Recent spate of hotel refinancings contributes to flat sales volume

Mumford Company is experiencing a steady transactions pace this year, which includes brokering the recent sale of the 88-room Holiday Inn Express & Suites in Culpepper, Va.

The number of hotel transactions in the U.S. so far in 2017 is holding steady, albeit flat (as predicted), and a wave of hotel refinancings is playing a big role in keeping the number on an even keel.

“Hotel sales transaction volume in the major metro markets, which declined by 29 percent in [the first half of 2017], was offset by a significant increase in activity in the tertiary markets,” said Suzanne Mellen, senior managing director and practice leader at HVS.

Ed James, managing principal at Mumford Company, said his company is seeing a steady transactions stream, which has leveled off from 2016.

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“Midway through 2017, we continue to see roughly the same relatively strong transaction volume in mid-market and economy hotels that we have realized over the past 24 months or so,” he said. “Sales prices have leveled off from the high-water mark achieved in early 2016 but are still in the attractive range for sellers.”

Financing Stream

Mellen said refinancing has played a key role in the number of transactions taking place—or not taking place.

“HVS experienced a significant rise in the number of assets appraised, largely attributed to a wave of refinancing, low interest rates and availability of debt drove hotel owners to refinance and realize gains on their investments,” she said. “Owners recognize that this is an optimal time to refinance, with hotel performance at peak levels and new supply entering the market.

SVN Hotels, which has handled 25 hotel deals so far in 2017 and was responsible for brokering 42 transactions in the past 12 months in 18 different states, said three types of financing have played a key role in 2017:

  • For owners and operators with a deal size less than $6 million, the Small Business Administration 7(A) has the least requirements and seems to be the most attractive option. With 15-percent equity, financing is available anywhere in the continental United States.
  • For deals above $10 million, there is plenty of money available to be financed through commercial-mortgage-backed-securities debt.
  • National banks are financing everything in between, but requirements are higher. Banks are only doing business with existing clients, and they are looking for a sponsor guarantee for the lower interest rates.

“The expectation of a seller is generally higher than what the buyer is willing to pay,” said Sanjay Mundra, CEO of SVN Hotels and chairman of the Hospitality Council. “Money is going to secondary and tertiary markets when the deals are not affordable or doable by the buyers in the larger primary markets. We are seeing an increase in cap rates, but only slightly.”

Climate Concerns

Brokers and developers expect transactions numbers to remain healthy in 2018, carried by steady financing.

“There is currently an abundance of debt and equity in the markets chasing fewer deals and buyer interest for the assets on the market is strong and provides continued support for pricing,” James said. “We expect interest rates to continue to move up slowly over the next year in keeping with federal policy.”

Tax reform remains an issue in the ups and downs of hotel transactions, James said.

“The prospect of tax reform in the near term has kept many potential sellers on the sidelines of late and high-quality mid-market acquisitions remain difficult to find for many buyers,” he said. ”As the tax reform picture clears up, we should see more direction as it relates to inventory on the market.”

SVN Hotels has brokered 42 transactions in 18 states during the past 12 months, including the Homewood Suites—Chicago-Schaumburg.

Growth in revenue per available room, however, is expected to decline.

“Slowing RevPAR growth, largely associated with the entrance of new supply and increasing operating expenses, represents the biggest concern of hotel investors,” according to Mellen. “Buyers are hesitant to formulate a purchase price on current peak earning levels. Furthermore, travel remains strong, moderate economic growth continues,and the capital markets remain active.

As far as the political climate, immigration policy is most likely to affect the hotel industry, according to Mundra.

“With the industry notorious for paying the least for labor, we will need to keep an eye on future policy changes and how they might affect human resources and pricing in the market,” Mundra said. “This can also have a huge impact on construction costs going forward.

“If we can’t get to a strong labor pool, prices will go up. This impacts blue-collar staff (cleaning crew and maintenance) and construction workers, primarily.”

Changes Coming

Among the biggest factors playing a role for the next several years will be interest rates and the performance of non-hotel entities, Mundra said.

“The hotel brokerage business is cyclical. Right now, we are at a peak, which I see holding into 2018. But when interest rates go up, we generally see volatility in the market that can be unpredictable,” he said. “I think the next cycle of change will be less volatile because the banks are being more careful.

“Non-hotel entities are entering the market due to a lot of liquidity available in this asset class. This happens whenever the market is high—hotels are an attractive class due to the cap rates.”

The industry also must be aware of what disruptors are up to, Mundra said.

With new options like Airbnb and HomeAway, hotel brands are experiencing a disruption they will have to pay attention to,” he said. “Long term, this will obviously have an impact on the market that is yet to be seen. We’ll see what happens.” HM