U.S. hotel developers, lenders and industry analysts say lending for new lodging product remains tight despite recent interest-rate drops, as flattening hotel-room demand and higher U.S. treasury-note rates are making lenders pessimistic about the chances of potential lodging developments penciling out.
The U.S. presidential election and the availability of distressed hotels for sale at below-replacement costs have also put a crimp on U.S. lodging construction debt, where developers typically take out three-year loans for build-outs before refinancing on a longer-term basis once the properties are built.
Developers had hoped that the U.S. Federal Reserve’s reduction of interest rates would help spur the lending market. The Federal Reserve cut its overnight borrowing rate by a quarter-percentage-point on Nov. 7 after reducing its borrowing rate by a half-percentage-point in September.
Still, the U.S. 10-year Treasury yield, which fell from about 4.7% in April to about 3.6% in September, has since jumped to about 4.4% as of mid-November.
“Elevated interest rates as well as the ballooning of construction pricing over the last three years make a lot of deals not pencil,” said Ryan Bosch, principal at Scottsdale, Arizona-based Arriba Capital. The company's recent construction-lending deals include a $36 million loan it originated for the Residence Inn by Marriott Ormond Beach Oceanfront near Daytona Beach, Florida, this past March.
“On the banking level, we’re seeing a lot of regional and local banks that have been the backbone of construction lending constrained on liquidity right now,” Bosch said.
For now, interest rates on construction loans have stayed high.
“When you’re doing a construction project, you’re getting a short-term loan, so it’s not surprising to see construction with 10% to 12% interest rates,” said Luigi Major, Los Angeles-based managing director at hospitality-industry consultant HVS. “That limits the feasibility of these projects.”
The cautiousness of the financial markets should keep somewhat of a lid on new U.S. hotel-room supply for the near future. CoStar data shows in the third quarter, U.S. hotel-room supply — which stood at about 5.7 million — increased just 0.5% from a year earlier.
Meanwhile, bankers may be hesitant to invest in a U.S. lodging sector where rising demand since the pandemic has flattened this year. U.S. third-quarter revenue per available room rose just 0.9% from a year earlier as a slight uptick in average room rates was partially offset by a slighter drip on occupancy, according to CoStar. While the third quarter’s RevPAR of $107.44 was about 24% higher than 2019’s pre-pandemic RevPAR of about $87, real RevPAR has been about flat when adjusted for inflation during the past five years.
Adding to that cautiousness is the availability of hotels on the market from owners trying to sell their properties at a relative discount before their lower-interest-rate loans come due.
“If you’re a lender and you have an option to lend at $100,000 a door with renovations instead of $150,000 a door for new construction, you may take that project at a lower basis,” said Will Woodworth, vice president of investments at Atlanta-based Peachtree Group, which develops, lends money on and manages hotels. “We’re eager to lend, but there’s not a big universe of projects that are ready to go.”
But hotel construction is at higher levels than it was a year ago. As of September, about 157,000 hotel rooms were under construction, which was 7% more than a year earlier. A recent peak of about 220,000 U.S. rooms under construction occurred in the spring of 2020, just as the pandemic hit the U.S.
Groundbreakings typically lag debt agreements and don’t necessarily reflect the bankers’ current appetite for writing new loans, according to Daniel Lesser, president and CEO of New York-based LW Hospitality Advisors. He said construction lending is “definitely on the low side,” adding that “anything coming out of the ground penciled out probably 12 to 18 months ago.”
“Some of these deals have been signed for some time, and the brand companies are pushing it through” Isaac Collazo, vice president at CoStar hospitality analytics division STR. "No one foresees interest-rate levels to go back down to pre-pandemic levels anytime soon.”
There are, however, some projects where lenders have recently been convinced to write construction loans. Geographically, states such as Georgia and Florida account for about a quarter of the current U.S. hotel rooms under construction, Collazo said.
Meanwhile, upper-midscale to upscale limited-service hotels under brands such as Comfort Inn, Hampton Inn, Holiday Inn Express, Hilton Garden Inn and Hyatt Place remain relatively popular projects for lenders and prospective developers, Major said.
“If you look at a market like Uptown Dallas, that’s a great example of a market that’s incredibly supply-constrained, and it’s really difficult to get a project approved,” said John Schellhase, assistant vice president of investments at Peachtree Group.
Peachtree’s recent groundbreakings include a Residence Inn in San Antonio and a dual-branded AC-Moxy project in Dallas’ Uptown district, which reflect continued optimism in Texas’ growth among both leisure and business travelers.
“Nashville is on fire in terms of demand, and the convention business in San Antonio is doing phenomenally well,” Lesser said.
That said, stubbornly high interest rates relative to historic levels will continue to make the math difficult for both hotel developers and lenders looking to expand their exposure to the U.S. hospitality market within the next year or so.
“Without a doubt, during the back half of next year, we’ll see some loosening on lending,” Bosch said. “But there are going to be a lot of deals in the pipeline that don’t ever come to life.”