Despite pressure on profits, brokers buoyant about market

Hotels brokers are reporting very strong 2019 transaction volume, which is creating an upbeat attitude about sustained activity in 2020. But while things look positive going forward, owners also need to be realistic to maintain profitability, said Mike Cahill, CEO and founder of HREC-Hospitality Real Estate Counselors. 

And the biggest threat to profitability? The increase in labor costs is the No. 1 challenge for maintaining profitability as revenue growth slows, Cahill said. 

“Everything is affected by property-level performance,” said Ed James, managing principal, Mumford Co. “The availability of financing. The ability to operate profitably.”

Value Watch

Brokers are working to communicate to sellers what’s reasonable to expect on pricing, said Drew Noecker, managing director, brokerage and advisory at HVS. “We help them take on realistic expectations; if they want an aggressive cap rate, the counterissue is about what the market is bearing right now.

“But pricing is still attractive,” he added. 

Cahill noted the forces at play: “The fundamentals are slowing and that’s a downward force, but when you can get debt cheaper that’s a strong upward force, so right now those two things are balancing out a pricing change.” 

Pricing in the third quarter of 2019 grew 0.2 percent in year-over-year comparisons, according to Real Capital Analytics. However, there can be a disconnect between buyers and sellers on value. 

“Some sellers are trying to value assets on strong growth going forward and are generally more aggressive than buyers in their projections,” Noecker said. “We are very direct with sellers and work with those who want to transact based on current growth projections.”

James said anyone who plans to sell in the short term should be doing so now. 

“This upcycle, it’s one of the longest growth periods in history,” he said. “People who own things that maybe they shouldn’t own in three to five years should look at getting rid of [them] now. Two things could happen—[they could] remain strong at current levels or decline, but what won’t happen is tremendous gains. It’s probably wise to evaluate a portfolio from that standpoint.” 

Cahill said there are fewer transactions at the higher end of the market, but the $10 million to $20 million category is still very active.  

This has increased activity in secondary cities, according to Noecker. 

“People are (rightfully so) targeting college markets and places with major medical centers,” he said. “They are a draw for a lot of fundamental demand drivers. It can be a really good play.”

Supply will continue to affect growth going forward, James said. 

“We believe going into 2020 and 2021, growth will stop in many markets, and maybe decline, and that’s healthy in a normal market,” he said. “We do not think it’s going to be difficult to endure. It’s going to be much more gradual than 2007 or 2008 and will take three to five years to get back to increases, so the picture is for a good solid marketplace going forward.”

Transaction Data

The brokers expressed satisfaction with the high transaction activity at the end of 2019 and heading into 2020. 

Conducting business during a prolonged peak is a good place to be. Not surprisingly for this point in the cycle, however, the third-quarter “U.S. Capital Trends” report from Real Capital Analytics shows modest growth comparisons in deal volume and pricing. 

RCA reported that deal activity for the limited-service segment increased 4 percent year over year during the quarter. For full-service hotels, activity was up 36 percent, largely fueled by the portfolio acquisition of Chesapeake Lodging Trust by Park Hotels & Resorts. Without it, the segment would have seen an 11 percent decline in deal volume. 

Single-asset sales were up 12 percent during the quarter, year over year, with transaction volume of $2.5 billion. 

Interest Rate Stability

“Cheap debt is fueling transaction volumes, and this props up value for buyers,” Cahill said. Interest rates are expected to remain low for the next two to three years, he added. 

David Sonnenblick, cofounder and principal of Sonnenblick-Eichner Co., said he believes interest rates are stable.

“I don’t see any fiscal pressure on upward-moving interest rates,” he said. “I expect them to remain low and stable at least for the first half of [2020]. Although we may see some changes to credit spreads, I expect the first part of 2020 to be extremely attractive for borrowers as we don’t see any shortage of capital for real-estate financing and we’re finding the environment to be extremely competitive.”

It’s a great environment, Sonnenblick said. “Borrowers should take advantage of it, as we don’t know when this current cycle will come to an end.”