Lodging pundits and people involved in the industry will continue to try to sell you that the lodging industry is doing great, and has been, and will continue to for many years. The hospitality pundits and appraisers have been selling the fiction since 2016 that the industry would be doing great through 2019. They have had to materially modify their story lines since then because the numbers were simply not happening to support the fiction they were putting forth. Their projections made in 2016 for 2017-18 were off by 50%, or more.
Here is the dirty little secret about all the pundits, appraisers, and brokers in the hotel industry. The pundits and STR are pressured heavily by these people and Wall St who have a financial vested interest to make things sound better than they really are, and to project them to continue to be very good so that buyers will buy hotels and lenders will lend more than they should. Appraisals are invariably falsely optimistic unless done for bankruptcy hearings or other reasons where a low value is needed by the client. Then the values are magically low. Having been an expert witness in numerous hotel trials, it is always hysterical to listen to the opposing appraisers try to convince the judge that their value is correct, even though the high and low are way far apart. This is just further proof that appraisals are really MAI- made as instructed, and just a bunch of manipulated assumptions that have no real basis in fact. I used to be a speaker at most of the lodging conferences, but finally one of the conference sponsors told me I could no longer speak because conferences are designed to be optimistic sales programs, and my reality check comments about how the industry was going to flatten out after 2016 were not welcome, and that sponsor is a good friend of mine.
Did you ever wonder why STR and the pundits only provide Revpar numbers and not cash flow? It is because Revpar generally does rise, even if only by inflation, so they can make things sound better than they really are. To me, it is net cash flow and cash return on invested equity that matters, not Revpar. Even revenue numbers are not reported fully as they are often gross revenue and not net revenue after OTA commissions, which are eating as much as 25% of OTA booked revenue in some cases.
The point is, by summer of 2015, hotels had finally recouped a substantial portion of the massive value decline they suffered in 2008-9. However, it really took until another year or more for inflation adjusted values to reach 2007 levels. In some markets it is not clear they ever again got there. Now we have a situation where low end wages are rising, and labor is often 80% of expenses. Interest rates are rising and cap rates along with interest. OTA commissions are rising and eating more of revenue. Supply is exceeding demand growth despite the strong economy, which means hotels are not able to raise prices much if at all in some markets. It is likely that the bulge of new supply will ease in 2019 and 2020, as the industry stats will not support the construction loans in many markets to have a lot of new supply.
Bottom line, hotels are street corner businesses. Location is everything. There are still some good hotel deals to be had, but one needs to be very selective. Some hotels are just poorly operated, or poorly maintained, and so these may have value add justification to acquire. There are now more ways to bring in technology to eliminate some costs and labor. However, many owners decided to refinance rather than sell at what has become reality in market value. This was a dumb move since interest rates will continue to rise, and when those owners go to really sell they will find the value of their now older hotel to be even lower. Whatever they earned in cash flow by waiting and refinancing will then be lost through lower value. Possibly by the time they decide to sell, or their refinanced loan matures, we will be in another economic downturn and they will really get screwed, Ignore appraised values, ignore the industry pundits and if you are planning to invest in hotels, get the cash flow numbers and do not let them sell you on Revpar. It is simply the top line and does not take account of all the expenses that are rising even faster.
The views expressed here are those of the author and not ALM Real Estate Media.
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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.
