Plateau in Hotels a Good News/Bad News Story

Q2 Sales Highlights

NEW YORK CITY—Primary US lodging metrics during the first half of 2016 reveal that after five consecutive years of above average increases in occupancy, average daily rate and profits, hotel performance appears to be reaching a plateau. While growth is clearly decelerating, there is also no evidence of a decline in US hotel fundamentals indicating that the current cycle has ended. The US hotel industry is currently a good news / bad news story. The good news is that:

• The US economy is demonstrating resilience in spite of global economic uncertainty;
• The US central bank is holding off on raising short-term interest rates until the economic outlook is more evident;
• Energy prices including gasoline remain below historical levels which has led to stronger leisure travel;
• Foreign capital continues to enter the US seeking safety and superior risk adjusted returns for long term investments such as hotels;
• The pipeline of legacy 10-year CMBS loans originated between 2005 and 2007 will continue to mature this year creating a variety of recapitalization opportunities for new money seeking yield;
• Construction financing for new hotel development is now scarce and difficult to obtain which places a damper on the entrance of new supply to the market;
• Airbnb is facing potentially crippling regulations with numerous state and local regulators, and struggling to prove its platform is not promoting discrimination.

The bad news includes:

• For many years now, US GDP and Jobs growth has been tepid;
• There has been a marked weakness in US corporate travel thus far in 2016;
• Brexit initially shocked global markets but rebounded shortly thereafter; however, in its wake an enhanced level of uncertainty is creating market instability;
• Hotel supply has increased and select markets such as New York, Houston, and Miami are experiencing the consequences of too much product being introduced within a short time frame resulting in a dampening of room rate increases;
• The strong US dollar has created negative pressure on the amount of foreign visitation to America;
• Airbnb has signed agreements with three major travel management companies namely, American Express Global Business Travel , BCD Travel and Carlson Wagonlit Travel that will allow it’s 2 million listings in 31 countries be added to these companies’ corporate travel programs;
• The pipeline of legacy 10-year CMBS loans originated between 2005 and 2007 will continue to mature this year while refinancing options are unclear as sales of commercial mortgage-backed securities have fallen to levels not seen in more than a decade;
• Availability of CMBS hotel financing has been nearly nonexistent thus far this year;
• For developers, construction financing for new hotel development is now scarce.

The LW Hospitality Advisors (LWHA) Q2 2016 Major US Hotel Sales Survey includes 50 single asset sale transactions over $10 million, none of which are part of a portfolio ( click here to download sales highlights.). These transactions totaled roughly $4.7 billion, and included approximately 13,400 hotel rooms with an average sale price per room of $350,000. By comparison, the LWHA Q2 2015 Major US Hotel Sales Survey identified 56 transactions totaling roughly $4.5 billion including 16,800 hotel rooms with an average sale price per room of nearly $267,000. With 10 major hotel sales, Florida has been by far the most active transaction market followed by New York with 9 trades, and California with 6 sale transactions.  The $65 million sale of the 49 room Capella Hotel in Washington DC has by far set a new per room high water mark of roughly $1.3 million per key in Washington DC.  Additionally the $315 million sale of the 462 room LondonHouse in Chicago has set a new per room high water mark of roughly $697,000 per key in Chicago eclipsing last years $600,000 per room trade of the Waldorf Astoria Chicago.  Finally, it is worth noting the sheer size of the $780 million single asset trade of the 1,230 room Hyatt Regency Waikiki Beach Resort & Spa in Honolulu, HI, which has skewed upward the total sales volume during the second quarter of 2016. While the US lodging industry is projected to continue experiencing increases in performance metrics, the gap between increasing demand and growing supply is narrowing.  Demand growth is decelerating and barring a black swan unforeseen event, fairly stable occupancy levels are anticipated, while increases in average room rates are expected to continue to facilitate a rising RevPAR, albeit at a moderate pace.   Despite strong fundamentals during the first half of 2016, hotel investment has been subdued due to perceived concerns that a dramatic slowdown to an already tepid US economic expansion is forthcoming in the near future.  The market has talked itself down which has resulted in a widening of bid/ask spreads for desirable hotel investment opportunities. I believe that as time passes, when looking in the rear view mirror, last year’s pricing of US hotel properties will clearly become known as the peak. I have been privy to information regarding select transactions that provide empirical evidence of price erosion of various US hotel assets.  For no reason other than negative market perception, I have seen contract prices reduced between five and twenty percent.  A recent $100 plus million hotel sale is noteworthy in that one year ago the seller rejected a bona fide offer of 15 percent more than the amount of the current sale price.  In addition to the seller, the institutional broker, who on both occasions marketed the property for sale, confirmed that although during the last twelve months, the subject property and its sub-market’s performance metrics have improved, today’s lower closing price was due merely to an impression by investors of a market value correction. Although several recent US hotel trades indicate value erosion during the past six to twelve months, it is important to note that there is insufficient evidence to support a broad, national market price correction. While some assets may currently be experiencing negative pricing pressure, not all hotels and/or markets have been subject to such a phenomenon.   Lodging is a neighborhood business and underlying fundamentals can vary widely amongst submarkets.  Values of irreplaceable hotels in high barrier to entry 24/7 and/or resort markets remain robust. While on average US hotel prices are expected to remain stable for the balance of the year, broad market trends cannot be directly applied to an individual asset.  Numerous factors influence the value of a specific hotel asset including a property’s age, condition, location, amenities, reputation, and replicability. While during the near term some hotel assets and/or submarkets may experience declining property values, others will continue to endure rising prices. Daniel H. Lesser is president and CEO of LW Hospitality Advisors LLC. The views expressed here are the author’s own. To download the lodging sales highlights, click here.