For many hotel owners and investors, it’s been a long time coming.
The U.S. Federal Reserve is expected to start a series of gradual cuts to interest rates at its meeting this week, and while the markets have expectations baked in, it remains to be seen exactly how many and by how much.
The Fed began raising interest rates in March 2022 to try to cool the job market and slow the annual rate of inflation closer to its target of about 2%. The Fed raised rates 11 times between March 2022 and July 2023, ranging from 25 to 75 basis points at a time. In total, the federal funds rate grew from the range of 0.25% to 0.5% up to 5.25% to 5.5%.
Oxford Economics is expecting the Fed to cut interest rates by 25 basis points this week and continue with these cuts at every other meeting through 2025, said Aran Ryan, director of industry studies at Tourism Economics, a division of Oxford Economics. The baseline forecast anticipates two cuts by the end of 2024, decreasing the central bank policy rate from 5.38% to 4.88%, with additional cuts amounting to 100 basis points by the end of 2025.
The economy proved to be stronger than expected, so it was the right call be patient and not cut sooner, Ryan said.
“So, in one of [Oxford Economics’] recent notes, they termed it as the economy is exiting the fast lane and transitioning to more sustainable growth,” he said. “We don’t think there’s going to be a rapid increase in unemployment and the economy tipping into recession. It’s a slower pace, and that’s a sensible environment for the Fed to be gradually cutting rates. They’ll be dependent on the data that comes in.”
Spurring more hotel deals
While JLL doesn’t forecast the degree of cuts, looking at the forward SOFR curve — or any forward-interest-rates curve — shows they’ve all been priced to have at least 50 basis points in cuts over the balance of the year, said Zach Demuth, global head of hotel research at JLL's hotels and hospitality group. Regardless of the total of cuts this year, any amount is welcome.
“It’s been a long time coming, and there’s been this expectation that this higher-for-longer scenario wouldn’t have persisted as long as it has,” he said. “The fact that interest rates are finally — there’s a sign that they’re finally being cut is very welcome.
“Again, these cuts have now been priced into forward curves for the past two to three months, so it’s not like the day the cut happens, suddenly interest rates fall,” he said.
When the Fed indicated months ago a cut would come in September, the forward curve started declining, and more buyers immediately entered the market and more capital came off the sidelines, Demuth said. The more the Fed indicates its willingness to cut rates, the more it will spur significant transaction activity.
“That’s really been on our minds. The biggest reason why transaction volume has declined — I mean, it’s no secret. As we start to see interest rates cut, particularly to a more meaningful measure, we expect that to drive transaction volume rather significantly, whether that’s this year or next year.”
The view of Pebblebook Hotel Trust’s executive team is that the cuts will be a catalyst for the transaction market, said Raymond Martz, Pebblebrook’s co-president and chief financial officer. Regardless of whether that happens at the start of the year or comes in the back half of 2025, next year will see more deals activity.
Along with that, there’s more debt capital out there, particularly on the commercial mortgage-backed securities side, Martz said. With the market being more fluid, the spread on that debt has come down.
“That means that not only debt costs are getting cheaper because interest rates are going down, but also spreads are going down from where they were a year ago, so the cost to borrow will be a lot lower,” he said. “That just helps the underwriting and reduces risk and helps buyers provide them with conviction to move.”
The Fed has been signaling it wants to get to a more neutral rate, so while the initial 25-basis-point cut isn’t going to move needle, the Fed indicating it wants to get to a more normalized rate that is significantly lower than where it is now provides a path for people to get comfortable, Martz said. The markets are pricing 220 basis points in cuts between now and the end of 2025, a signal that would be encouraging for the transaction environment.
“It's really the direction and confidence that the Fed is on a continued path down,” he said. “If they give any sort of mixed signals, it won't spur any transactions. If people know that, we're going to get to that low- to mid-threes area in a relatively short period of 12 to 15 months, it helps the transaction market a lot.”
A long way for development
There will be a lag in hotel development after the first cut to interest rates, even if rates are lowered by up to 50 basis points, said Isaac Collazo, vice president of analytics at STR, CoStar’s hospitality analytics firm. There are 761,000 hotel rooms in the U.S. hotel development pipeline, with 43% in planning, 36% in final planning and 21% under construction. There are a lot of projects ready to move forward but need to get financing shored up, and as money frees up, there will be movement in the final planning phase.
Rate cuts will free up some of that money, allowing progress in the pipeline phases, but this is a long-term play, he said.
“We’re talking years, not months,” Collazo said.
Along with cheaper debt, developers need a reworking of some lender requirements, he said. Banks have been requiring a lot of equity in a deal, and that will take time to change, too.
“It's great that interest rates are coming down, all of us would agree with that, but to see an immediate impact? No, it's going to be years,” he said.
While the rate cuts won’t result in an immediate change to the development pipeline, they should still have a positive impact on new projects, Collazo said. The first hurdle is perception, and many people generally have a negative view of the U.S. economy when the numbers show it’s actually doing well. If an owner has a negative view, they’re going to want to sit tight and wait it out.
“Interest rates coming down could start changing that perception, even among bankers, builders — everyone,” he said. “And yes, that starts to flow, getting everyone back to normal where they feel more comfortable making a decision to move forward.”
As owners and developers consider new projects or moving forward on existing ones, they have a number of factors to weigh, he said. Materials and construction labor are still expensive, and availability is still an issue. That combines with the current level of demand, which is overall a bit lower than where hoteliers would like it to be.
It likely won’t be until 2026 until the numbers start to show more hotel projects progressing, Collazo said. There are small amounts advancing now, but there’s still a hesitancy that will hinge on confidence of the future.
“You have to be confident you can get the money, and you have to be confident that everything’s going to be great, because once you start, there’s no turning back because you’re spending money at that point,” he said.
That said, there may be a risk at missing the right point to start, Collazo added. Hotel developers who wait too long may end up entering a market along with more competition than if they had taken the leap earlier.
“It depends on their appetite, right? Their risk appetite,” he said. “Do you risk it now or not? And then, how much?”
Impact on travel
The U.S. economy is slowing down, and the labor market is weaker, Ryan said. While it’s in a weaker place, lower interest rates will lead companies to invest more. That could mean pulling the trigger on projects, whether that be construction, technology or something else.
“I tend to look at that sort of investment as being correlated with business travel,” he said. “That when you are more focused on getting things done, you’re going to be approving more business travel and trying to get more folks out there spending money on events to drive future sales or events to train people.”
The first rate cut, while not necessarily material itself, would indicate the economy is on a stabilizing path, Ryan said. There are likely some decision-makers who will start advancing things knowing this is the path ahead. They’re going to borrow at longer-term rates many times, which may not change as much, however.
Others may sit there, saying the initial cut isn’t fundamentally changing the rate at which they would borrow, and wait for a bigger impact, he said.
As for how much of an impact the rate cuts will have on consumers? It depends, Collazo said.
People on the lower end of the income spectrum are feeling squeezed from their credit card debt, he said. Even if rates go down 2%, credit card interest rates will still be high, as evidenced by how high they were even when rates were even lower.
In the latest quarter, credit card balances increased by 11%, he said. That's down from the 17% growth seen in the first quarter of 2023, but that's still double-digit percentage growth in debt.
"There's a lot of debt out there on credit cards that's going to still hold people back," he said. "I don't think that's going to go away even as interest rates come down because servicing that debt is just going to take so much time, and if you're just paying the minimum, you'll never get out of it."
Ninety-plus day delinquencies are also up, indicating more people are having trouble paying off this debt, he said.
"As interest rates come down, the individuals being impacted by this environment of [credit card debt] stuck in high interest rates, I don't think they get any better anytime soon, unless there's some kind of stimulus package, which I doubt that's going to happen," he said.
Higher-income households will benefit from the housing market opening more as lower interest rates may make people with already low rates more comfortable selling again, Collazo said. As for credit card debt, most high-income households don't struggle with this as they typically pay off their balances at the end of the month.
It's the lower- and middle-income earners that need watching to see whether and how quickly their credit card debt comes down to the point where they can start spending again like they used to, he said.
"Because right now, they're just in high debt, so right now they're stuck, so they've got to reduce it to be able to go back to their old way of life," he said.