The Congressional Budget Office has reduced the forecast of potential GDP growth through 2020 by a substantial amount. The IMF has forecast slow to moderate growth for the world economy for the same period. There is, at the moment, little to suggest that 2014 is going to be a good year or that GDP growth will exceed 3%, which is not good at this stage of a recovery. There are fears of deflation in Europe, although that is not likely, it is possible. Millions of baby boomers are now retiring, and the long term unemployed and the number of part time employed is growing as Obamacare and now higher minimum wage rules and new overtime rules further reduce hours worked for many.
The financial services industry continues to get hammered by this administration who seems to think it is good politics to levy huge fines on JP Morgan, B of A and others. They don't seem to understand that these fines are a transfer of working capital form job creators to the government, and so the result is thousands fewer jobs in the industry, less spending on T&E, less spending in general by tens of billions. The huge added compliance costs further strain budgets at banks for thousands of useless people to fill out useless forms that nobody will ever read. These are all costs that could instead be going to loans and lending officers. The cost of doing any transaction has risen for all of this unproductive paper pushing. That leads to further reductions in productive revenue production, spending on supplies, travel, marketing and lots of other things which add salaries, loans and other productive uses of capital.
The hotel industry is in some sort of happy gas state, believing that life is wonderful and the laws of economics and gravity do not apply to the industry. Reality is somewhat different. The numbers are: real Revpar in 2007 adjusted for 2013 dollars, was $73.73. It dropped in 2009 to $58.15. In 2013 it has only risen to $68.99. Still 6.4% lower than 2007. If industry forecasts are correct for 2014, revpar will still not equal 2007. The 18.6% increase from the low of 2009 to 2013 is nice, but really only is the bounce back from disaster. It will be 2015, eight years later, for the industry to simply get back to where it was. That is not something to brag about as wonderful. It means for eight years the industry has gone nowhere.
Industry pundits continue to forecast ongoing glory in spite of continued modest GDP growth, reluctance by banks and other industry to really ramp up travel spending, and a continued level of real unemployment, rapidly increasing retirement by baby boomers, and a very unstable world. There is no more using the home to borrow for big vacations. No more running up the credit card. No more splurging savings to go on a big vacation. None of this is likely to get better for at least a couple more years if not longer. When the hotel industry produces statistics, they usually combine all areas of the country into one massive number, and often all segments together, making it seem that things are much better than they really are. New York, San Francisco and a couple of other cities like Miami are doing very well, but they skew results for those in ordinary locations. There are many hotels across the country that are not doing nearly as well and which have not had the capital investment in over eight years to do a PIP or other upgrades.
It had always been a key metric that revpar fairly closely correlated with GDP. During the recovery from the crash this correlation disappeared because of the anomaly of the depth of the collapse of Revpar. Now hotel prognosticators are ignoring the historic anomaly of the past several years and they are suddenly claiming there is no longer any correlation with GDP which allows them to just go on forecasting 5%-7% growth in Revpar. I believe that correlation will now return in 2014 and surely by 2015. If GDP continues to only grow at 3% or so, then the projected growth in Revpar will drop to around that level.
For those investing in hotels, you need to consider that you will likely have to invest material capital to do a PIP and possible upgrades of computer and other management systems. Interest rates are going higher over the next several years of a holding period. If growth from here on is limited to GDP growth, and if the spending by corporations remains somewhat constrained, then you need to be buying hotels at a higher cap rate than they have been trading in order to make the numbers justify the effort and risk. Hotels are always subject to the black swan event risk as we saw in 2001. They are going to be subject to slow growth of GDP. They need regular upgrading of the building and systems.
This is just a cautionary explanation that you should not believe the regular forecasts of big value increases by certain leading appraisers, and you should better understand how the increases in revpar to date have occurred and are not likely to continue at the same rate of growth. Claims by one appraiser that revpar and values are back above 2006 levels are simply not true. They are nominal numbers and just puffery to promote more happy gas appraisals. Before you invest be sure to better examine the numbers and especially the NOI today and likelihood of what that will be given higher minimum wages, Obamacare, and other cost increases.
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Joel Ross
Joel Ross began his career in Wall St as an investment banker in 1965, handling corporate advisory matters for a variety of clients. During the seventies he was CEO of North American operations for a UK based conglomerate, and sat on the parent company board. In 1981, he began his own firm handling leveraged buyouts, investment banking and real estate financing. In 1984 Ross began providing investment banking services and arranging financing for real estate transactions with his own firm, Ross Properties, Inc. In 1993 Ross and a partner, Lexington Mortgage, created the first Wall St hotel CMBS program in conjunction with Nomura. They went on to develop a similar CMBS program for another major Wall St investment bank and for five leading hotel companies. Lexington, in partnership with Mr. Ross established a hotel mortgage bank table funded by an investment bank, and making all CMBS hotel loans on their behalf. In 1999 he formed Citadel Realty Advisors as a successor to Ross Properties Corp., focusing on real estate investment banking in the US, UK and Paris. He has closed over $3.0 billion of financings for office, hotel, retail, land and multifamily projects. Ross is also a founder of Market Street Investors, a brownfield land development company, and has been involved in the acquisition of notes on defaulted loans and various REO assets in conjunction with several major investors. Ross was an adjunct professor in the graduate program at the NYU Hotel School. He is a member of Urban Land Institute and was a member of the leadership of his ULI council. In 1999, he conceived and co-authored with PricewaterhouseCoopers, the Hotel Mortgage Performance Report, a major study of hotel mortgage default rates.
