Hotel owners and operators looking to pick up distressed assets have had to wait longer than previously expected, but industry experts believe those opportunities will arise later this year.

During the “Dissecting Distressed Hotels” panel at the online Americas Lodging Hotel Investment Summit Winter Update, hotel executives said owners of troubled properties have been able to work out deals with their lenders to hold onto their properties. While those deals won’t last forever, the general consensus is neither owners nor lenders are in a hurry to make any moves.

Hotel transaction volume in the U.S. declined approximately 68% to 70% year over year from 2019 to 2020, said Dan Peek, president of the hotels group at Hodges Ward Elliott.

The transactions that did happen in 2020 were driven mostly by owners — not lenders or servicers — he said. Some were selling one asset to raise capital to protect others, while other owners were leaving the industry and deciding to invest in other real estate classes, such as multifamily housing.

Peek said volume was pretty good in January and February and carried over from the momentum of 2019 until the pandemic lockdowns started in March.

“That’s when we saw that dramatic fall-off in volume year over year,” he said. “Probably if it was a full year, it would have been more than 70%.”

Prism Hotels & Resorts added about 150 distressed hotels to its management portfolio during the previous two recessions, Prism CEO and founder Steve Van said. The company has added 25 in this pandemic.

“If you listen to what's happening now, lenders do not want to take back hotels,” he said. “Owners do not want to sell their hotels.”

Owners have benefited from all the government programs, including the Coronavirus Aid, Relief, and Economic Security Act's Paycheck Protection Program, he said, calling it “the greatest anti-foreclosure program in U.S. history.”

Owners and lenders will want to wait and see what happens with the next proposed relief package, Van said.

“You don’t have a willing buyer, you don’t have a willing seller, and you’re being subsidized trillions of dollars to wait, so everyone’s waiting,” he said.

The larger the bank, the harder it is to get a deal done, said DJ Rama, president and CEO of Auro Hotels. Working with smaller banks has been easier for his company to get to the finish line.

As forbearance runs out and business volume doesn’t come back, friction will begin, he said. The industry could see the chips starting to fall in another six months.

Another reason lenders are holding back is they don’t want to foreclose on assets with a negative operating carry, said Michelle Russo, CEO and founder of HotelAVE. In the last downturn, lenders often foreclosed because of bad borrower behavior or overleverage, but they don’t want properties with negative operating carry.

“It’s just easier to kick the can with the borrowers right now,” she said.

The PPP and similar programs are helping support the operating cash flow, but lenders don’t want to take these troubled properties, even if the owners do, she said.

“We even had a client try and give back keys on the asset, but the lender would not take,” she said.

The special servicers for commercial mortgage-backed securities are “enormously overworked,” Van said. One of the largest companies Prism works with has seen a significant decrease in the number of staff members, so they are overwhelmed at this point.

In the handful of transactions that HotelAVE has been involved in, it has seen buyers looking for value creation in the residual, Russo said. They’re accepting there will be some negative carry or breaking even, but most of the value creation is for when they exit and fulfill their business plan, and most of that plan is market recovery.

Visibility is low from an underwriting standpoint, which means having to stress-test the assumptions of the velocity of the recovery, she said. To prepare, HotelAVE has been playing out various scenarios to look at returns.

“That first year has a great impact on the overall value, and some deals still work even if you miss a year,” she said. “Some — especially the ones where you’re potentially buying an asset at full and equal to the current debt and you’re off a year — your returns can go down massively.”

Auro had a three-hotel portfolio comprising 450 rooms with about five buyers interested, Rama said. There was a big spread, but after a few weeks of negotiation, they were down to single digits from their bid-to-ask price and they decided to go through with the deal.

“It was institutional capital, and they had liquidity in order to close,” he said.

With ground-up construction practically nonexistent for the next several years, the value of the company’s existing hotels will increase, he said. They’re going to target full-service hotels because those values will increase, given the slow pipeline.

Currently the market has full-service properties that are capital deprived, and brands will come back with capital expenditure requirements as the industry recovers through 2022 and 2023, he said. Owners of these properties will have to decide whether they’re willing to hold onto these assets for two years with negative cash flow and upcoming capital expenditure requirements.

Van said he agreed with Rama’s approach. Full-service hotels are dependent on group meetings and are in dire straits now. Funds from the PPP and any remaining reserves will run out soon while they’ll still be responsible for ongoing costs of these properties.

“The big opportunities for those that have the stomach for it — and I mean a big stomach — are the markets like New York and San Francisco and [Los Angeles]; they're just disasters,” he said. “Full-service hotels and meeting room space are going to be the biggest opportunities, but nobody knows when the recovery is going to be, but those are the biggest targets for opportunities.”