Select-service hotels continue to drive transactions market

First Hospitality Group is developing Hilton's first triple-brand hotel, consisting of a Hilton Garden Inn, Hampton Inn by Hilton and Home2 Suites by Hilton, at Chicago's McCormick Place.

2017 is expected to be flat for U.S. hotel transactions, at least according to JLL’s Q4 2016 U.S. Lodging Investment Outlook, which forecasts $29 billion in U.S. transaction activity in 2017—a repeat of the market’s 2016 performance.

Meanwhile, lenders continue to exhibit caution in a market where the gap between supply and demand is narrowing. The effect of the Trump Administration on hotel investment is also proving impactful as ambiguity surrounds potential modifications to real estate taxes, interest rates and labor costs.

“Investors are seeing more risk, not only because cap rates have moved against the seller and buyers are still looking for stronger cap rates, but because of the uncertainty surrounding interest rates, the political climate domestically and internationally, tax deductions and income tax rates,” said Herb Warmbrodt, principal at HREC Investment Advisors. “This is giving investors pause and we’re seeing this across the board.”

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Availability of Foreign Capital

The new administration has, however, committed to extending the EB-5 program, at least through September 30. So foreign investment driven through this immigrant visa program is still a viable option for the capital stack of new hotel developments. But the future of the program in its current form may change as members of Congress are currently negotiating a reform package that would raise the minimum investment from $500,000, revise the definition of what constitutes a “targeted employment area” to allow investments at the minimum level and establish visa “set-asides” for investments in certain rural and truly distressed urban areas. 

Despite the incertitude surrounding regulatory changes and Trump policy, certain trends are still holding strong—a topic that will be examined at the 2017 NYU International Hospitality Industry Investment Conference, specifically during a panel entitled: “A Challenging Market: Trends and the Players on the Buying, Lending and Joint Venture Front.”

Select Service In, Full Service Out 

Marriott’s Courtyard/Residence, Hilton’s Garden/Hampton and their ilk aren’t just brand combinations in the investment community, but buzzwords. According to Bryan Younge, managing director and national practice leader at Colliers International, full-service hotels are often too much of an expense to develop and too much of a drain to operate unless they have close proximity to a major group demand generator such as convention center.

“Business and leisure travelers are more often just as happy at select-service properties, and those with suite products are a good option for families,” he said. “Dual- and triple-branded properties with at least one select-service element have also been successful attracting a wider base of travelers, and that’s a major development trend that will continue into the future.”

Atlanta-based Stonehill Strategic Capital has several of these dual-brand deals in the works, which Principal Mat Crosswy explained work well as new builds despite labor and material driving up costs. In fact, select-service hotels account for the bulk of new rooms under construction, according to the Q4 JLL Investment Outlook. “Lenders like us invest 70- to 75-percent debt or just finance the construction loan or a bridge loan until the asset is stabilized," Crosswy said. "In some markets, it’s justified, but there’s also a deep supply pipeline.

These dual-branded projects—fast evolving to triple-brand projects like the Hilton Garden Inn, Hampton Inn by Hilton and Home2 Suites by Hilton announced for Chicago’s McCormick Place in January—are fast becoming a mainstay in urban markets, but they’re also gaining traction in some secondary markets.

Beyond the Horizon of Gateway Cities

Even beyond the scope of select- and limited-service properties, investors are still betting on Tier 2 and Tier 3 markets. In February, commercial mortgage banking firm Conlon Capital closed $49 million in non-recourse CMBS loans for eight hotels, six of which are located in secondary and tertiary markets. HREC Investment Advisors also has several projects in tertiary markets that Warmbrodt said have seen interest from national investors who are looking to small metro markets because they expect projects in these areas to drive better yield. “We’re seeing more investment groups looking at secondary and tertiary markets without a doubt,” he said, adding that adaptive re-use is also taking hold in these markets, including Kansas City where HREC is located.

Stonehill Strategic Capital also has five historic re-use projects in its pipeline, a growing trend that’s developed in tandem with the revitalization of downtown urban centers across the country. “The goal is to get into a historic building with character, renovate and convert to a hotel, hopefully at a discount because there are different federal state and city incentives to help with the overall investment,” Crosswy said. “But there’s still a lot of risk because you never know what you’ll find in the walls, so you want to partner with the right sponsors to mitigate the risk and you’re already starting to see pressure at the state and federal levels on the credits associated with these projects.”

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