07/27/2021 | News release | Distributed by Public on 07/27/2021 14:56
This article was originally featured in The Mid-Year 2021 Magazine,which contains research from Trepp and Commercial Real Estate Direct. Access the magazineto see more commercial real estate and CMBS insights.
Even as the country began to recover from the Covid-19 pandemic and states reopened to get back to business-as-usual, many hotel owners continued to suffer from 2020, a doomed year for the hotel industry.
Back in May, the Centers for Disease Control and Prevention provided new guidelines that people who are fully vaccinated against Covid were no longer required to wear masks or physically distance, regardless of the location or size of the gathering. However, many hotels still did not open.
That left owners wondering whether they will be able to survive until the recovery has worked its way through the system. With more than one billion unsold room nights in 2020-the highest ever recorded-many hotel owners are not able to meet their debt-service payments or cover their basic operating expenses.
Others who are coming out of pocket to cover these costs in order to keep their loans current are finding that servicers are conflicted and must protect their lienholders' interests by trapping cash flow and imposing restrictions as specified by loan documents.
How are owners of hospitality assets going to cover operating expenses and debt service until the market stabilizes, which may not happen for another two to three years?
The answer is capital, and it just so happens that there is plenty of it available right now. Lenders are providing capital in many forms for hotel owners, be it equity to purchase properties or creative debt structures to ensure liquidity and carry interest until stabilization. Suzanne Mellen, senior managing director of HVS International, one of the nation's leading hospitality advisory and valuation companies, noted that hotel values are not being discounted today. 'Investors are purchasing hotels based on 2019 income, though those numbers are not expected to be realized again until 2023 to 2024.' She pointed out that this results in zero or negative capitalization rates today for quality assets that are trading.
However, many hotels have not yet reopened or are only opened with limited services.
Jeff Lugosi, executive vice president of CBRE Hotels Advisory, another leading advisory and valuation firm to the hospitality industry, said, 'Hotels are utilizing (Paycheck Protection Program) funding and whatever money may be available from other sources to pay their operating expenses, or are opting to open with limited services, including housekeeping and food and beverage outlets.' He noted that hotels subject to ground leases 'are especially negatively impacted.' So why are lenders and equity providers looking to the hospitality market? Part of the reason may be that hotels provide an attractive alternative to other real estate investment classes, such as multifamily and industrial properties, where credit spreads and yields have been severely compressed.
Randy Reiff, chief executive of Allegiant Real Estate Capital, a leading provider of capital to the commercial real estate industry, explains: 'We are a basis lender and see an opportunity to lend in the hotel sector right now. The volatility of hotel cash flows makes a lot of investors nervous. As a result, many are quick to sell off in distressed markets. People need to travel and don't be surprised if the market recovers more quickly than many think. We believe this provides a great opportunity to obtain attractive risk-adjusted returns.'
Not All Hotels Are Created Equal
The rapid recovery is not being realized equally throughout the market, however, as not all hotels are created equal. Leisure demand has been leading the market recovery as evidenced by the fact that Marriott resort hotels in the United States and Canada are seeing reservations over 60% above 2019 levels and at rates almost 20% higher for rooms booked at least 30 days out, according to Leeny Oberg, executive vice president, and chief financial officer of Marriott International.
When Hawaii rolled out its program of vaccine passports, the Hawaiian Airlines website crashed due to volume. As a result, much of the liquidity available for hotel loans is earmarked for assets that cater to the leisure traveler. Lenders are aggressively pursuing these assets and providing capital. They're including interest reserves that allow for debt-service payments for up to 3 years. Hotel properties with near-term maturities or with limited or no operating history that cater to leisure travelers are finding an abundance of available financing, which has resulted in interest-rate compression.
Capital for hotels that aren't necessarily driven by leisure travelers also is available. Well-located properties with limited or no operating history or hotels that have not yet seen their cash flows improvemay be attractive to some lenders. Financing for these types of assets typically requires a multi-tranched structure, with a lower leverage first mortgage and a subordinate mezzanine and/or preferred-equity tranche.
Such a structure can be beneficial for hotel owners facing a pending loan maturity against a property lacking the in-place cash flow to refinance an existing loan, or for owners who do not have the capital to keep their existing loans current.
Providing capital to hotel owners facing a near-term maturity or that have prepayment flexibility 'allows them to lower their first mortgage debt and, therefore, perhaps reduce the interest rate, creating less stress on the asset,' explained David Brown, senior managing partner of Somera Capital Management, a Los Angeles company with investments in hospitality. 'We will then provide capital to provide for interest carry until the loan stabilizes.'
Such structures work nicely for assets that are not seasoned, or perhaps are in locations dependent upon corporate travelers. Pricing for the subordinate tranche in these transactions typically is in the 10% to 12% range but could be as high as 15% to 17%, depending on the property's location and perceived risk. Though some owners may feel the cost of this subordinate capital to be expensive, it is less expensive than equity and a better alternative to a work-out situation with an existing lender.
We are often asked when the long-term fixed-rate loanswill eventually be available for the hospitality sector. Hotels, unlike other asset classes whose net operating income is supported by long-term tenant leases, are underwritten on a trailing 12-month basis as opposed to expectations. Due to the last 12-months showing poor operating results for hotels, lenders are having difficulty sizing new loans for a 10-year fixedrate execution. Some lenders are looking at 2019 performance and discounting those numbers in order to size new fixed-rate loans, but those lenders are selective. As a result, few long-term loans have been originated during the pandemic.
Hotel Construction Loans Hard to Line Up
Among the most difficult hotel transactions to finance today is new construction. Lenders are wary of making loans for new hotels in a market that is still recovering from the worst year the industry has ever seen. This will bode well for existing hotel owners, as they seek to stabilize their own assetswithout worrying about new supply. The drive-to-leisure market, however, may experience some increase in supply, as this is a market that has proven to be resilient, even during the pandemic.
Markets with barriers to entry, such as coastal locations, may see some increase in supply if owners are able to get approvals to build. Debt for these types of properties typically is provided by commercial banks, which could lend up to 50% to 55% of a property's construction cost, and debt funds, which might be willing to lend as much as 65% to 70% of the cost for quality assets.
In summary, we continue to be in a historically lowinterest rate environment, with a tremendous amount of pent-up capital-both debt and equity-that is looking for yield. Prudent lending and investing in the hospitality sector right now provide a risk-adjusted return for those who are comfortable with the risks. As evidenced by the resurgence of the leisure traveler and the expectation that corporate demand will return, it is expected that capital will continue to be available for hospitality transactions at least through the return of stabilization for these assets.
David Sonnenblick is co-founder and principal of Sonnenblick-Eichner Co., a Los Angeles real estate investment banker specializing in the hotel sector, whose other principals are Elliot Eichner and Patrick Brown, who have a collective 100 years of experience.
Disclaimer: The information provided is based on information generally available to the public from sources believed to be reliable.