WASHINGTON — The hotel industry started 2024 with great enthusiasm, but as the year has rolled out, things haven't gone quite as hoteliers expected.
During the "Investment & Development Insights" panel at the 2024 ALIS Summer Update conference, hotel company executives spoke about stagnation in the hotel transaction market and what potential interest rate cuts would actually mean for owners.
Following the Americas Lodging Investment Summit in January, RLJ Lodging Trust Co-Chief Investment Officer Kate Henriksen said she felt optimistic that hotel performance would continue to be strong coming out of 2023, with anticipation of multiple interest rate cuts. Month after month, those cuts never came but inflation continued to roll along.
“March performance was a little bit off, some of it due to the timing of the holidays, etc., but just more and more uncertainty,” she said.
By the time the NYU International Hospitality Industry Investment Conference arrived in June, the sentiment had changed, she said.
“You weren’t really sure if 2024 was going to be another wash of a year,” she said. “I think there might still be some time to recover by year end, but it’s definitely different in at least my opinion as to how we started the year.”
Pebblebrook Hotel Trust sees similar conditions, said Linda Yau, senior vice president of investments for the hotel real estate investment trust. The higher-for-longer interest rate rhetoric is causing more stagnation in transaction volume. The volume for the first half of the year is down significantly from last year, and it’s among the lowest in the past decade aside from the pandemic years.
“That’s a little startling to see given that everyone started the year thinking that transaction volume was gong to pick up this year,” she said. “What is encouraging is that we are seeing lending volume increase.”
Peachtree Group’s lending operation started off the year strong, and it has continued to lend throughout the year, said Jared Schlosser, executive vice president in hotel lending and C-PACE. What the company is seeing more now than at the beginning of the year is balance sheet stress with owners contending with higher interest rates and higher costs.
“Everything that we’ve all discussed here today is starting to impact them, and now we’re in a position where I think owners have to pick winners and losers,” he said.
Peachtree is being mindful in how it views each potential loan and where its potential borrowers are in their portfolio as well as from a health and liquidity standpoint, he said.
In terms of overall liquidity, Peachtree sees more competition for issuing loans now than it did in January, he said. There’s more liquidity today than before. In comparing a deal closed in January and closed now, from a spreads standpoint, it’s 50 to 75 basis points more today than at the beginning of the year.
“You either have a double-digit debt yield or close to a double-digit debt yield and you’re structured to attract capital, or you don’t,” he said. “If you don’t, that’s where we’re seeing highly structured transactions. If you do — we’re competing with a lot more groups than we were six months ago.”
Lowering Interest Rates
Should the Federal Reserve lower interest rates this year, it will spur more intrigue in making deals, but it will take time for the deals to move through the process, Henriksen said.
“I do think once you see the first rate cut, it’s going to be a sea change,” she said, citing owners with balance sheet stress from refinancing, renovation costs or end of fund life.
“Just fatigue,” she said. “People are ready to transact, and if they can see and grasp onto that catalyst, I think we’re going to start to see a lot more activity."
A 25-basis-point drop doesn’t do anything for anyone, Schlosser said. Neither would 50 basis points.
“If you get two cuts this year — I mean, if your deal hinges on two cuts, then it’s probably not a good deal,” he said. “Does it help with sentiment? I guess that makes people feel a little more positive.”
Looking at the forward curve and other factors in the market, however, unless there are meaningful 100-plus basis point cuts over a period of time, he said he’s not sure what they’ll accomplish other than making people feel better.
The double-dipping happening in lending right now is due to the lack of liquidity in the banking sector to make everything flow, Schlosser said. A drop of 25 to 50 basis points is unlikely to alleviate that. There’s a lot of talk about balance sheet stress on hotel owners, but there’s not much discussion about the balance sheet distress banks are experiencing.
A rate cut will be a positive indicator for the industry, Yau said.
“That’s what all the investors are waiting for, right?” she said. “They’re waiting for the first rate cut just to give them a little more confidence in the markets.”
Yau said she agreed with Schlosser that the cuts proposed won’t be enough for the floodgates to open, but it’s a process that takes time and will end up being a positive for the industry.
Assessing Transaction Pace
It’s difficult to predict whether transactions will pick up and when volume and pace will reach pre-pandemic levels, Yau said. It will likely take longer than people anticipate. It takes a lot to get the transaction market flowing again, such as international capital returning, debt becoming more affordable and investors having conviction.
“A lot of investors are underwriting deals right now,” she said. “They say they’re risk-on, but their underwriting indicates they’re risk-off. We really need to see a lot of the mindset change first, and it does take someone jumping in first and being a leader in terms of investing and starting to square that transaction market. We haven't really seen that yet.”
Once investors feel they’re missing out on the opportunity and that the market has bottomed out, it’s time to start investing, she said. The industry is still a couple years away from that.
It’s difficult to estimate, Henriksen said, but her estimate is pace will pick up again in about 12 to 18 months. There’s a little more stress on the owner side that is going to push them to be sellers. If interest rates decrease, the buyer side may equally drive deals because they need to transact.
Peachtree closed an acquisition loan in May 2023 and did not close another one until about 60 days before the conference, Schlosser said.
“That just shows you where the transaction market is because that used to be our bread and butter,” he said. “There just hasn’t been that many transactions. They’ve all been refinances and various other ways for people to free up liquidity.”
Schlosser said he agreed with his colleagues' assessments that a pickup will occur when owners will have to pick winners and losers and transact by the end of the year.
Yau said she expects cap rates will stay where they have been historically, and that’s because hotels specifically are a specialized operational asset class.
“I think that scares some investors, which is why a lot of investors avoid this space completely,” she said. “I think that won’t change. You really need a specialized operator. You need investors who understand the pace in order to invest in hotels, and so I think that will cause us to always be a little bit wider than other asset classes.”
Part of it right now is simply math, Henriksen said. Hotels overall are performing well, so they have cash flow as compared to office buildings that don’t, so they’re trading with lower cap rates.
“With the exception of a handful of markets, most markets have recovered fairly well, and so they’re generating cash flow and they’re being priced for future cash flows,” she said.
It will be interesting to see how assets perform over the next couple of years, Schlosser said. There have been a lot of people who can’t get the yields they normally do in multifamily and industrial, so they’ve made the jump to hotels, and only time will tell how they do in this new asset class.
If the industry performs well, they’ll definitely continue to invest in the space, he said.
“If they don’t, on the flip side, then it just goes back to the narrative of hotels being a riskier asset class,” he said.
*Correction, July 18, 2024: This story has been updated to correct a word in a direct quote by Jared Schlosser.