HM on Location: Debt is pricier, but hotel development and deals press on

PHOENIX — "People will come, Ray,"... James Earl Jones' character prophetically tells Kevin Costner in "Field of Dreams," exhorting him to not sell the baseball field he's built in his backyard because, as he correctly predicts, people will come to Iowa, forking over money and "longing for the past."

If not for his acting chops, James Earl Jones might have made a great franchisor. His ken and positivity were on full display during a panel session at The Lodging Conference focused on deals, development and M&A, where there was no shortage of confidence in the market despite myriad challenges developers are dealing with.

It's the irrepressible traveler that is the impetus for further hotel development, either through new construction, which is becoming harder due to rising interest rates and construction costs, or conversions. "The prospect for travel is very high," said Sonesta International Hotels Corp.'s chief development officer, Brian Quinn, crediting the resiliency of the traveler. "People are going to travel," said Chip Ohlsson, EVP and chief development officer at Wyndham Hotels & Resorts. "Business travel is coming back," said Mark Purcell, SVP of development, North & Central America, at Accor.

The suspected demand for travel has brand development teams confident, but not irrational. Julienne Smith, who assumed the role of CDO, The Americas, for IHG Hotels & Resorts, in June, following the retirement of Joel Eisemann, explained her optimistic outlook despite the macro challenges. "I am positive, but it is tough when you factor in headwinds like the supply chain. It's causing hotels to be delayed in opening," she said.

The one non-brand on the panel was a bit more muted in tone. Chris Devine, CFO and chief investment officer of Pyramid Global Hospitality, pushed caution on transactions and development ahead of a potential recession, but was equally sanguine over the prospects for the hotel industry, particularly as it related to customers and travel. "Interest rates are an issue for new deals," he said, "but fundamentals for hotels are continuing to improve."

He referred to the 2008 financial crisis that he said resulted in a slowdown in transient business and a spate of group cancellations. "We haven’t seen that this time around," he said. 

Hotel developers are taking cues from the traveling public as a travel binge unfolds amid a widow of so-called "revenge travel." Transportation Security Administration throughputs are now on par with 2019 levels, with sustained leisure travel and, according to hotel executives, a return in corporate travel as companies get back on the road to secure deals with customers in person. It's all a recipe for more brands, further development and franchisors convincing owners to convert properties to their flags.

Last February, Wyndham Hotels & Resorts launched an extended-stay product in the economy segment and seven months later broke ground on its first project, in Plano, Texas. At the time, CEO Geoff Ballotti called the segment both recession and pandemic proof. Ballotti's CDO, Ohlsson, echoed his boss' sentiment. "We are building new construction now to capitalize two years from now," he said. 

Quinn made a similar point, pointing to the "resiliency of the global traveler" as the explanation for sustained development. "When markets are tough, that’s the time to do deals," he said, noting that hotels take time to build and open, which allows developers to maximize their investment when the ship rights. 

Devine volunteered that new construction is tough, but pointed to the success and profit margins of brands down the scale, what he referred to as "compact extended stay and not full service with big meeting space," and located in the Sunbelt states. 

Ohlsson pointed out that new hotel development is not a game of timing. Real estate can go through many iterations but can also stand the best of time. "This is a long-term game," said IHG's Smith. "If we are in this to build it and flip it, it usually doesn’t work. Those who focus on liquidity will get through this."

Down on Debt

JLL Hotels & Hospitality Group's September Global Hotel Investor Sentiment Survey revealed that nearly 80 percent of investors plan to be net buyers in 2022. JLL said that total hotel transactions in the first half of 2022 were up 2.4 percent versus the same period in 2021 and up 89.7 percent to 2019, but deal flow still lags headier years that preceded the pandemic. In today's buying market, cash is king. 

"If you are a higher loan-to-value buyer, it’s tough to get deals done," said Pyramid's Devine. "This environment calls for lower leverage and waiting for rates to settle." The question, he asked, is "how long will that take?"

Even the chair of the Federal Reserve, Jerome Powell, isn't sure. “It’s very hard to say with precise certainty the way this is going to unfold,” Powell said last week. “No one knows whether this process will lead to a recession or, if so, how significant that recession would be.”

The Fed since March has lifted its benchmark lending rate by a full 3 percentage points, the fastest increase of that size since 1982. Powell said that rates probably will rise an additional point-and-a-quarter before the end of the year.

The uncertainty is making it hard on investors. "Debt is behaving strangely," Quinn said, "but there is a ton of equity chasing this space." He said people want to put money to work and the hotel space is considered a better yield opportunity in the market right now than office or retail. "If you do it now when it’s hard, you’ll get outsized returns."

Indeed, extended-stay hotels are all the rage for developers and customers—they are quicker and relatively cheaper to build, can be operated by seven to 10 full-time employees and the segment altogether is still relatively untapped vis-à-vis other types of hotels. Said Ohlsson, "People always tell me they kick themselves for not looking at this space before."