Lenders, Investors Get Hungry for Hotels as Sector Benefits from Healthy Demand Rates

By: Elaine Misonzhnik for NREI

The U.S. hospitality sector has, until recently, lagged other commercial property types in the recovery from the downturn. Lenders and investors worried about the sector’s close relationship to the overall health of the economy as GDP growth stalled in the low single digits. Yet hotels are coming back in vogue as demand is spiking up just as supply growth has plummeted to a record low in 2012, according to panelists and attendees of New York University’s 35th International Hospitality Industry Investment Conference, which took place in New York City on June 2 through June 4.

The U.S. hospitality industry has been setting records in room demand over the past year, according to Randell A. Smith, chairman of STR Global, a provider of benchmarking reports for the industry. Currently, hotel occupancy rates nationwide average 67.8 percent, an increase of 1.3 percent compared to a year ago. The average room rate per night has climbed to a new high of $110.89. Revenue per available room (RevPAR) now averages $75.17, a 6.2 percent uptick from the same period in 2012. Meanwhile, new hotel supply will grow by just 1 percent in 2013 and 1.6 percent in 2014, STR Global forecasts.

“We have never seen supply growth this low when demand has been this high,” Smith said during his presentation on the industry’s “Statistical Reality.” In terms of RevPAR, there has been “very consistent, solid growth.”

That, in turn, has led to steadily increasing property values for the hospitality sector, to the point where investors who had bought hotels at the peak of the market in 2006 have now been able to recoup their capital, according to Steve Rushmore, chairman of HVS, a hospitality intelligence firm. In 2006, values per hotel room in the U.S. averaged $99,000. This year, the figure is up to $106,000 per room. By 2015, it will likely reach $133,000, HVS predicts.

Hotel owners who were trying not to sell at a loss can now feel free to put their properties on the market, Rushmore noted. It has also become a lot easier to refinance hotel assets.

“Now is the time you may want to start thinking about selling,” Rushmore told conference attendees. In 2013, the sector may see up to 300 major sales transactions, he noted. “People are unloading their properties at a gain.”

The biggest obstacles to completing investment sales in the hotel sector is no longer lack of demand—it’s the fact that many buyers still carry the illusion that they can buy at a discount, notes Greg Morris, managing director with Premier Capital Associates LLC, a real estate investment banking firm that specializes in hospitality properties. It’s true that in the years after the recession most hotel sales were driven by necessity as owners couldn’t refinance maturing debt, according to Mike McNamara, head of real estate capital markets with Ernst & Young. But those days are over, he says.

In fact, the market is nearing a point when values on existing assets will surpass replacement costs, leading to a growing development pipeline. Hilton Hotels & Resorts, for example, is expanding its extended stay brands Homewood Suites and Home2 Suites primarily through new construction in 2013 for precisely that reason, according to Bill Duncan, the brands’ global head. Hilton’s plans include the opening of 25 new Homewood Suites properties this year, and approximately 15 Home2 Suites.

Stepping up to the plate

Today, refinancing existing assets and securing capital for new acquisitions remains easier than getting lenders to commit to new hotel development projects, according to Jeff McKee, managing director with Premier Capital Associates. McKee and Morris note that everyone from banks and life insurance companies to CBMS and mezzanine lenders is eager to place loans on hotels as long as they can see healthy cash flows. On a refinancing transaction, a 10-year bank loan may now offer a fixed interest rate of 4 percent to 5 percent with no recourse and a loan to value ratio of approximately 65 percent.

CMBS lender may be willing to go up to 75 percent LTV on existing assets. But Wall Street firms won’t originate on new construction.

“The CMBS lenders will not touch development,” notes McNamara. “There is not a lot of development financing around and it’s really in specific locations: New York City, Washington, D.C., San Francisco and Boston.”

Securing equity for new hotel projects remains a challenge as well, according to McKee. The process that used to take less than three months pre-recession can now take up to six months. Yet most people attending the conference expect development to pick up starting in 2013.

What will happen and that the hotel industry will lean on mezzanine and bridge lenders to close the gap in funding for new construction, notes Brian Tress, leader of Ernst & Young’s hospitality practice for the North Atlantic region.

“The buzz word is going to be mezzanine,” Tress says. “Even the hotel [operating] companies are going to use their balance sheets and provide mezzanine loans. To get these development deals, it’s going to be a necessity.” 

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