The U.S. lodging sector has continued to outperform expectations even as the post-COVID travel and hotel booms of the last two years have mostly faded and operating performance metrics have come back down to earth.
Hoteliers and debt and equity investors in the space are enjoying the benefits of the only asset class that showed meaningful price gains in the previous 12 months through the second quarter, as other asset classes deal with more significant erosion in value and mounting debt default concerns, according to research from Colliers, which cited data from MSCI. More recently, acquisition activity picked up slightly while price gains for the hotel sector flatlined year-over-year through the third quarter, per Colliers.
The sector’s performance has been buoyed by resilient consumer spending power, particularly an eagerness to spend on travel and experiences in the aftermath of the pandemic. This is despite the swiftest campaign of monetary policy tightening by the Federal Reserve in decades to fend off stubborn inflation and slow down the world’s largest economy.
“As long as the consumer stays healthy, it will continue to be a strong sector,” said Trinity Investments President and CEO Sean Hehir, whose firm partnered with Credit Suisse Asset Management to acquire The Diplomat Beach Resort in Hollywood, Fla. earlier this year for $850 million. It marked one of the largest hotel sales on record in the U.S. at a time of great uncertainty in the commercial property market.
Honolulu-based Trinity Investments holds a unique seat at the table in today’s lodging market. Hehir’s firm is an operating partner to large private equity funds, often teaming up with notable names such Credit Suisse, Oaktree Capital Management or Elliott Management on upper-scale and luxury, brand-managed hotel investment opportunities. Trinity aims to acquire premier assets, with 300 rooms or more, in “smile states,” plant a Hilton, Hyatt or Marriott flag in the ground, and deploy a value-add strategy to boost revenues.
Trinity will partner with Hilton to put The Diplomat under the Signia flag, an upper-upscale brand, according to STR’s 2023 chains scale.
Upper-upscale hotel property fundamentals have been strong in the 12 months through June, although the segment hasn’t really recovered occupancy losses from prior to the pandemic, according to data from CBRE and Kalibri Labs. Average daily room rates and RevPAR ran 14 percent and 5 percent above where they were in 2019, respectively. RevPAR in the segment climbed 2.9 percent on the year in June, while occupancy was still down 8 percent from 2019.
“When you focus on assets that are 300 rooms and larger in these destination locations, they tend to have a lot of meeting space and a full suite of offerings, where we attract multiple market segments,” Hehir said. “We’re value-add buyers, so we’re not just buying turnkey assets, we’re buying assets that need to be repositioned, renovated, et cetera, so our job is to constantly look around corners to figure out what the customer wants.”
Consumer Spending Habits
One thing has been clear over the last two years: consumers in the U.S. want to travel and they want experiences. The job market is strong, wage growth just recently surpassed the rate of inflation for the first time in two years and consumer spending power hasn’t abated since the pandemic. This dynamic has helped keep most subsets of the hotel market—from budget to luxury offerings—humming.
“If fears of a recession continue to get pushed out, that suggests a good backdrop,” said Aaron Jodka, Colliers research director for U.S. Capital Markets.
Hotels since 2021 have served as somewhat of a natural inflation hedge. The asset class has generally traded or priced at wider cap rates—the rate of return that can be expected on a real estate investment—than other popular property types, such as multifamily and industrial, and hotels are capable of staying ahead of inflation through the ability to reset room rates and the prices of on-site services on a nightly basis.
These dynamics allowed hotels to “absorb higher interest rates than other asset classes” during the pandemic, Hehir said. “You’re able to advance room rates and food and beverage on a very active basis. It helps you stay ahead of inflation.”
Elevated interest rates have meant acquisition and refinance activity, and the debt and equity capital that fuel it, have not been able to match the fervor of the hospitality consumer.
Since the Fed took action to combat inflation early last year, it has had a predictably negative effect on transaction activity in the U.S. commercial real estate market overall. Transaction volume in the U.S. tumbled 54 percent on the year in the third quarter to about $82.6 billion, per MSCI data. Lodging registered the least amount of sales volume by far as an asset class, plunging 46 percent to just $5.9 billion; it was, however, the only property category in which prices did not fall over the previous 12 months. Prices for hospitality assets actually surged 4 percent and 6 percent on the year in the first and second quarters, respectively.
“If the deal is larger, you have more of a liquid market, because you're not dealing with the capital restraints of the smaller lenders,” said Mark Owens, Colliers vice chair and hospitality practice group leader. Community, local and regional banks enter the bidding process to provide more “depth of liquidity” in recourse debt deals, terms with which Owens said most of his institutional clients do not accept.
Opportunistic Play
Return profiles for participants in hotel transactions have climbed with the increased cost of debt. There’s “quite an appetite” from opportunistic equity and debt providers looking to fill voids in the capital stack above the senior mortgage lender, in higher-risk mezzanine debt and preferred equity positions, where they can capture heightened returns and still somewhat control their exposure to losses, Owens said.
The commercial mortgage-backed securities (CMBS) space—a smaller and less active financing arena—is one where hoteliers like Trinity are finding solace from potential interest rate volatility. CMBS can be more stringent in its terms and requirements, as it aims to protect bondholders and historically, it requires properties to have more cash flow.
“Hotels in today’s market are probably one of the best asset classes in terms of cash flow and are able to use CMBS,” Owens said.
Hehir’s company tapped the CMBS market for a $515 million refinancing of The Westin Maui Resort & Spa, an upper-upscale, 769-room oceanfront resort in Lahaina, Hawaii, in a deal that closed in late July. Trinity locked in a roughly 7.75 fixed rate on a four-year, interest-only loan that’s prepayable—without penalty—after 36 months, according to a S&P Global Ratings analysis of the transaction.
Market participants have pointed to the Westin Maui deal as significant for not only the size of the transaction, but the fixed-rate nature of the financing. Trinity is essentially betting that rates will go higher and has moved to shield itself from that risk in the short-term, while also saving money on the costs it would have incurred in a typical floating-rate debt execution.
“While you may be locked into a rate today that is higher than the long-term average in lodging, it’s still far cheaper than doing a floating rate deal in today’s market,” Owens said. Hotel interest rates in the CMBS space in August came in at around 8.4 percent, up from 8.2 percent at the same time last year, according to CBRE research that used data from the Federal Reserve and CoStar Group.
The financing optionality that Trinity can attract for its profile of assets—top of the market, full-service properties—differs from what’s available for the budget to mid-scale, limited-service properties below them, but the latter subset isn’t any less popular.
Limited Service Appeal
Travel demand, a tendency for longer stays at hotels and the work from home phenomenon have compelled a number of brands and institutional investors to commit to the lower-cost, limited-service segment, particularly extended-stay.
Limited-service shined during the pandemic, and that’s carried over into today’s market.
It is a cheaper alternative for customers, and it’s less expensive to build and operate, since it generally lacks food and beverage and entertainment and leisure services, which means less money spent on things like staffing.
“Extended stays did great [during COVID-19]; you had folks going across the country, whether that’s truck drivers, essential workers, and in some cases it was people who were priced out of housing because of the cost of rents and homes for purchase,” Jodka said. “That created a fairly solid, steady state rate of occupancy.”
Blackstone and Starwood Capital Group saw the writing on the wall in the summer 2021, acquiring Extended Stay America for $6 billion. More recently, as that market has developed, Hilton and Marriott announced plans earlier this summer to expand their lower price point offerings in that segment starting next year.
“They’re clearly seeing opportunities there, so that’s going to create new construction and new products, which will require new investment and financing from banks and lenders,” Jodka said. Last year, extended stay hotels registered an occupancy rate above 74 percent, outpacing the overall market’s 62 percent occupancy, according to STR data.
Demand for mid-scale hotels, in general, slowed through the first half of this year, falling 5.4 percent year-over-year in June, but ADRs remained elevated, climbing 1.8 percent over the same period, according to CBRE research. The mid-scale segment, though, experienced consistent year-over-year drops in RevPAR growth from June through August.
Jack Levy, a longtime hotel executive and senior consultant with CBRE, wrote in a research report in July that it’s likely that the additional opportunities presented by major brands expanding into the extended stay segment will compel bank lenders to “provide funding for what are perceived to be lower-volatility, higher-return hotels, particularly those associated with well-established brand[s].”
The extended-stay expansion had been progressing for years prior to the pandemic, only to be bolstered by shifting consumer dynamics. Levy calculated, using CBRE and STR data, that large, global hotel brands had grown their extended-stay portfolios by more than 50 percent over the last 10 years, at a compound annual growth rate (CAGR) of 7.1 percent, compared to a 3.2 percent CAGR for the broader U.S. hotel market.
Occupancy Softening
Hotel occupancy tumbled into negative growth territory after the first quarter, a trend that has persisted through August, per CBRE research and Kalibri Labs data. RevPAR and ADR—excluding independent hotels—have also softened with occupancy as the year has progressed, but each figure has remained above water, indicating that some upward pressure on pricing still exists in many markets and hotel categories.
The dips in occupancy and demand can be attributed in part to travel dynamics. A higher number of excursionists from the U.S. set out abroad this summer, particularly to Europe, while the percentage of inbound travelers remains well below 2019 levels, according to data from the National Travel & Tourism Office.
Domestically, leisure and group travel persist—often in competition with each other—and there’s an expectation that business travel will gain even more steam going forward. Some market participants hypothesize that pervasive work from home dynamics could also serve as a feeder for hotels in the upscale categories. The National Association of Realtors expects hotel room demand to expand throughout the rest of 2023 and likely into 2024, according to a July analysis of first and second quarter data.
Despite uncertainty about the possibility of a recession, hospitality is poised to continue to outperform other asset classes. It will be supported by the spending power of the U.S. consumer and strong domestic and international travel projections.
This article originally appeared on our sister site, hospitalityinvestor.com.