REPORT FROM THE U.S.--There are a number of macroeconomic factors that will affect the real estate industry as a whole and the hotel sector in particular in 2012, according to the The Plasencia Group's Lodging Investment Roadmap 2012. The roadmap highlights factors impacting the health of the lodging sector and details lender activity, including recent underwriting criteria.
Many of the largest companies in America have made strong financial gains in 2011, and domestic economic growth is recuperating, albeit at a very slow pace. However, in Europe, America’s largest trading market, economic challenges will clearly have a detrimental impact on the U.S.
- Virtually every sensible economist in the U.S. believes that there is little chance of another national recession in 2012.
- With $2 trillion in cash on their balance sheets, the most since 2007, U.S. businesses are considered to be well-positioned for expansion, investment, and ultimately, employment growth.
- With their strong corporate balance sheets and deep cuts in operating costs, U.S. businesses are perfectly positioned to make further investments and buyout acquisitions in 2012. This will serve to drive economic growth in the face of a tepid economy.
- Corporate earnings growth in the U.S. in 2012 is expected be a healthy 8.5%.
- Standard & Poors suggests a possible recession in Europe during the first half of 2012 and a “half-speed” recovery in the U.S. during that period. S&P also predicts that non-U.S. stocks will be modestly higher at year’s end.
- Given the unsustainable sovereign debt situation in Europe, fewer commercial real estate loans will be made in the U.S. by foreign banks in 2012. This presents an opening for U.S.-based balance sheet lenders to ramp up lending and greatly expand their market share.
While we see promising improvements in the U.S. economy, the health of the lodging sector – in terms of operating fundamentals and its attractiveness as an alternative investment vehicle – remains very dependent on macroeconomic factors well out of anyone’s control. We believe that there are four factors affecting the course of the U.S. economy and the health of the lodging sector for the balance of 2012: U.S. monetary policy, the European Union debt crisis, Chinese GDP growth, and the price of oil. For the foreseeable future, then, and until there is more clarity and stability in these four areas, we can expect to see more of the meager gains that we have experienced since Fall 2008.
What will be the level of lodging investment activity for 2012?
The unprecedented volatility caused by the recent recession will create a real estate sell-off which will eclipse the sell-off experienced after the U.S. Savings & Loans crisis of the late 1980s to mid-1990s, and the Asian currency crisis, which began in Thailand and South Korea in 1997. We believe that sell-off has already begun.
A study issued by U.S. hedge fund Fortress Investment Group supports this view. They report that more than $2 trillion in global real estate assets are up for sale as we go into 2012, either as a result of distress or deleveraging. To put the 2012 number in perspective, Fortress points out that the 1990’s S&L crisis generated real estate sales of just over $260 billion, while the Asian crisis, by the time it ended in 2000, prompted an approximate $345-billion sell-off. Stressed borrowers, whether countries, banks or real estate investors, have been focused on surviving but must eventually resort to selling their troubled assets. The inevitable can only be forestalled for so long. This is the year that dispositions accelerate in earnest.
In the commercial real estate market and the hospitality sector in particular, there were a number of improvements in 2011. And barring a total European financial meltdown, we expect continued strengthening across U.S. lodging throughout 2012. Commercial real estate prices across all sectors are up considerably since mid-2009. Hotel sale prices have also improved dramatically, now on par with late 2006 levels and only 10% below the 2007 peak.
- According to Real Capital Analytics, Inc. (RCA), transaction volume across all five major U.S. commercial property sectors was expected to reach $200 billion in 2011.
- Unused reserve financial capital held by hedge funds increased to nearly $86 billion in 2011. This represents a significant amount of unused capital readily available for real estate investments and shows that much of the capital hedge funds have raised has yet to be deployed.
- According to TravelClick’s December 2011 North American Hospitality Review (NAHR), hotels will continue to see strong growth in 2012, driven primarily by rate increases and strong, steady room demand. The NAHR is based on actual hotel bookings from Q4 of 2011 through Q3 of 2012.
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Several key elements inserted into the 2012 U.S. Omnibus Budget (approved last December 23) will greatly enhance
inbound foreign travel. This recent yet overlooked Congressional action could have a major impact on hotels, especially in gateway markets such as New York, San Francisco, Orlando and Miami. The actions include calls for (a) the relaxation of requirements for in-person interviews, (b) extending the expiration dates on certain visas, and (c) reducing visa wait times by increasing the number of visa interview officers in Brazil, India and China. - U.S. travel emanating from China has increased by 300% since 2005. That number would be even higher were it not for the difficulty experienced by Chinese travelers in obtaining visas to the U.S. Chinese outbound travelers are expected to hit 100 million by 2020, up from 65 million in 2011, with a great many heading to the U.S.
For a variety of reasons, the hotel sector continues to be a very attractive vehicle for those investing in commercial real estate. Year-end performance for 2012 is expected to show that the industry will nearly be back to its peak 2007 levels.
- The industry saw more rooms occupied in 2011 than ever before, with over a billion room nights sold.
- Occupancy in 2011 was up 4.0% and rate increased 3.6%, generating RevPAR growth of 7.7%. The greatest rate of RevPAR growth was in the luxury segment (6.7%) followed by the upscale segment (6.7%).
- The lack of new hotel construction, due mainly to the virtual absence of construction financing, will allow the hotel industry to continue to raise rates without the threat of any meaningful supply increases for the foreseeable future.
What is the single most important factor having the greatest impact on the lodging sector in 2012?
The huge volume of distressed lodging debt being held by lenders and servicers continues to be one of the greatest challenges for the real estate industry. Banks will be more apt to unload the hotels in their portfolios in 2012 as maturities accelerate across all asset classes, necessitating work-outs on their more traditional real estate holdings. Since early 2008, lenders and borrowers have reached workout agreements on 53% of distressed hotel loans, the highest among all commercial real estate categories, according to data from RCA. Loan maturities and delinquencies will continue to present a major source of anxiety for hotel lenders and borrowers in 2012.
- Trepp, a New York-based analytics firm that tracks the commercial mortgage-backed securities industry, reports that the delinquency rate on securitized hotel loans was at 12.3% through October of 2011, highest among all commercial real estate classes.
- About $21.7 billion on 232 hotel CMBS loans is coming due in the next 12 months and will need to be refinanced, according to securities ratings firm Realpoint. This, coupled with the lack of available debt for refinancing, will result in near historic levels of hotel foreclosures in 2012.
Most lenders and special servicers are not in the business of holding and owning hotels and few have the patience and in-house expertise needed to successfully manage lodging properties. They have avoided foreclosing on hotels by postponing tough decisions. Improving operating fundamentals and active capital markets now provide lenders and troubled owners the exit they’ve been waiting for. Expect the sale of distressed hotels to increase in 2012.
Most banks and servicers holding hotel loans will end their “extend and pretend” practices, instead opting to now sell management- and capital-intensive lodging properties. In addition, other “forced owners,” a number of REITs and C-corps will also be selling more of their non-core hotel assets.
What does the lending environment look like for the lodging industry?
Lenders’ underwriting of hotel loans has tightened to reflect the realities of the challenged economy. Today, lenders are using a combination of (a) trailing-twelve-month cash flows, (b) projected 2012 NOIs, and (c) a quick look back at performance in the peak years of 2007 and 2008. Most buyers and lenders have come to the realization that underwriting to financial statements for 2009 and 2010 is almost meaningless. Across all major asset classes, life companies and other balance sheet lenders are quite active. The Mortgage Bankers Association reported an increase of 406% in hotel loan originations in third quarter of 2011 as compared to the third quarter of 2010. Hotel loan terms are generally three to seven years with pricing hovering at 200 to 300 basis points over LIBOR. Life companies' loan terms generally offer loans up to a loan-to-value ratio of 65 percent with terms of five, seven or ten years. Five year loans are generally priced at 3.0% to 3.5% over, and loans with 10-year terms are priced at 3.75% to 4.5% over. And when it comes to new construction, there is also a disincentive to equity investors who may not be overly keen or patient with new development. They can begin to reap the benefits of ownership immediately by acquiring an existing asset far more quickly, likely at a discount to replacement cost, and with significantly less risk.
Where should investors in the lodging industry focus?
Hotel investment returns are greatly affected by local and regional factors. As such, the more attractive markets continue to be those with decreasing degrees of volatility and improving economies. Markets in which hotel performance is quickly stabilizing are characterized by robust corporate travel, strong leisure travel and improved group bookings. We have identified those markets in which we expect continued improvement in the hotel sector in 2012. Many of these markets benefit from improved corporate demand and a strong leisure component. We have purposely left out many gateway markets where cap rates have gotten so low that they have almost become unattractive to the value-oriented investor.
- Austin
- Boston Suburbs
- Charlotte
- Dallas Suburbs
- Denver
- Houston
- Indianapolis
- Los Angeles
- Miami
- Minneapolis
- Nashville
- New Orleans
- Northern New Jersey
- Northern Virginia
- Philadelphia
- Portland
- Raleigh-Durham
- San Diego
- San Jose
- Seattle
- Tampa
Who will be the primary buyers and sellers in 2012?
While hotel REITs were the most active buyers of lodging assets in the first half of 2011, they became almost extinct later in the year as their stock prices tumbled and their access to public markets evaporated. REITs are not expected to be meaningfully involved in acquisition activity again until their stock prices rebound, which may not happen at least until mid-2012. The more active acquirers of hotel properties for the coming year will be private equity funds, insurance companies and pension fund advisors. Additionally, the Association of Foreign Investors in Real Estate (AFIRE) reports that more than 60% of its members view the U.S. as the best market for capital appreciation. Since most of Europe finds itself in financial distress and Asian markets have not met expectations, the U.S. presents itself as a very promising and stable venue for offshore capital. Hotels, especially those in gateway markets, will be very attractive to international capital seeking a safer haven.