Hotel owners, operators, lenders, and investors are all facing greater challenges than ever anticipated, as they grapple with plummeting occupancy, average rate (ADR), and RevPAR and seek solutions to mitigate the impact on EBITDA.
Owners and operators are dealing with the current crisis day-to-day, making hard decisions regarding staffing, continuing or suspending operations, and having difficult conversations with their management companies, franchisors, lenders, and investors.
Management companies and franchisors are working to identify ways to support their hotels while maintaining a coherent business strategy, while lenders and investors are grappling with fundamental questions concerning risk, returns, and value.
We don’t know how long the pandemic will last, how long the related restrictions will be in place, or how much worse this could get for our industry. We also don’t know the final net impact on the economy, or the depth and duration of the downturn. We do know that these events will have, and have indeed already had, a significant impact on hotel values.
While it is difficult to assess the full impact, an examination of value trends in prior cycles can provide some useful guidance. Those historical patterns, together with an understanding of the market’s current expectations for the ultimate recovery of the industry and its performance, provide guidance for the probable trajectory of decline and recovery for hotel values.
Hotel Values and Market Cycles
EBITDA is defined as earnings before interest, taxes, depreciation and amortization, and for hotels, it includes a deduction for management fees and a reserve for replacement.
The volume of hotel transactions and the price paid for individual assets are influenced by two principal factors: the availability of capital and the performance of the lodging sector as a whole. When the industry is performing well and financing is available on favorable terms, investors are attracted to the market, and both prices and the number of transactions increase.
These market conditions often induce sellers to put their properties on the market, further fueling the pace of transaction activity. Conversely, when hotel performance declines significantly, generally due to a contraction in demand caused by an economic downturn or, in this case, the pandemic, owners refrain from selling their assets until the market improves.
Additionally, many hotel lenders withdraw from the market, making hotel financing less available; the debt that is available is usually characterized by lower leverage and higher interest rates. As a result, transaction activity drops off significantly. The impact of these influences results in a cyclical investment market, recording peaks and valleys in response to changes in the capital markets and the economy.
Value Trends Evident Through the Great Recession and Recovery
To provide a basis for our analysis, we looked at hotel sales transaction trends from Q1 2007 through the end of 2019. As illustrated in the graph below, hotel sales transactions started to decline markedly in late 2007 as the market began to falter. The financial crisis in the fall of 2008 stalled out the transaction market, with few sales occurring in late 2008 and 2009.
Once hotel performance bottomed out in late 2009, hotel investors jumped in, and the number of transactions began to accelerate mid-year 2010.
Historical Hotel Transactions
Source: RCA
Lodging industry performance bottomed out in Q4 2009, with demand growth turning positive in early 2010. With a recovery in fundamentals underway, transaction activity began to recover in 2010, fueled in large part by the aggressive acquisition programs of newly formed and existing REITs and investment funds. Mortgage capital became increasingly available in the latter half of the year, including both on-book loans and renewed CMBS lending programs.
The substantial improvements in the performance of the lodging industry, combined with widespread optimism concerning the outlook for the sector, contributed to the resurgence of interest in hospitality investments. These trends are evident in the data for 2010, which indicate that the number of transactions was more than triple the total recorded in 2009.
Once hotel performance bottomed out, and hotel EBITDA had nowhere to go but up, investors jumped in. Transaction activity continued to rise in 2011 and then moderated in the latter half of the year and in 2012 given the uncertainty caused by the debt crisis in the U.S. and Europe.
Sales activity resumed in 2013 and continued at a healthy pace throughout the remainder of the cycle, up to and including 2019. Sales volume spiked in 2015 given the high number of large high-priced asset transactions that year, including the sale of Strategic Hotels & Resorts’ portfolio of 16 large, luxury hotels. That year’s volume was not reached again in the cycle.
The average sales price per key parallels trends in transaction volume. The following chart reflects the average price per key, as reported by RCA. This metric is calculated by dividing total sales volume in a given period by the total number of rooms transacted and thus is greatly influenced by the type, size, and price of hotels transacted and thus can be misleading.
A review of historical cycles illustrates that the lodging industry will experience a significant decline in asset values due to COVID-19 and the economic downturn. While in recent years, lending has been more disciplined with generally lower leverage and stricter due diligence than in prior cycles, the current magnitude of revenue and EBITDA decline will likely require a myriad of solutions, including debt service deferment, and loan modifications and restructuring.
Given the lending freeze, the transactions that are likely to occur will reflect capitalization and discount rates above historic averages, given the high level of uncertainty, as well as low-leverage or all cash transactions. Once hotel performance bottoms out and assets come to market, well-capitalized buyers will be in a position to acquire hotels at prices well below both replacement cost and recent norms, creating an opportunity for high returns.
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Anne R. Lloyd-Jones, MAI, CRE, is Senior Managing Director of the New York office and a Director of Consulting & Valuation at HVS, the premier global hospitality consulting firm. Since joining HVS in 1982, Anne has provided consulting and appraisal services for over 5,000 hotels. Anne’s particular areas of expertise include market studies, feasibility analyses, and appraisals. She is also an expert in the valuation of management and franchise companies, as well as brands. Her experience includes a wide range of property types, including spas and conference centers. She has appeared as an expert witness on numerous occasions, providing testimony and litigation support on matters involving bankruptcy proceedings, civil litigation, and arbitration. For further information, please contact Anne at +1 (516) 248-8828 Ext. 208 or ALloyd-Jones@hvs.com
Suzanne R. Mellen, MAI, CRE, FRICS, ISHC is the Senior Managing Director and Practice Leader of HVS Consulting and Valuation. She has been evaluating hotels and other hospitality real estate assets for 40 years, has authored numerous articles, and is a frequent lecturer and expert witness on the valuation of hotels and related issues. Ms. Mellen has a BS degree in Hotel Administration from Cornell University and holds the following designations: MAI (Appraisal Institute), CRE (Counselor of Real Estate), ISHC (International Society of Hospitality Consultants) and FRICS (Fellow of the Royal Institution of Chartered Surveyors). Contact Suzanne at +1 (415) 268-0351 or smellen@hvs.com
Tanya Pierson, MAI, Managing Director of HVS Minneapolis, has conducted market studies, feasibility analyses, and appraisals for over 2,000 hotels and resorts in nearly every U.S. state, as well as Canada and the Caribbean. A featured speaker and panelist at major hotel conferences, she has also lectured at the University of Denver on topical issues in the U.S. lodging market. Tanya graduated from the University of Denver with a degree in Hotel, Restaurant, and Tourism Management. She is a designated member of the Appraisal Institute (MAI). Contact Tanya at (303) 588-6558 or tpierson@hvs.com
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