This past year was shaping up to be a big year for hotel transactions in the U.S. as the industry's recovery continued to strengthen, but the rising cost of debt had buyers hitting the brakes.
It feels like 2022 should be broken into two segments, one that runs from January to August and the second from September until the end of the year, said Kevin Davis, Americas CEO at JLL Hotels & Hospitality.
“It’s been night and day in the market, and that started in March as the Fed started to tighten monetary policy,” he said.
Overall, it’s been a strong year for transactions with about $29 billion in total transaction volume, Davis said. That’s 10.4% more than 2021’s dollar volume, and last year was a near-record year, beaten only by 2015. A material decline for the last couple months of 2022 was expected, mitigated somewhat by three hotels from the Strategic Hotels & Resorts portfolio trading in the fourth quarter, he said.
There were more individual hotel sales in 2022 compared to 2019, a 136% increase to 871, Davis said. While there have been some portfolio deals, the deals environment has been mostly granular with smaller deals being made.
The most liquid markets in the U.S. have been New York, Los Angeles and Washington, D.C., as group business and corporate travel have recovered further, he said.
When looking at portfolio deals, the sale of Watermark Lodging Trust to Brookfield Asset Management for $3.8 billion was consistent with the overall theme in the ongoing interest in acquiring high-quality luxury and upper-upscale properties, Davis said. The portfolio has hotels and resorts in top markets in the U.S.
As seen by this portfolio deal and the three sales from the Strategic Hotels portfolio, even with the current economic challenges in place, investors are willing to pay full price for high-quality hotels, he said.
“Luxury, irreplaceable real estate is proving to be the most durable,” he said. “Those are the assets that investors are chasing. There’s no price discounting here.”
The Cost of Capital
In March, the Federal Reserve raised interest rates by 25 basis points to a range of 0.25% to 0.5%, the first increase in rates since 2018. The Fed raised rates again in May to a range of 0.75% and 1%, followed by another in June to 1.5% to 1.75%. Inflation continued to increase year over year, so the Fed raised rates another 0.75% to the range of 2.25% to 2.5%, again in September by 0.75% and once more in November by 0.75% to a range of 3.75% to 4%.
On Dec. 14, the Fed raised rates for the last time in 2022, increasing them by 0.5%. That all means that in nine months’ time, the Fed raised interest rates from nearly zero to 4.5%, increasing the cost of debt.
As the cost of capital has increased, U.S. hotel transaction volume slowed dramatically, particularly toward the end of the year, said Daniel Lesser, president and CEO of LW Hospitality Advisors. His company tracks hotel deals valued at $10 million or higher on a quarterly basis. Though fourth-quarter figures aren’t available yet, his tracking of the first three quarters of the year and their comparisons to 2021 show changes in the transaction market.
The LWHA third-quarter 2022 hotel sales survey reported 119 single-asset sales valued at more than $10 million, combining for a total of about $3.7 billion with an average price per key of $212,000. Looking back to earlier in 2022, the first-quarter sales survey reported 128 single-asset sales, totaling $7.9 billion with an average price per key of $306,000. The second-quarter survey reported 133 single-asset sales for a total volume of $5.3 billion with an average price per key of $248,000.
The survey for the third quarter of 2021 reported 88 single-asset sales, and total dollar volume reached $4.8 billion with an average price per key of $261,000. Comparing the third quarters of 2021 and 2022, the number of deals increased year over year by 35% while dollar volume dropped by about 24% and price per key fell 19%.
Who’s Investing
The last year has been a stellar acquisition year for hotel real estate investment trusts, said Gilda Perez-Alvarado, global CEO at JLL Hotels & Hospitality. Companies such as Host Hotels & Resorts and Braemar Hotels & Resorts have focused on quality assets that don’t need a lot of capital investment and should continue to perform well.
“The REITs have also been sellers, so they’re graduating up,” she said. “They have conviction that this luxury leisure demand will continue to outperform going forward.”
The family office phenomenon is a global trend, Perez-Alvarado said. They’re no longer backing just a single family or buyer, so many of them have grown significantly and are starting to act like private equity in that they’re pooling money from many families, so they’re becoming more acquisitive.
“They’re targeting that forever real estate, but they’re being somewhat opportunistic,” she said.
Private equity has been focused on select-service hotels, and these investors were involved in two of the largest portfolio trades of the year, Perez-Alvarado said, referring to Blackstone and Starwood Capital acquiring 111 WoodSpring Suites hotels for $1.46 billion and the CorePoint Lodging deal with Cerberus Capital Management and Highgate for $1.5 billion.
However, private equity has grown quieter in the second half of the year, she said.
Off-shore capital investing in U.S. hotels is at an all-time low, she said. It’s below 5% when historically they’re between 10% and 15% of deals in any given year. That lull is expected to continue.
When looking at all of the money raised for hotels, it’s still at an all-time high, so there’s no liquidity issue, Perez-Alvarado said. It may be that the opportunities haven’t been there yet, and investors are trying to get a better sense for pricing given the Fed’s movement on interest rates this year.
“I would say the dry powder is there,” she said, adding that there should be an increasing number of hotels available for purchase next year. “From a volume perspective, 2023 should actually be a very, very robust year.”
Pressure To Buy and Sell
The pent-up capital discussed at great lengths through the pandemic and its recovery is still out there, and in an inflationary environment, every day someone sits on that cash, they’re actually losing money, Lesser said. He has spoken with equity investors who feel so much pressure to deploy that capital, some to the point who are willing to adjust their expectations on returns.
“They can’t sit on cash anymore, so they’re willing to lower their return requirements irrespective of rising interest rates,” he said.
There is a tremendous amount of debt that’s coming due over the next 12 to 24 months, Lesser said. That debt was structured during a much lower interest rate environment, and owners will have to make a decision about refinancing or selling.
“A lot of deals are going to be challenged in terms of when the mortgage comes due,” he said. “’Do we want to put more cash in? Do we want to sell the hotel?’ Are they going to end up having to do a workout?”
The spike in interest rates will lead to an increase in transaction activity next year because any deal that comes up for maturity will have to get recapitalized at a different basis, Lesser said. This is going to open up a lot of opportunity for preferred equity, mezzanine financing and all levels within the capital stack.
There will be distressed deals, but they’ll be on the capital structure side, not the operational side, Lesser said. If there is a severe recession with rising unemployment and less travel, that could cause problems for operations, but he doesn’t think that’s likely.
That pent-up capital is going to go after the distressed deals, and with so much money out there looking for bargains, would-be buyers will end up competing for properties, driving up the cost, he said. At the start of the pandemic, everyone expected hotels to sell for 20 cents to 30 cents on the dollar, but that never came to fruition.
An Owner’s Strategy
The last year has been an iconic year for NewcrestImage, Managing Partner and CEO Mehul Patel said. In January, the company closed on the sale of 27 hotels for $776.5 million and two parking structures for $24.8 million along with $20.7 million in various financial incentives. Since then, the company has acquired dozens more hotels through individual and portfolio deals.
Along with selling off its hotel operations platform to Aimbridge Hospitality and making it the company’s preferred management company, NewcrestImage has become an ownership-only company. NewcrestImage has also shifted its portfolio makeup from mostly budget-level properties to premium select-service and extended-stay hotels, he said.
“That’s been our DNA,” Patel said. “When the market is down or when people are in fear, that’s where we pretty much go in the market and really dominate with our capabilities to acquire assets.”
In today’s market, large institutions are selling their properties because they haven’t invested capital, in some cases for more than three years, and that’s a major issue for the entire hotel industry, he said. That could lead to companies selling off hotels or a portfolio of hotels, and the buyers in many cases will be private equity as other buyer types may not have the balance sheet.
While others are cutting back on their business plans, NewcrestImage is going to be ready to buy because even though things are still down, they’re going to go back up again, he said.
“That’s the nature of short-term, long-term strategies,” Patel said. “You have to understand what is your short-term risk that you’re willing to take that’s going to pay off in the long term.”
After acquiring a hotel or portfolio of hotels, the company’s strategy is figuring out the next 30, 60 and 90 days, Patel said. The company and its hotel management partners immediately set out to fix five low-hanging fruits in the first 30 days to improve the hotel experience for guests before tackling bigger challenges.
Once the company has made improvements and feels a property has matured into a market that wants to buy, it will start selling individual hotels and even portfolios, he said.
Patel said he hopes NewcrestImage will acquire more than 50 hotels next year and sell between 15 and 25. It will likely expand from the select-service hotels it has focused on this year to more full-service properties next year.
“We feel like there is a lot of full-service that has been neglected and they haven’t invested capital in it,” he said.