LOS ANGELES — The higher cost of capital has slowed the pace of U.S. hotel deals over the past year, but new factors coming into play soon could spur more activity.
During a panel on the transactions environment at the Americas Lodging Investment Summit, hotel industry executives spoke about who they think will be active buyers and sellers and what will help drive more deals.
Deals Appetite
There are three main categories of hotel buyers: the real estate investment trusts, private equity funds and high-net-worth individuals and private companies, said Richard Stockton, president and CEO of Braemar Hotels & Resorts. Last year, the REITs and private equity funds mostly took a step back, but now they’re starting to come back. The high-net-worth buyers are also interested.
“It's difficult to generalize and say that your categories of buyers are totally different from what they used to be,” he said. “I think it's just there's a lot less of them, and they're slowly coming back to the market.”
Last year there must have been more broken deals than ever, and only about 10% of all deals marketed actually traded, Stockton said. There were a lot of opportunistic sellers who didn’t get the price they wanted after testing the market to see if they could hold on to their valuations. When they didn’t get the number, they pulled back.
Much of that has been washed out of the system now, he said. This year, the hit rate will be higher because there will be sellers who want or need to sell.
“They’re no longer out there opportunistically testing the market to see if they can reel in a big number,” Stockton said. “I think that these are the days when that opportunity passed.”
KHP Capital Partners' hotel portfolio is a balance between major urban markets and leisure destinations, said Ben Rowe, co-founder and managing partner. Prior to the shift in capital markets, the firm had looked at selling some of its higher-performing leisure properties because it was worried about a downside risk to performance given the expectation that demand patterns would normalize. There was also a lot of capital chasing those opportunities, driving up valuation.
Today, many of those markets have pulled back to some degree, Rowe said. The cost of capital has affected valuations.
“I think that an entry point in the leisure side is starting to get a little more interesting,” he said. “But our primary focus today is more on those opportunities where there still is lingering distress from COVID, which is compounded by the capital market pressure and where you can buy it at that deep discount to replacement cost.”
KHP Capital Partners likes to buy high-quality assets in good locations and markets where it has conviction in the intermediate to the long run, Rowe said. It also likes properties in need of renovation where it can do something transformative to create value.
McNeill Investment Group has fundamentally restructured the way it thinks about the hotel industry, CEO Chris Ropko said. It has long been a select-service hotel owner, operator and developer, but the pandemic flipped everything on its head, so the company started to think about things differently. McNeill is now looking at things from a human capital and branding perspective.
The McNeill team looks at the chain-scale segments and how they all interplay with each other, Ropko said. The high end and low end are a classic barbell approach.
“Love the luxury side of the coin, love the lowest of low end, but I think it’s now a function of reimagining and repositioning what we think of as traditional brands,” he said. “I don’t think we’ve had enough of that.”
With the barbell approach, all the things in the middle have been jumbled up, Ropko said. The classic full-service hotel was a tough investment case even before the pandemic, and now, unless someone is buying one for pennies on the dollar, it’s worse.
“The big-box convention hotel, I don’t know. I just haven’t seen that value proposition come back yet,” he said.
The luxury segment outperformed and select-service hotels and below outperformed as well, Ropko said. There’s a lot of innovation going on in those lower segments, he added.
Distressed Hotels, Owners
The type of distress that Braemar is seeing is motivating sellers, Stockton said. They are hotel owners who have a refinancing event coming up and don’t want to put more equity into the deal because the proceeds will be less than their outstanding debt. The other reason is they may have a big capital expenditure project coming due but they don’t want to fund it.
“It’s owners that don’t want to reach into their pocket, and those can be good deals,” he said.
Seeing actual distress is spotty, Stockton said. Braemar has received calls about hotels in which the mezzanine loan is about to fall, but it hasn’t played in the space much because it’s tricky and requires performing due diligence quickly with limited access to information.
“We’re not necessarily that comfortable running after these distress opportunities, but again, we're not seeing a ton of them right now,” he said. “That could change, but frankly, going forward, again, things look like they're getting better, not worse.”
An owner that wants to ride things out until their cash flow improves still likely has to deal with a debt maturity and renovation, said John Murray, president and CEO of Sonesta International Hotels. The only way they would stick with their current lender is if they pay down some level of debt if they can’t refinance out completely, and they would have to put some money into the next cycle’s renovation.
“You’re really committing a fair amount of equity into the deal if you want to stay in,” Murray said. “I do think that there’s going to be more activity coming as a result of that because some people have already held for five, seven years. They say, ‘Well, you know, I don’t want to spend $25,000 a key on a renovation and pay down my loan by 25%.”