The Meet the Money conference hosted by Jeffer Mangels Butler & Mitchell LLP, was held in Los Angeles May 1-3 after a three-year pause. As usual, the conference was packed with high-quality content and actionable insights on navigating current hotel capital markets.
Below are key takeaways from the two-day event:
Continuing Disconnect Between Operating Fundamentals and Capital Markets
Hotel demand and revenue per available room continued to post robust performance through the first quarter of 2023, with demand fully recovered to 2019 levels and nominal RevPAR 13.1% above the first quarter of 2019.
Despite strong operating fundamentals, hotel capital markets continue to be impaired by both the availability and cost of capital, with credit spreads widening over the past 60 days, in addition to record-high interest rates driven by 10 consecutive rate hikes in the Federal Funds rate. This disconnect between operating fundamentals and capital markets is expected to continue until there is a clear signal from the Federal Open Market Committee that the tightening cycle is complete and that they will begin lowering interest rates.
Hotel Demand Expected To Grow Despite a Recession
Most economists are forecasting a recession in the second half of 2023. The recession is expected to be mild, according to Oxford Economics. However, travel — and therefore hotel demand — is expected to continue growing despite a recession, since several demand segments such as business transient and international inbound are in various stages of recovery, but not fully recovered to pre-pandemic levels.
Additionally, U.S. households are in a position of strength driven by the 53-year-low unemployment rate. And remote and hybrid work are driving new sources of hotel demand. 2023 will likely be the first year where a 30-year trend of the strong correlation between GDP and hotel demand is not expected to hold.
CapEx Challenges Persist, Expected To Weigh on Investment Decisions
Hotel renovation costs have escalated between 25% and 35% over the past three years, with no imminent signs of easing. The historical trend of $8,000 to $10,000 per key for a soft-goods refresh every seven years for a select-service hotel is now priced at $22,000 to $25,000 per key.
Further, most owners’ capital plans do not factor in ESG requirements over the next three to five years, which could pose a material risk to planned capital expenditure estimates. The average age of a hotel in the U.S. is 37 years; in the next three to five years most of these properties will be at the end of life cycle for major mechanical systems and building infrastructure. These higher capital costs will affect underwriting and weigh on investment decisions.
Alternative Sources of Financing Are Available, Albeit Selectively
As traditional sources of hotel financing become more constrained, sponsors are exploring alternative creative sources of equity and debt capital. These include PACE financing, EB-5 Immigrant Investor program, Opportunity Zone financing, and Historic Preservation Tax Incentives program.
In many cases, this type of capital is available at a lower cost than traditional sources. However, these newer capital sources come with their unique criteria and requirements. Sponsors should leverage the expertise of advisors that have practical experience navigating these capital sources.
Debt Maturities Will Be a Catalyst for Transactions
Approximately $236 billion in lodging loans were originated between 2017 and 2019. These loans, made at or near-peak EBITDA and values, are coming due amid rising interest rates and significant dislocation in capital markets. While lenders extended loan maturities during the pandemic, given current regulatory requirements, they are expected to be more focused on near-term solutions for upcoming maturities — including equity infusions by the sponsor and tighter underwriting standards for the go-forward pro forma.
The combination of capital required for brand-mandated renovations, material principal pay-downs and more stringent underwriting standards is creating a significant liquidity crisis, and will likely lead to a generational buying opportunity in the hotel sector.
Romy Bhojwani is director of hospitality market analytics, Northeast and Midwest, at CoStar Group.
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