Where the Deals are in Hospitality

The hospitality industry is exhibiting encouraging signs of growth after the disastrous years of the pandemic, which slashed travel and hotel bookings. But while its very success is creating new problems, like a shortage of air-traffic controllers and hospitality workers, the industry continues to face a complicated lending environment as well as rising costs.

Marcus & Millichap’s midyear 2023 national report on the hospitality industry depicts a sector still trying to regain its footing amid uncertainties over the direction of interest rates, higher wage rates, hesitant lenders, and lower deal flow.

Despite these challenges, the company sees opportunities for investors. 

After strong trading activity in 2021 and 2022, 2023 saw a slowdown. And as sales have slowed, prices have slipped. “The average entry cost during the first half of 2023 was $103,200 per key, a 4.1 percent decline relative to last year’s measurement,” M&M reported. “Still, hotels remain an attractive investment option for yield-driven buyers, especially as the 10-year treasury rate remains near a decade peak in the high-3 to low-4 percent range. The average cap rate in the hospitality sector was at 8.7 percent in June, which is nearly 100 basis points higher than any other major commercial property type.” 

The most sought-after deals involve economy and limited-service hotels. The hottest markets are Florida, California and Texas. However, New York City, Atlanta, Phoenix, Chicago and Charlotte have also attracted investor interest.

Despite potential buyer interest, “one of the most challenging aspects in the hospitality lending environment is aligning buyers, sellers and lenders on pricing expectations,” the report notes. “Elevated borrowing costs have some buyers seeking lower pricing on acquisitions in order to achieve healthy returns.” 

At the same time, while liquidity is still available, some lenders remain skittish and more selective about the type of hotel and locations they will consider. Banks generally provide the lowest cost of capital, but now favor borrowers with experience in the lodging industry.

For investors willing to take the plunge, there are reasons for optimism.

One sign that the hospitality sector is on the way to recovery is the 634 million room nights booked so far this year — a 2.6 percent increase compared to the same time frame in 2022. “Estimates suggest total room demand will reach a new all-time high this year,” the report notes. As of June 2023, the average daily rate (ADR) and revenue per available room (RevPAR) were roughly 17 and 12 percent higher than their pre-pandemic peaks. 

However, because a tight labor market has limited capacity in some hotels, occupancy remains 250 basis points below the 2019 rate, the report found. Furthermore, growth could slow in the fourth quarter because student loan payments have resumed along with high interest payments.

On the other hand, if demand remains strong, a traveler could have a harder time finding a hotel room. That’s because, even though an estimated 94,500 hotel rooms are slated for delivery across the U.S. by the end of this year — 37.6 percent more than in 2022 – that number is still lower than 2016 to 2021 levels, and annual room deliveries still trail the long-term U.S. average by 2.4 percent.

What is driving the increase in travel demand? According to Marcus & Millichap, leisure travel is booming, especially during the summer, with outdoor activities and the National Parks big attractions. International travel to the USA is also looking up, although it is not expected to fully recover until 2025.

Business travel continues to lag. “With fewer staff members regularly in the office, many companies have changed their business travel policies by either reducing the frequency of these trips or by sending fewer employees on them.” Higher travel costs have not helped.

However, group travel statistics are improving. Some companies have begun to book small corporate meetings to build team culture and cohesion. Conventions and association meetings are resuming. Several hotel chains have also reported more group travel. 

And on another happy note, “the volume of weddings reached a nearly three-decade high in 2022, and the amount of receptions are projected to remain above pre-pandemic levels throughout 2023,” the report comments.