR still grew at a healthy 3.3% YoY in June 2016, according to Smith Travel Research. Thirdly, when averaged over the past 10 years, new supply is still relatively conservative. Fourthly, consumer spending and corporate expenditures, both of which drive the hotel market, remain healthy. Retail spending was up 2.00% YoY (0.30% MoM) as of May 2016, summer travel is expected to reach an all-time high in the US this year, and corporate expenditures in 2016 are expected to stay on pace with 2015 expenditures.
As a financier, it is my job to understand these broader market themes and how they affect my clients’ deals. The uncertainty and mixed feelings in the market right now certainly make capital raising for hotels a more challenging proposition, but by no means have the capital markets turned their back on the sector. The current market demands more creativity than in the past few years. More focus is being put on the sponsor, the market, the investment thesis, the capital structure and the like. When you can paint the right picture though, deals are just as financeable in today’s market as before. My $25 million ground-up hotel project that closed this month – for which I arranged the senior construction loan – is evidence of that. Not only was it an attractive bank loan, but it was also non-recourse. I thought that was particularly ironic in light of the consensus opinion amongst the capital markets panel at the ULI conference that non-recourse hotel construction loans are unavailable in the current market.
So, what inning are we in? Well, it depends on who you ask and how you interpret the market data. The correct answer is probably more nuanced, which is that it’s the 8th inning in some markets with extremely rich pricing and huge supply pipelines and the 5th inning in other markets with pent up demand and only moderate new supply over the past 8 years. The consensus sentiment in the capital markets right now is one of caution; however, it does not mean that all capital providers are of the same opinion about the hotel market’s durability. Some capital providers have pulled back, but many others are still out there looking to place money and generate yield. The data and the trends in the market right now are mixed. More than ever in the past few years, it takes a thorough marketing effort and a well-articulated investment thesis to find the right capital partners for hotel projects.
The author, Justin Laub, is a Senior Director in the Dallas office of Metropolitan Capital Advisors.