The COVID-19 pandemic has brought unprecedented disruption to the U.S. lodging sector. Travel restrictions, quarantines and global air travel pullback have rocked hotel fundamentals. How will that disruption affect both recovery and hotel investors?
COVID-19 pandemic disruptions include:
- RevPAR fell 80%. Occupancies bottomed out at 22% in early April; rebounding to 48.1% in late July per STR.
- Owners/investors have tried to preserve liquidity, including temporary and outright closures, furloughs/layoffs, PPP loan applications, drawdowns on FFE reserve, negotiating forbearance on mortgages and deferring CAPEX and brand-mandated improvements.
- Short-term rentals — Airbnb and the like — are recovering more quickly than hotels, due to demand for “staycations” and a need for local short-term housing. Short-term rentals will remain a formidable lodging player, and their 10% U.S. market share is expected to grow.
What insight are our Capital Markets thought leaders providing?
- Hotel transaction volumes fell 91% year-over-year, per Real Capital Analytics, totaling just $643 million in the second quarter.
- Values are dropping — RCA’s CPPI declined by 5.4% in June YTD. With so few transactions, pricing discovery is difficult, exacerbated by buyers expecting 20%–30% discounts to 2019, widening the traditional “bid-ask” spread.
- Much equity capital is targeting hotel acquisitions; debt acquisition financing is limited
There is distress emerging from this pandemic:
- RCA is tracking $23 billion in distressed lodging assets across lender types. Due to less clarity about the status of non-CMBS loans, this figure could rise. The second round of forbearance negotiations is ongoing.
- Trepp predicts a cumulative default rate of 21% in the lodging sector, far more than that for other asset types. The current LTV of these loans is 41.5, with a DSCR of 2.14. Trepp forecasts a peak-to-trough price change of negative 47.9%.
- Balance sheet lenders are more accommodating to borrower work-out requests than are debt fund and CMBS lenders. Note sales are just beginning.
What will the recovery look like?
- Economy, Midscale limited-service and extended-stay hotels are performing relatively better than Upper Upscale and Luxury (UU/L). Economy rooms drove 41% of demand in May 2020 but 25% in May 2019, while UU/L decreased from 21% to 8% year-over-year.
- Secondary, tertiary and drive-to leisure markets are expected to outperform big cities.
- Some expected permanent closures are a welcome macro trend in some markets, notably New York, with excess supply.
- STR and other firms project that U.S. hotel performance might not return to 2019 levels until 2023.
The market turbulence represents opportunity for astute investors for the foreseeable future. The recovery in the hotel market is not a matter of if, only when. We believe in a strategy of “flight-to-quality” acquisition of newer, premium-branded Midscale, Upscale, and extended-stay hotels in markets with diverse demand drivers. Despite the current price discovery challenges, the quality-focused intuitive and aggressive buyer with access to capital will thrive.
New development remains attractive, although caution is advised. There are 215,000 rooms under construction, more than the previous peak in December 2007. New hotels with the latest technology will command a market premium. Inevitably, distressed hotels will be offered as viable hotel acquisitions, but buyers must be sure that investment targets have upside in branding, CAPEX and management.
About the Authors:
Rich Lillis, Executive Managing Director Hotels | USA, is a leading expert providing strategic advisory services to clients on hotel and resort investment sales and financing in Florida, the Eastern U.S. and the Caribbean. As a frequent speaker at national hotel investment conferences ALIS, NYU and NABHOOD, Rich offers a unique perspective from his deep experience and diverse lodging background.
As the Managing Director, Research & Client Services | Boston, Aaron Jodka oversees all aspects of the Client Service offerings, including Research, Marketing, Graphics, Financial Analysis, Lease Administration and Client Service Coordination. He assists brokers with pitch preparation and delivery, while continuing to push the Colliers brand via best-in-class research reports, thought leadership, and contributions to numerous panels, media, and industry events.