Key Takeaways From MBA’s Hospitality Trends in a Pandemic
Hospitality experts recently discussed their outlooks given challenges in the broader economy and continued soft room demand and business travel.
The Mortgage Bankers Association hosted an online conversation with experts from across the troubled hospitality sector. Gregg Gerken, Executive Vice President & Head of U.S. CRE Lending with TD Bank, moderated the dialogue, which focused on the impact of current events on hotels with an eye toward what the second half of 2020 taught us and what is to come. The webinar included brokerage, ownership, receivership, valuation and lender perspectives.
Gregg Gerken, Executive Vice President & Head of U.S. CRE Lending, TD Bank
Marc Sallette, Senior Vice President, CBRE Capital Markets
Kevin Gallagher, Senior Vice President, Business Development, Prism Hotels & Resorts
Suzanne Mellen, Senior Managing Director, Practice Leader, HVS
Mohamed Thowfeek, Senior Managing Director, Westmont Hospitality
A slide presentation prepared by the speakers is available here.
An Empty Room with A View The impact from the economic shutdown in March was immediate and profound for hospitality sector. Whereas business tapered off for hotels in past recessions, hotels emptied out in a matter of days in response to the shutdown and travel demand fallout.
Many in the hotel industry thought this situation would be like a sprint to get through, not a marathon. At this point, it can be said that in some respects, the hotel industry has been sprinting ever since March 2020 to deal with the continued lack of demand and challenges. Leisure was the only thing that did not totally fall off. Group business remains nonexistent. A defining characteristic of 2020 has been an inverted chain scale with extended stay product being the most desirable and better performing on a relative basis than other products.
Nobody had a playbook for the developments that occurred in 2020. Each month, the goal posts of recovery have kept getting moved out as the pandemic continues to evolve. Economy segments are doing better on some operating metrics, which is an anomaly. Huge burn rates for empty hotels and the current situation is anything but sustainable.
Brands have been flexible on Property Improvement Plan completions, standards. There is only so much they can do on this. Brand standards which include keeping hotels maintained and designed to a required standard of quality has been put on hold and remain so. Brands have been generally accommodating given the environment. They will come back around with the need to bring properties up to snuff and that will impact owners and their budgets.
One other helpful point has been the suspension of contributions to “FF & E” (furniture, fixtures and equipment) reserves where feasible. Many of these funds have been liquidated via forbearance agreements. Sustainability depends on the size of checkbook. Some owners are turning in the keys given unsustainable situations.
The situation for many hotel owners is dire. In this environment, it is not about being able to make debt service and it is not about making principal and interest payments. Before even getting to these costs, it is about making payroll for many hotels.
CBRE Transaction & Investment Sales Trends Research is showing some “green shoots” from a capital markets perspective with improved liquidity for hotel lending seen in second-half 2020 and anticipated going forward.
Last June there were 23 hotel lenders in the market. By December a survey found more than 100 lenders, primarily debt funds and some banks. Two CMBS lenders have come back, looking for smaller loan sizes. Debt yields in the 13 percent range. Coupon of 4.5-5 percent. 60 percent range for leverage creeping up to 65 percent. Looking at 2019 cash flow for underwriting. Looking at replacement cost and 2019 sales comps two to three years out to underwrite exit debt yield. Debt service reserves are required. Interest and carry reserves are required. Many are offering non-recourse financing. Cash-in required most often for refinancing with equity gap vs. cash-out, which is the common approach in a strong economy. Banks are quoting 3 to 4 percent coupon with recourse and 50 percent leverage.
Many lenders say they expect to be back in the market later this year. The recovery is happening very differently across chain scales, with luxury lagging more economical sectors in terms of revenue per available room recovery.
What’s It Worth to You? There was more transaction activity than expected during the second half of 2020. May were expecting less volume than occurred, like the standstill that happened during the Great Financial Crisis. However, there was an uptick in the third- and fourth-quarter volume, although from a low point and at levels that remain weak.
There are active lenders for some hotels although transaction volume is down significantly across all categories. There is enough activity to get a sense that pricing is not as distressed as many have expected. There is lots of capital and some institutions willing to take a bet on the recovery and potential light at the end of the tunnel as vaccines are rolled out.
These properties carry a huge amount of risk with assumptions above recovery timeline as well as the playing out of potential secular trends that may change the industry over the long term that are not well understood yet. Harsher assumptions were being made in the second quarter of 2020, when transactions initially fell off in terms of discount rates chosen than appraisers are now using since a relatively thin market for transactions opened back up. Valuations are happening with some level of transactions to use as data points, although these are not the forced trades that may ultimately occur.
Many are hanging on to their properties and loans, hoping for the recovery to help minimize any losses. The transactions that are occurring are ones where there is a narrative about how to get to recovery. There is a “Barbell Effect” where the first assets to trade are voluntary. High-quality assets with a low burn rate and a short time to recovery. There are also forced trades, distress, with a high burn rate and less clear path to recovery transacting at higher discounts. There is far more liquidity during this crisis than the last one.
From an investor perspective, there is a belief in the long-term recovery of hotels. Equity gap problems and cash flow problems in the middle are going to be a struggle. The amount of investor interest is extremely high. The cash flow hemorrhaging and not knowing when that will reverse makes it risky.
Looking at note sale activity, there is an unbelievable flow of capital into the loan sale space. Both traditional and non-traditional capital. There is a very aggressive bidding environment. Accelerated recovery pro formas and timelines given the demand. Scarcity premium created. It’s an exciting area to keep watching. Hotel paper makes up approximately two-thirds. Valuation requests coming in from lenders for actual sale transactions. More local regional banks and debt funds are most active in this space.
A Rough Year and More of the Same Predicted for 2021
–More of the same for most of the year. The year 2021 could look like a mirror image of 2020 with potential for herd immunity created by the fourth quarter which could compare with 2020, when there was a normal first quarter before the falloff. As for modeling, close the spreadsheets while the hotels are closed. Business travel is not in the budget for 2021 already. When it goes back in will be a decision made for future budgets more than likely than mid-year. Leisure destination markets may have pockets that recover.
–Worsening pandemic. Vaccination rollout being slower than expected is a negative development. Restriction of international travel. These three factors will make 2021 a tough year. Pent-up demand will help some locations, but business travel will be tough going forward. Cancellation clauses have practically gone away so it has become harder to forecast group segment.
–Transaction volume may continue at its current pace, rolling along but not frozen. It will be a while before it picks up considerably when there is more clarity. Demand recovery will likely come first, perhaps some pick up in fourth-quarter 2021. Perhaps the forced trades could be where volume picks up later in 2021.
Andrew Foster is Associate Vice President in MBA’s Commercial/Multifamily Group. He is a former Analyst with S&P Global Ratings and Fitch Ratings as well as a regular contributor to MBA NewsLink. Foster can be reached at firstname.lastname@example.org or 202/557-2740.