CRE & Lodging Landscapes Post-COVID: Conversation with JLL’s Ryan Severino, Michael Huth
MBA’s Andrew Foster recently spoke with Ryan Severino and Michael Huth of JLL on the outlook for commercial real estate and in particular, the hotel/lodging sector in a post-coronavirus environment.
Ryan Severino is the chief economist at JLL where he manages the economics team and is responsible for global and regional economic research, analysis and forecasting as well as property market forecasting.
Prior to JLL, Severino served as senior economist and director of research at Reis in the research and economics department, the team responsible for the firm’s market forecasting, valuation, and portfolio analytics services. He also served as the Associate Director of Research at MetLife Real Estate Investments where he was responsible for macroeconomic and real estate market analysis, formulating portfolio strategy, and conducting deal reviews. Before joining MetLife, he served as the Director of Investment Strategy and Market Research at Starwood Capital Group where he directed the entire research effort at the firm. He also held research positions at Prudential Real Estate Investors and UBS.
Michael Huth is an Executive Vice President with JLL Hotel Investment Banking team based in Los Angeles. Since joining the firm in 2006, He has been involved in debt and equity financing transactions and asset management of commercial real estate loans. His primary responsibilities include financial analyses and underwriting, managing debt financing and equity recapitalization processes, and coordination with clients, lenders, and investors regarding due diligence materials and property logistics.
MBA NEWSLINK: What are three important factors that you’re closely watching that may determine what 2021 CRE landscape looks like?
RYAN SEVERINO: There are a few closely related factors outlined below.
Level of the pandemic/pace of vaccination. This is the key. The economy and CRE markets cannot fully recover until we get past the pandemic which is only going to occur via widespread vaccination. That should likely occur around mid-year but if vaccination experiences troubles or delays, pushing that timeframe out, CRE will take longer to recover.
Fiscal stimulus. Because the economy cannot fully heal until we move past the pandemic, fiscal stimulus will remain important to support the economy which is currently taking simultaneous hits on both the supply side (due to lockdowns, shutdowns, etc.) and the demand-side (consumers avoiding activities like travel and dining out). Fiscal support is no panacea, but it can help the economy move through the next 6 months until we can arrive at widespread vaccination.
Employment growth. Employment growth should tell us a lot about the state of the economy and CRE. As more people become immunized and the pandemic abates, more people will feel safer returning to mundane economic activities. That should generate more meaningful employment growth, including in hard-hit industries like accommodation and food services.
NEWSLINK: Transaction volume is down significantly although unevenly by market and property type. How do you expect volume to fluctuate in 2021 and how do large sums of capital raised for distressed opportunities play into your outlook?
SEVERINO: A healing economy and a forward-looking investment market should provide support for transaction activity this year. Some investors will capitalize on distressed activity, but some of the most dire forecasts about pain in the sector seem a bit overdone, similar to what happened with the last recession. Enterprising investors and developers are already working on plans for some struggling properties, including redevelopment and repositioning.
NEWSLINK: Last cycle’s recovery involved gateway city outperformance followed by secondary markets which attracted more capital over time through more compelling yields and strong job growth numbers. When do you think next cycle’s investor themes will become clearer? How do you anticipate affordability factoring in?
SEVERINO: We will likely have to get beyond the pandemic for a while to see how some of this plays out. Some of what has been occurring is really the acceleration of continuing trends (e.g. movement from city centers to suburbs, use of ecommerce, increased prevalence of WFH) that is being mistaken for paradigm shifts. After we get through the pandemic, people (individuals, household, organizations) will make decisions on how to proceed. But that is not possible during the pandemic – too much uncertainty remains for many to make decisions.
NEWSLINK: Real estate is local but are there any specific market rent, occupancy or absorption numbers that you feel highlight larger trends that may be playing out across various markets in the coming quarters and years?
SEVERINO: The laws of supply and demand still generally work. Therefore, the equilibrium variables (rent, vacancy) will tell us a lot about the health of markets as we move through the crisis. CRE lags the overall economy so we will not know the full extent of this downturn for some time. But the markets that hold up better during the downturn should position themselves better for the recovery.
NEWSLINK: Hospitality is the asset class most challenged this year. What are your expectations for 2021 and do you see buyers and sellers coming together to drive transaction growth in some of these categories?
MICHAEL HUTH: There is no doubt that the lodging sector has been severely impacted by the pandemic, but there are reasons to be optimistic about the outlook for this asset class as we enter 2021.
Nationally, revenue per available Room (RevPAR) hit bottom in April 2020 but has since begun to recover. The industry will face continued challenges in the months ahead. As we’ve seen already, the recovery path will have its ups and downs tied to infection rates and travel restrictions, and not all products and markets will follow the same trends. Prognosticator consensus indicates that national RevPAR is expected to recover to 2019 levels by 2024.
Hotel transaction volume was down by 72% in 2020, according to JLL Research. The extreme uncertainty that characterized most of the year caused substantial disparity in value expectations between buyers and sellers, which limited the amount of product on the market and the number of completed transactions. The lack of debt financing for hotel transactions was another limiting factor.
JLL expects hotel transaction volume in 2021 will reflect a strong year-over-year increase. The amount of capital available for investment into commercial real estate remains near record levels. The availability of debt for hotel transactions is increasing markedly, resulting in more favorable terms. With the development and rollout of multiple, highly effective vaccines, many investors are expressing a higher degree of conviction around the timing of a more robust recovery and are beginning to deploy equity in the space at more modest discounts to pre-pandemic values. These factors should work together to reduce the bid-ask spread and increase transaction activity.
While conditions are right for increased activity in 2021, the impact of another round of government stimulus and increased confidence related to the timing of a more robust recovery may cause owners of mildly distressed hotels to hold on a little longer instead of taking assets to market. Similarly, lenders who may have sought to take notes to market or exercise more severe rights and remedies, may choose to provide additional relief in hopes of maximizing repayment in the future.
NEWSLINK: We’ve seen the headlines around many hotels closing. How significant a role do you feel adaptive reuse will play in the economic recovery?
HUTH: Time will tell, but it is not likely that hotel conversions will be a primary driver of widespread economic recovery. Not all markets have experienced the same volume of hotel closures and not all closed hotels are good candidates for alternative use conversions. In some markets like New York City and San Francisco, there are other macro trends that are likely to affect demand for alternative uses, which may impact the timing and/or feasibility of the conversion of closed hotels in those markets.
NEWSLINK: How do you anticipate the recovery of lender interest to play out? What are the dynamics like heading into 2021?
HUTH: During the second half of 2020, we started to observe a gradual but notable increase in liquidity for hotel financing. A few weeks into the new year, this trend has accelerated as more lenders return to the space. While conditions are improving, lenders remain highly selective. As competition mounts and the recovery of the lodging market and broader economy gain momentum, we expect lenders will branch out to more transitional hotel assets.
While certain opportunistic lenders remained open to hotel financing opportunities throughout the pandemic, other sources of capital quickly moved to the sidelines and remained there during the early months of the pandemic.
After lodging market fundamentals hit bottom and started to trend in a positive direction and the first “post-COVID” sales transactions provided a gauge of current market values, we saw some lower cost lenders begin to reemerge. With the development and distribution of multiple highly effective vaccines underway and the conclusion of a divisive election and the transition of administrations in the rearview mirror, the availability for hotel debt has improved.
Banks and insurance companies are once again entertaining hotel financing opportunities, though that market remains thin and highly selective. Debt funds are starting to gain confidence in their ability to obtain leverage through the A-Note market or via credit lines, which means they can provide more efficiently priced loans to their clients. Even the single-borrower, floating rate CMBS market has shown signs of life.
Given the prevailing “flight to quality” mentality among lenders at this time, the focus continues to be on opportunities involving the highest quality assets, markets, sponsors, and situations. While exceptions abound, as a general rule, acquisition financing will continue to be more prevalent than refinancing (construction financing remains scarce); branded assets will garner more attention than independents; drive-to markets with strong leisure demand drivers will be favored over urban markets reliant on corporate and group demand; and assets with strong and stable cash flow during and prior to the pandemic will attract more interest than those that struggled before the pandemic began.
In our view, we are currently within a finite window of time where lenders will be able to provide lower leverage loans to strong sponsors backed by high-quality assets with enhanced structure to address interest and operating shortfalls and still achieve a disproportionately high yield compared to other asset classes and certainly compared to pre-pandemic conditions. We are already seeing spread compression and improved structures for the best hotel deals. As more lenders re-enter the space over the course of the year, we expect that increased competition will push some lenders to take on additional risk to justify higher yield requirements.
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