The US Lodging Industry: Mid Year 2010

NEW YORK CITY-The US hotel industry experienced a dramatic spurt of positive indicators during the first half of 2010, driven in part by the economic acceleration of the world beginning to emerge from the deep recession. The national economy features positive news which includes an increase in manufacturing, the addition of private sector jobs for six consecutive months, rising corporate earnings and greater business confidence, and an almost nonexistent level of inflation. The negative news still present in the economy include anemic job growth, unemployment hovering just below 10%, foreclosures and bank closings exceeding last year’s levels and a slump in home sales. Furthermore, the stimulus passed by Congress last year to kick-start the economy is about to wind down. World financial markets continue to exhibit anxiety, and the US economy while currently relatively stable remains fragile, and at risk of a double dip recession.

Operationally the US hotel industry has recently experienced a robust and dramatic revenue growth surge driven in part by an unleashing of pent-up corporate travel demand. Group booking patterns however have yet to significantly improve from the recent downturn, as smaller group business continues to be reserved within a short time frame before events are held.

Similar to other commercial real estate, the US lodging industry is in the early stages of resolving a wide array of financially distressed hotel investments. Legislation such as modifications of mark to market accounting rules, and US bank regulators allowing lenders to hold loans on their books at par although collateral may be worth less, has not created incentive for banks to dispose of distressed assets. With a significant number of legacy US hotel investments having negative equity, there continues to be a considerable amount of distressed debt that will need to be extracted from the market, which should spur further transaction activity in the near term. Current Federal Reserve monetary policy allows banks to be extremely profitable, borrowing at close to zero and earning remarkable spreads, thus minimizing the amount of cash banks must set aside in reserves for future losses. There is currently little if any impetus for lenders to market distressed assets for sale, and thus far they continue to hold out hope for a rebounding economy to increase hotel room night demand and pricing.

The CB Richard Ellis (CBRE) Valuation & Advisory Services Hospitality & Gaming Group continuously monitors the major US hotel sale transaction market. The CBRE Mid Year 2010 Major US Hotel Sales Survey includes 42 single-asset sale transactions over $10 million each that are not part of a portfolio allocation. These transactions totaled more than $1.8 billion, and include 11,700 hotel rooms with an average sale price per room of $158,000. During Q2 2010, 28 sales transacted for a total of more than $1.1 billion, as trade activity continues to outperform on a quarter-over-quarter and year-over-year basis.

Notable observations from the CB Richard Ellis Mid Year 2010 Major US Hotel Sales survey include:

• Heightened transaction activity has clarified capitalization rates, both on a Trailing 12 Month and Projected Year One basis, but offer limited transactional insight as they display a broad range from negative to upwards of 10 percent for quality assets;• Coming off of severely depressed 2009 operating metrics, US hotel transaction pricing is not capitalization rate-based, but rather predicated on discounted cash-flow analysis that factors in perceived upside during the next several years;• Public companies, both seasoned (i.e. Sunstone Hotel Investors, LaSalle Hotel Properties, DiamondRock Hospitality) and newly formed entities (i.e. Chesapeake Lodging Trust, Pebblebrook Hotel Trust) dominate the acquisition landscape;• Private equity groups that are exclusively focused on the hotel sector (i.e. HEI Hotels & Resorts, Noble Investment Group, Apple Nine Hospitality) are also actively deploying capital to acquire US lodging assets;• Three major US hotel trades represented closed lodging properties, each of which is slated to receive significant capital expenditures to reopen;• Two operating hotel assets were acquired by educational institutions for conversion to student housing/dormitory space; • The highest price per room paid was $600,000 for the Buckingham Hotel in New York. When compared with the Qatar Investment Authority’s recent acquisition of the Raffles Singapore at $2.7 million per room, US hotel assets are relatively inexpensive.

While transaction activity of US hotel assets has begun to percolate, thus far in 2010, deal movement has been stifled by the lack of available debt. The majority of deals on the CB Richard Ellis Mid Year 2010 Major US Hotel Sales were reportedly consummated with 100% equity. At some point the Federal Open Market Committee (FOMC) will have to raise the current exceptionally low federal funds rate, which in turn is expected to negatively impact bank profitability and force lenders to face losses already imbedded on their balance sheets. At this juncture or possibly sooner US hotel assets will become available from lending institutions that have heretofore not been willing or able to part with them. During the next three to five years sophisticated lenders will sell assets and take back mortgage financing that will contain operating performance kicker provisions to take advantage of the upturn in the lodging market, and boost their yields. As better assets are brought to market, competition to win bids will be stiff as significant amounts of all types of stockpiled domestic and international capital looks to deploy to restructure or acquire value enhancement opportunities in US hotels. Those hotel centric cyclical investors that are the early entrants to a rebounding market stand to earn superior risk adjusted returns driven in part by the epic appreciation of US hotel assets that will occur during the next several years.

To download a .pdf of the full Mid-Year Report, click the link located at the bottom of this article.

Daniel Lesser is the senior managing director of the Hospitality & Gaming Group at CB Richard Ellis (CBRE) based in New York City. The views and opinions expressed in this article are the author's own.

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Daniel H. Lesser, President & CEO of LW Hospitality Advisors LLC (LWHA), brings more than 35 years of expertise in a wide range of hospitality operational, investment counseling, valuation, advisory, and transactional services. He provides services to corporate, institutional, and individual clients as well as public agencies on all facets of hospitality real estate including: litigation support and expert testimony, site evaluation, highest and best use analysis, appraisals for mortgage, acquisition, and portfolio management, workout strategies, operational analysis, development consulting, property tax assessment appeal evaluations, economic impact studies, fairness opinions, deal structuring, and negotiation of management and franchise agreements. Mr. Lesser had been retained in connection with a broad variety of lodging assets throughout the Americas, as well as in Europe, the Middle East and Asia.