The Federal Reserve's decision to cut the federal funds rate a further 25 basis points will lower the cost of capital. But even when combined with the two previous cuts from this year, hotel industry experts don't expect much relief.
"A lot of people were expecting interest rates to come down, which they are, but these are not trends being translated into the rates that you have to pay for hotel financing," said Alan Reay, president of hotel brokerage firm Atlas Hospitality Group.
The Federal Open Market Committee voted to reduce the federal funds rate to a range of 4.25% to 4.5%, down a full 100 basis points from its post-pandemic peak. Its first cut in this run arrived in September, dropping the rate 50 basis points to a range of 4.75% to 5%. A 25-basis-point cut followed in October.
The FOMC also indicated two likely cuts in 2025 should conditions call for it. That's down from four cuts in 2025 projected by the FOMC in September.
Hotel industry perspective
The cutting of the federal funds rate affects the prime rate, which affects personal loans or credit card debt, but most hotel loans are tied to the five- and 10-year Treasury rates, which have gone up since the Fed started cutting rates, Reay said.
"It's still making it very, very tough for hotel owners to get purchase money financing, and, more importantly, to get refinanced out of their loans that are coming due," he said.
Lenders have also been taking a tougher look at hotel deals than they were previously, Reay said.
"We're finding that they're not willing to loan as high as they would before in terms of loan-to-value," he said.
Hotel owners have come out of an environment that had historically low interest rates, Reay said. Owners who bought or refinanced at the time factored those low rates into their cost of money, but now as those debts are coming due, they're facing higher rates.
The rates now aren't high from a historical context, as they had been in the 7% to 8% range, he said.
"So, it's not an anomaly," he said. "That's just what we've averaged over the last 30 years. It's just that we were in an economy post-COVID where interest rates were really driven way down."
The Fed's latest cut was already priced into the market, so it won't have much material change one way or another, said Greg Friedman, managing principal and CEO of real estate investment firm Peachtree Group. On the pricing side of real estate, that doesn't necessarily affect people being more risk-on.
The more concerning parts are the Fed telegraphing only two interest rate cuts in 2025 and that economic data supports that the U.S. is headed for a soft landing.
"I think most people were underwriting the fact that rates were probably going to come down another 100 basis points next year," he said. "And now that doesn't seem practical, as the Fed is only going to potentially cut rates twice next year."
A soft landing is not necessarily good for commercial real estate or the hotel business from a capital markets perspective, particularly for balance sheets, Friedman said. The balance sheets and the values of these underlying assets are so interest rate-sensitive. When there's an environment of higher-for-longer interest rates, that puts downward pressure on the underlying value of hotels.
Many hotels are supported by shorter-term loans, typically three to five years, and a lot of those are floating-rate loans based on SOFR, which tends to correlate with the federal funds rate, he said.
"It's going to stay substantially higher than the expectations were for 2025, and that's going to impact the cash flows that are available for owners of hotel assets and other commercial real estate assets," he said. "It's just going to create a very sluggish 2025. It's going to be a catalyst that's going to force groups to consider selling assets."
Comments from the Fed
During yesterday's news conference, Fed Chairman Jerome Powell said recent indicators suggest that economic activity has continued to expand at a solid pace. Gross domestic product rose at an annual rate of 2.8% in the third quarter, and the growth of consumer spending has remained resilient and investment in equipment and intangibles strengthened. Activity in the housing sector, however, has been weak.
The FOMC members generally expect GDP growth to remain solid, with a median projection of about 2% over the next few years, he said.
On the labor front, market conditions remain solid, Powell said. Payroll gains slowed from earlier in the year to 173,000 per month over the last three months. While the unemployment rate is higher than it was a year ago, the rate of 4.2% in November was still historically low. Nominal wage growth has eased over the past year, and the jobs-to-workers gap has narrowed.
"Overall, a broad set of indicators suggests that conditions in the labor market are now less tight than in 2019," he said. "The labor market is not a source of significant inflationary pressures."
Inflation has eased significantly over the past two years, but remains somewhat elevated relative to the Fed's 2% longer-run goal, Powell said. Estimates based on the consumer price index and other data indicate that total personal consumption expenditures prices rose 2.5% over the 12 months ending in November. Excluding the volatile food and energy categories, core PCE prices rose 2.8%.
The median projection in the summary of economic projections for total PCE inflation is 2.4% this year and 2.5% next year, somewhat higher than projected in September, he said. As a result, the median projection falls to its 2% objective.
The FOMC participants laid out their individual assessments of an appropriate path for the federal funds rate going forward, Powell said. The median projection is reaching 3.9% for the federal funds rate by the end of 2025 and 3.4% at the end of 2026.
These projections are higher than in September, when the FOMC median projection indicated four cuts in 2025 instead of two, but they are consistent with the firmer inflation projection, he said.
"As the economy evolves, monetary policy will adjust in order to best promote our maximum employment and price stability goals," Powell said.
The slower pace of projected cuts next year reflects both the higher inflation readings the Fed had this year and the expectation that inflation will be higher, Powell said. Even so, he sees the Fed on track to continue to cut.
"I think the actual cuts that we make next year will not be because of anything we wrote down today," he said. "We're going to react to data. That's just the general sense of what the committee thinks is likely to be appropriate."
In related news, the Bank of England held steady on its interest rates, keeping it at 4.75%.
UKHospitality CEO Kate Nicholls expressed her disappointment through a statement to the media.
“A rate cut could have helped incentivize economic growth and relieve the pressure of high interest rates on businesses, particularly those in hospitality saddled with COVID loan repayments," she said. “While inflation increasing for the second consecutive month is concerning, generating economic growth has to be the priority."