The hotel market seemingly reached its apex in 2015 when hotel selling prices saw a record high and hotel transactions reached an eight-year high. According to Lodging Econometrics, a reported 1,575 individual hotel and portfolio transactions (including merger and acquisition activity) took place in 2015, up from 1,491 in 2014. The real estate consulting firm also reported 1,117 hotel sales with selling prices at an average selling price per room of $162,781. But if the market volatility that kicked off 2016, particularly in commercial mortgage-backed securities, is any indication, the honeymoon is nearly over.
“CMBS is all over the map; the CMBS lending market is in a state of flux compared to where it was last year,” said Mukesh Mowji, CEO and founder of hospitality real estate website The Hotel Inventory. “Part of it is that last year was euphoric as it was the best market in the history of the hospitality industry. That can’t be sustained forever and after getting burned last time, lenders now want to think about what we’re doing and do it right.”
The Squeeze Is On
Mowji’s assessment of lenders’ attempts to avoid past mistakes is in line with findings in Jones Lang LaSalle’s “Debt Capital Markets Insights—Hospitality,” released in March, which reports that hypervigilant CMBS underwriting has squeezed liquidity in that market. Since January, average loan pricing in the CMBS market has increased by approximately 40 basis points to 60 basis points and fixed-rate loan coupons are now in the very high 4-percent to low 5-percent ranges. The report’s findings also include a significant drop in CMBS loan origination volume due to current market fluctuations. Also expected to impact the CMBS market are new regulatory requirements, specifically risk retention rules, that will go into effect in December.
“The focus tends to be on the CMBS market because it’s very liquid and very transparent, so there’s a lot of data available for borrowers and anyone and everyone to see the transaction volume that’s going on in the market,” said Bill Grice, EVP with JLL’s hotel investment banking team. “As far as I’m concerned, I don’t think it’s as bad as people are playing it out. Where new construction loans are repeatedly being funded, debt funds and large banks have stepped in to fill loan originations where CMBS may have slowed. So we’re seeing a lot of transaction across the board.”
The Hotel Innvestor, an alternative hotel investment banking platform that raises debt and equity capital for hotel projects through an equity crowdfunding platform, is another financing option that’s gaining traction because of market volatility. “There are certain lenders—either debt funds or banks or private equity funds—that were interested in hotels because hotels were hot during six consecutive years of [revenue per available room] growth that are either exiting the market altogether or have cut back on their allocations for hotels; if everyone else is jumping out of the space because of perceived headwinds, that just opens up more opportunities for us,” said Tim Edgar, founder and president of the company.
Cost Of Liquidity
But Grice also pointed out that while other sources of liquidity are available, a greater demand for that capital has debt funds and banks driving up their prices accordingly. “It’s not about liquidity, but the cost of liquidity that’s available,” he said. “The cost of funds is going to be higher than what we saw 12 months ago, anywhere up to 100 basis points. The cost of funds is the differential.”
Mowji also attributed the cost increase to last year’s quarter-point increase in the Fed’s target funds rate. “You’re not going to get loans at the gutter level forever,” he said. “The costs are starting to adjust and that’s got to continue. But there’s still money out there to get a loan, so if you’re planning to get one, do it now.” Mowji suggested Small Business Administration loans as an alternative solution that can expedite the lending process.
Another reason to act now is the possibility of another recession. While Mowji expressed concerns over the market’s ability to sustain current rates and occupancy levels, Grice attested that JLL doesn’t seen signs of a recession, at least not for the lodging industry. “The lodging industry’s performance shows strong signs and that continues to make hotels an asset class for lenders to finance. So we’re not seeing a lot of concern,” he said.
Foreign investors seem to agree with Grice’s assessment of a stable U.S. hotel market as Chinese insurer Anbang vied for ownership of Starwood Hotels & Resorts International, before recently pulling out. It also recently acquired Strategic Hotels & Resorts for $6.5 billion. Meanwhile, the Abu Dhabi Investment Authority closed on the $230-million sale of the Miami Beach Edition in February.
While a strong U.S. dollar may make investing in real estate here more expensive for foreign investors, returns on properties in top markets can exceed those in other foreign locations. Plus, last year’s change in tax code resulted in fewer restrictions on foreign investment in commercial real estate. “Foreign capital providers have shown a strong interest in the U.S.," Grice said. "It's likely to continue."