“Things are really good for existing properties,” says Jan Freitag, SVP at Smith Travel Research. “In the first quarter, RevPAR grew 6.8%—driven mostly by a 3.8% increase in room rate—mainly because of the interplay between supply and demand. Supply is growing but it's still low compared to other demand peaks and demand is still high.”

“Business travel is doing well,” he continues, “there's healthy leisure demand and group business is picking up. We're selling more rooms than ever and, at the same time, the room supply isn't growing quickly.”

R. Mark Woodworth, president, PKF Consulting, tells Real Estate Forum sister publication GlobeSt.com, “An accumulation of market, operational and economic factors has resulted in a business environment that is very conducive to increases of both the top-line and bottom-line.”

Adds Scott Smith, SVP, PKF Consulting, “Nationally, we're in the sweet spot where both occupancy and average daily rate are increasing to pre-recession levels in most markets. In the top 10 markets, there is a growing demand base of corporate users with below average additions to supply. Due to the increase in revenue created by all of this, there's been an increase in operational efficiency, so we are forecasting unit-level NOI increases of 12.4% in 2014, and another 14.2% in 2015.” The hotel sector has maintained annual profit growth of greater than 10% each year since 2011, the longest unbroken streak since the 1970s, according to PKF.

Still, Freitag cautions, “The pipeline is heating up; we have more rooms under construction than we did a year ago. In New York City, the number of rooms available in the first quarter was up 5.6% year-over-year. That's a lot, and we don't expect that number to ease. So frothiness is definitely of concern in the investment community and people are watching what happens.”

JP Ford, SVP and director of business development, at Lodging Econometrics, was even more concerned. “At the end of the first quarter of 2014, there were 180 hotel projects in New York's hotel pipeline, or 30,304 rooms. That is 20 additional projects from the end of 2013; that's a pretty significant rise.”

And even though New York City is something of an anomaly, the pipeline in gateway cities generally is something to watch, Ford adds. “For that same time period, Houston had 100 projects, Washington, DC had 85, Boston had 49 and Los Angeles had 60, so the pipeline is pretty significant in urban centers around the country.”

Nationally, he notes, “The growth rate in the pipeline since the third quarter of last year is 14% by the number of projects and 13.5% by the number of rooms. At the end of the first quarter, it stands at 3,226 projects and 407,235 rooms. We have about 33,000 more rooms in the pipeline than at the end of 2010 and we're 23,000 shy of how 2009 closed. Some people may look at that and say that's nothing, but the significant part of the pipeline is the momentum and there's nothing in front of it that's going to stop it from growing.”

Adds Geoff Davis, president and senior principal, HREC, “In a lot of the markets I'm seeing a 20% to 25% increase in supply; it's coming fast and furious. Some new properties won't get financing, but properties are coming out of the ground in the top 25 markets.”

The good news, counters Smith, is that the new rooms won't be added to existing inventory for a while, since “it takes 18 to 24 months to build a hotel.”

And the cause for concern isn't as great as in prior recessions, adds Freitag. “We're well off from the prior peak in 2007, when there were 211,000 rooms under construction. Today there are 102,000 rooms being built.” Meanwhile at existing hotels, “occupancy is up, giving properties pricing power, which drives RevPAR.”

That's creating some new investor types as well as an uptick in the amount of investment being made by some buyers, says Smith. “Private REITS are the most active on investment-grade properties.” Their cost of capital seems to be lower than other investors so they can offer higher prices, he adds. “When you look at financing for existing properties, it's as low as I've ever seen it. I've been in the business for about 25 years and have survived three recessions. I don't want to say we're in a perfect storm but revenues are increasing, loan-to-values are at 65-70%, the cost of capital is the lowest it's been over the past 20 years—based on the low interest rates for hotels ranging from 4% to 6%—and private equity funds and REITs are getting mandated to place money by year's end.”

Among the REITs now playing in the hotel space is American Realty Capital, which is the sponsor of American Realty Capital Hospitality. “We're new to the non-traded hotel space because it wasn't viable in previous years,” says Nicholas Schorsch, chairman and CEO of American Realty Capital and chairman of ARC Hospitality Trust. “After having a tough time from 2007 to 2012, hotels are experiencing stable demand, rising occupancy, increasing ADR and expanding RevPAR, so now is the time to move into hotels.”

He continues, “About six months ago we bought a company called Crestline—which was spun off from Marriott a number of years ago—that had assets of about $3 billion. It was owned by Barcelo Hotels and Resorts but we bought 60% of the portfolio and launched ARC Hospitality.”

Then last month, Schorsch adds, ARC Hospitality purchased six hotels in Connecticut, Maryland, Georgia, Rhode Island, Virginia and Washington, DC, in both the full- and select-service segments. “We like those property types because, as the economy recovers, that's what does best. Discount or luxury brands are the most volatile. The property locations were carefully considered too. We wanted to play in the US markets where the economy was recovering gradually.”

And ARC isn't done with hotels yet. In fact, it has ambitious growth plans, Schorsch reveals. “We want to get to 200 hotels within three years, bringing us to $2 billion of equity. We're at $100 million now.”

Not Everyone's Type

Schorsch's support for full-service properties is somewhat surprising as most investors and analysts say limited-service is the flavor of the moment.

“The select-service concept has taken over the hotel industry, it's the vast majority of new product,” says Davis. “It's a more efficient operating model to build a Residence Inn versus a Sheraton because you can rely on the reservation system and you don't need meeting space. A Hilton Garden Inn could be $150 per key from the ground up, but full-service might be $180. You have to ask yourself, 'Is the incremental cost worth it?' So you have a lower cost basis with select-service.”

Adds Smith, “Most of the new build is flex service because the properties are small and easier to finance; they're considered less expensive to operate. On the full-service side, there's meeting space and common areas, and group business is just starting to come back.”

Also in favor is the practice of buying existing properties versus those under construction. “It's cheaper to buy an existing property than to buy new,” explains Smith. “So that's what many investors are doing across all property types, and then maybe repositioning the asset.”

Show Them the Money

In terms of financing, there are many new types of players. Debt funds and private equity are joining CMBS and banks in the debt space, says Davis. “There are players emerging on the bridge side and, overall, there are many more players from different sectors of the investment community offering mezzanine and bridge loans versus just senior capital.

“It's an interesting dynamic,” he continues, “because all of these lender types bring something different to the table. CMBS is good on a cash-flowing property whereas bridge lenders can be more flexible on something that's not cash flowing, where maybe there's a repositioning story and the lender needs to look harder at the plan.”

But this creates challenges, too. Says Davis, “They're all competing for a finite amount of business and, as result, loan terms are getting more aggressive. We're seeing loan-to-values move up to 70%, we're starting to see interest-only periods of loans versus straight amortization and generally more aggressive debt yields.”

The trend creates some attractive borrowing conditions in non-gateway markets, notes Mark Owens, a managing director at Ackman-Ziff Real Estate Group. “Debt is aggressive for secondary and tertiary markets and most hotel owners and buyers in those areas are not even aware of it.” As he tells it, the majority of buyers are underwriting acquisition debt at 60% to 65% LTV, which means the balance of the deal's capital stack is equity. The higher the equity costs, the less able the buyer is to pay more for the asset. “When a buyer is educated on the availability of debt, such as 70% to 80% financing, it's able to pay more because it uses less high-cost equity capital and more inexpensive debt capital to achieve its returns.”

He continues, “Increasing the leverage on the property via refinancing generally does not trigger a taxable event. Many of our clients look at the hold/sell analysis and have elected to refinance their hotels/resorts instead of sell them because they can achieve substantially more debt proceeds than their existing loan at rates that may be significantly below their current terms.” This way, he explains, the clients get a repatriation of equity without a tax event, maintain control of the property, lock in lower rates for another period of time and still have a significant stream of cash flow to equity after debt service.

Lenders are coming from a wide variety of markets, particularly the gateway cities, Davis says. On the buyer side, US-based investors are not the only ones jumping on the hotel bandwagon. “Asian investors have been more active across the US than in other parts of the world; they've been doing deals across the country.” he relates. “They're looking for value and yield, a lot of them have formed partnerships with US-based operating companies who understand the domestic markets and can lead investors into it. In fact, maybe all off-shore investors are starting to branch out in search of yield.”

So when will the good times end? “I think we'll be all right through 2015, but after that we'll have to break out the crystal ball,” says Davis.

But Ford has a more optimistic view, believing that supply wont be an issue over the next year or so. “We're forecasting 1.4% growth this year and 1.7% in 2015; those are below historical trend lines,” he says. “But the story is that it's growing. We have a good run in front of us until 2018.”