HOUSTON — The U.S. hotel industry has been going through some disruption due to economic uncertainty, but players in the transaction market say deals can be done. They're just not as easy and more expensive than they used to be.
During a capital markets panel at the Hospitality Law Conference, John Keeling, executive vice president at Valencia Hotel Group, said historically hotels have been considered among the riskier real estate investment classes. The leases are for one night, making it difficult to predict accurately what the next night will bring, while buildings such as offices offered fixed leases for 10 years.
Now, the office market is recovering from the pandemic but is still in the doldrums, Keeling said. Those 10-year leases don’t seem as safe. The hospitality rate model means hotels can raise rates faster to account for inflation.
“The average rate of hotels in the industry today is about 26% higher than it was in 2019,” he said. “That’s significant. You won’t find that in any other class of real estate.”
National hotel occupancy is about 62%, a few percentage points shy of the long-term average, Keeling said. Resorts are generally the closest to the average as people sought out properties that offered people outdoor experiences and room to stay safe distances from others. City-center hotels suffered worst during the pandemic, but they’re now the fastest-improving segment in the industry.
The hotel market itself has bifurcated by chain-scale segment as a result of inflation, Keeling said. While hotels have been able to raise rates to keep up with inflation, that left more price-sensitive consumers with fewer options. The leisure travelers in the upper-quartile of wealth are still able to travel, helping drive performance at upper-upscale and luxury hotels.
The hotels that are hurting are in the economy, midscale and upper-midscale segments, he said. The guests that stay at these hotels are more rate-sensitive, and, due to inflation, they don’t have as much discretionary money available for travel.
“We’re seeing a very uneven recovery in the market, with high-end recovering rapidly and the low-end fighting,” Keeling said.
Short-term floating interest rates, primarily the 30-days SOFR, have come down about 100 basis points since their peak, so they’re at about 4.2% or 4.3% for the 30-day SOFR now, said Jonathan Falik, founder and CEO of JF Capital Advisors. Although rates have come down, they’re still higher than they were years ago.
The credit spreads, whether for SOFR of the 10-year U.S. Treasury, have generally compressed about 100 basis points, he said.
“If you’re a floating-rate borrower, you’re looking at paying about 200 basis points, or two points less, on your all-in interest rate on a hotel, whether it’s a development deal or existing deal, but your all-in rate is still substantially higher than it was during any period from 2009 to 2022.”
For owners of an existing property with a fixed-rate mortgage at 4% to 6% that’s coming due, they’re not going to be able to refinance it at the same level now, he said.
Short-term rates are projected to drop further and get closer to 3% while the 10-year Treasury is projected to stay relatively flat at around 4.5% to 4.8%, Falik said.
“All of that is highly dependent on what happens with tariffs, with happens with the broader economy, what the Federal Reserve does, what our Commander in Chief does,” he said. “That can whipsaw all over the place.”
Money is widely available, but it’s expensive and the stipulations are tougher than they used to be, Falik said. That includes development money, senior mortgage debt, mezzanine debt and commercial mortgage-backed securities.
“It’s just much higher covenants, much tougher underwriting and way more costly than it had been for 15 years or so prior,” he said.
Some lenders, however, aren't interested in financing hotel deals and development projects at this point, Keeling said. Valencia does ground-up development, and many regional banks are still out of the market for hotels.
While that creates a challenging development environment, that does support the argument that owners should build now since the overall pipeline for new hotels is down compared to the long-term average, he said.
"This is the time to build because it's going to take two years for you to open," Keeling said.
There are opportunities for deals, Falik said. There are hotels that have cash flows, but even if their rates are higher than before, they may not be generating enough income to refinance efficiently. They may also be facing property-improvement-plan deadlines from brands or just general necessary maintenance.
“That’s where we see a lot of this pressure, because that’s where an investor has to say, ‘I’m going to put more cash equity into this’ or ‘I’m going to sell’ or ‘Hey lender, I’m not putting any more money into it. If you want to come take it, you can come take it.’”
This is where investors will see opportunities to come in, he said. It could be buying from an undercapitalized owner or an investor that has the capital but doesn’t see the value.
“We’re seeing a massive increase in foreclosure sales and note sales from banks and different lenders,” he said. “We will see kind of a big uptick also in bankruptcy filings.”
Hotel owners underwrite deals with a 4% furniture, fixtures and equipment reserve, meaning they’re supposed to take 4% of their annual revenue and hold onto it to replace FF&E down the line, Falik said. The lender definitions of FF&E have expanded to include things such as roof and elevator repair.
The 10ks filed by hotel real estate investment trusts over the past 10 years show that REITs reserve a little over 9% annually on average, and more for luxury hotels, Falik said. The 4% might be enough for replacing actual FF&E, but it won’t cover the cost of roofs, HVAC systems, elevators and other major repairs. However, since the start of the pandemic, the hotel industry is behind in building up its reserves.
“Not even close to 4% for 2020, 2021, 2022,” he said. “In a lot of cases, borrowers went to their lenders and said, ‘Hey, we’ve got a couple of million bucks in the FF&E reserve account. We don’t have any money to make payroll. Can we take the money?’”
The FF&Es are widely underfunded, and there are massive capital expenditure needs, Falik said.
When reviewing renovation plans, hotel owners and operators have been seeing price hikes related to the new tariffs, Dimension Hospitality CEO Greg Friedman said.
“As soon as the China tariffs went to 145%, we had one broker that just said — with an order we’re literally three weeks away from shipping — he said, ‘I’m out,’” Friedman said, adding the broker offered to put them in touch directly with the factory in China.
Friedman added he’s cautiously optimistic the U.S. will work out trade deals so prices will even out. Some of these price increases were baked in, but no one expected them to reach these levels.
“When you get all the other external factors, it definitely makes it a big challenge,” he said.