Andrew Foster: Travel Nosedive Knocks Hospitality Industry
(Andrew Foster is MBA Director of Commercial/Multifamily Policy; he can be reached at email@example.com or 202/557-2740.)
COVID-19 has impacted the entire United States and commercial real estate is no exception; however, no property type is quicker to experience the impacts of a downturn than lodging, where rental rates reset daily.
The reopening of states is the first step in the process of determining the type of future demand that can be expected for hotel and motel owners across the country which cater to various segments of travelers. The fate of commercial mortgage lenders who have provided financing for now-struggling hoteliers hangs in the balance with a reported $300 billion of mortgage debt outstanding as of third-quarter 2019 according to the Wall Street Journal.
This review will discuss briefly 1) near-term challenges in the industry, 2) thoughts about the new post-COVID-19 era, 3) determining values of hotel and lodging properties, and 4) challenges for borrowers/lenders to transition to the new normal and 5) comments on government relief for commercial mortgage-backed securities.
Some key questions in the debt markets that support hotel operators across the country include:
- What will the demand drivers be for hotels going forward and how will they evolve from the reopening stage to the time a vaccine is developed to after the pandemic is behind us?
- How will hospitality sector property values shift given the number of new uncertain variables introduced by a global pandemic, changing consumer habits and large-scale government intervention?
- When will the market for transactions and lending return to a normalized level and how will defaults and distress be managed across different sources of capital?
Surviving the Current Pandemic
Near-term challenges that no market participant underwrote when loans were made include economies shutting down and travel dropping to a near standstill. In certain hotspots, hotels have been converted to supporting medical responses to the virus. The government and central bank responses have been historic in both their size and speed with a focus on providing liquidity to businesses and their employees. There is exposure across various capital sources that actively lend in commercial real estate; however, CMBS and non-bank lenders are notable groups financing hoteliers whose activities have been widely covered in the press, notably by pieces in the Real Deal and Trepp.
Developing Views on Demand Drivers Post-COVID-19
In determining the hospitality industry’s outlook, consumer behavior in the next few years and the longer term are key ingredients for understanding how properties will perform and the revenue component of their values. Questions will be thought through in terms of travel segments–leisure, business and convention, which will ultimately impact room rates, revenue per available room and excess supply across segments. Changing views about congregating in large groups will have a major impact on not only the occupancy but also affect the room rates that leverage peak demand around large events. Layoffs at the corporate level for franchisors like Marriott and Hyatt and these impacts downstream to profitability and operations of franchisees will be another area to watch. The amount of excess supply in certain markets may create situations where certain properties highest and best use shifts to a property type other than lodging.
In addition to demand, the outlook for expenses is affected by increased cleaning costs and possibly for changes required for social distancing.
Property Values, Debt and Transactions
When a recession hits, the market landscape becomes defined by how buyers and sellers reset their expectations. This process can be slow if the gap between what buyers will pay and what sellers will accept is wide. The ability or willingness of lenders to support owners through financing is challenged in these periods. In this context, today’s hotel lenders and borrowers will assess their existing loan exposures, collateral values and options for moving forward in a world with very different prospects than most expected heading into 2020.
Given the expectation for shifting demand in the medium term and the incredibly disruptive short-term developments that came from shutting down the economy, hotel owners and their lenders are in challenging situations across the country. This began as a short-term issue and the picture will change once economies re-open; however, there is significant doubt that many of these hotel businesses will be able to pay their obligations in the future. Establishing a view on value given decreased revenue and increased expenses is difficult to quantify but is important to establishing a property’s ability to generate profit for an owner.
These market dynamics contribute to the challenges of price discovery, which are an important input needed for buyers, sellers and lenders. Modeling typically uses historical data, and we are clearly in uncharted territory.
For example, Prism Hotels and Resorts Senior Vice President Kevin Gallagher said, “today, nothing in the hotel business follows history because there has been nothing like this in hotel business history. The current 80-90 percent drop in hotel revenue is colliding with shrinking hotel operating margins and re-writing everything we know–especially as it relates to debt service coverage and hotel asset value. The damage, scars and lessons from this rewriting of hotel loan history will be with us a long time.”
Loan Workouts in the Age of COVID-19
Given the dire situation of owners, one industry development that has occurred is a proposal from the American Hotel and Lodging Association. They have proposed government relief to policymakers on Capitol Hill for hotel borrowers with CMBS debt. While the need for relief in various industries facing existential threats to their existence is understandable, CMBS servicers and the investors they represent are victims of the circumstances brought on by COVID-19 like all property owners, not just hotel borrowers. Servicers are being inundated with requests from all types of borrowers and each request should be considered and handled efficiently and fairly. Universal forbearance for all assumes this crisis is short term and all businesses just need a few months to tide them over.
While the inability to pay business expenses when revenue dries up is understood, any relief outside of borrower and lender direct negotiations should consider all parties’ costs, not just business owners. This is true in all types of lending; however, CMBS has a more complex structure than balance sheet lending. The process can be slower and more cumbersome and comes with a different fee structure. As part of getting a CMBS loan, borrowers agree to servicer fees, just like other service providers. These fees cover their expenses just like the borrowers charge for their rooms or for services to cover their expenses.
Analyzing Government Involvement
Clearly, government involvement stands to impact outcomes, potentially delaying the timelines and perhaps giving favored status to certain groups. Addressing CMBS loan defaults need to take into account not only hotel borrowers, but also other business owners as well as other stakeholders. The amount of job loss caused by this crisis will make it impossible to save all businesses. Servicers are in a position to help evaluate which businesses are going to be able to pay their loan obligations. This is their legal obligation to investors. The servicers don’t deserve blame for doing their jobs any more than the borrowers deserve blame for laying off their employees.
The expectation for borrowers and servicers alike needs to be working together, honoring their contracts and being professional. Servicers have invested time to talk with borrower members of the American Hotel and Lodging Association and other trades groups representing the borrower community across property types about how to navigate the process. They deserve borrowers willing to work with them directly.
While the mortgage industry needs to work with borrowers and do the right thing, there are some facts that inform their fiduciary duty and should also be appreciated by policymakers. The owners/investors took out mortgage loans that expressly stated that if they could not pay their obligations, they would forfeit the property. Servicers are working with hotel owners and other businesses to try to avoid that outcome, while also following the legal and business rules that dictate the rights and responsibilities of different parties–including lenders. If the current owners are not capable of continuing as a business in the new environment, the best outcome may well be to transfer ownership to owners/investors.