As the majority of the country begins to “reopen,” the capital markets have begun to reopen as well. However, the appetite lenders/investors have for hospitality assets is still minimal. Our clients' focus for the next few months will be on asset management, both in terms of property operations and working with lenders on forbearance in order to get to "be here next year." PMZ has been involved with helping hotel owners obtain a variety of short-term relief structures for their properties. Typically, these have included deferral of interest payments from balance sheet lenders to approval of secondary debt and use of reserves attached to CMBS loans.
A variety of portfolio lenders we often work with to fund our client's loans have been in the market to generate capital for reinvestment and rebalance portfolios by selling hospitality loans. These loans have typically been for performing assets. Until there is more clarity in the market as to the volume of truly impaired hotel loans, it's unlikely that there will be significant transaction volume in nonperforming loan sales. Fitch has reported that more than 5,000 loans representing over $120,000,000,000 in principal balance are now either in default or have requested modifications from the special servicers. It's too early to tell if special servicers will be willing and/or able to work with the majority of these requests.
The market for new debt will remain relatively illiquid for the summer as well. Due to the lack of sales transactions and normalized TTM's, lenders will not be able to comfortably value assets. Balance sheet lenders who have provided summer deferrals on the majority of their portfolio will not be able to make new loans at terms that borrowers find attractive. On the positive side, subordinate debt (rescue capital) will begin to enter the market in earnest as borrowers prepare for a more active fall financing season when capital market reopen for hotels.
In the short term, borrowers should continue to focus on expense management as revenues increase. The “new normal” as it relates to staffing, housekeeping, amenities and brand requirements may provide an ability to increase cash flow and make up for some of the increased costs that are going to be required. We expect that strongly branded hotels located in drive-to, secondary and tertiary markets will be the first to recover to levels where financing makes sense. Extended-stay properties have performed the best during the past few months, and we see this trend continuing. We believe these types of assets will begin to be financeable at reasonable levels over the next several months. Leisure travelers will return to the road before business travelers, flipping the typical metrics for many hotels.
In conclusion, we see the hotel capital markets beginning to reopen in the third quarter. Initial investments will involve preferred equity and other forms of rescue capital. Barring a resurgence in the virus, we believe the fourth quarter of 2020 will once again see loan closings in the hospitality sector.
Michael Sonnabend is managing member and co-founder of PMZ Realty Capital.