The dramatic decline in United States hotel operating metrics and asset values during the Great Recession were much more severe than the downturns that took place during the Gulf War nearly 20 years ago and then immediately following 9/11.
An analysis of the fundamental drivers of the U.S. hotel business compared with early 2009 demonstrates some of the reasons for the recent turnaround of the sector. While extremely modest, the U.S. economy today is expanding as compared with 24 months ago when it was clearly contracting.
- Job losses have stabilized and consumer and business spending is modestly increasing.
- New hotel supply growth is declining, while demand for U.S. hotel rooms is growing.
- Monthly demand on a year-over-year basis turned positive during December 2009, although average daily rate did not see growth on a monthly basis until June 2010.
- Trailing three-month metrics indicate a slowing of new supply, and all relevant operating metrics are in positive territory for the first time in three years.
Unlike other forms of commercial real estate such as office and retail properties, which are typically encumbered by long-term, credit-worthy tenancies, hotels have to lease up guestrooms every night. This continuous re-pricing of guestrooms positions the hotel sector as highly volatile, with dramatic peaks and striking valleys. Both extremes were experienced by the sector during the past five years.
At the inception of the recent downturn, the stage was already being set for the anticipated turnaround, with the raising of a substantial amount of public and private capital aimed at the hotel sector. With the market bottom now behind us, committed capital is being deployed for investment.
U.S. hotel sale transaction activity so far this year already has exceeded deals that occurred during all of 2009. More recently, hotel debt capital markets have thawed and commercial mortgage-backed securities financing is once again slowly becoming available. While leverage is not back to peak levels, mortgage financing up to 75% can be obtained for cash-flowing high quality assets. Spreads have recently tightened and non-recourse debt is now selectively available once again.
A rise in asset values
A reactivated U.S. hotel transaction market is now producing empirical evidence of a rise in asset values. A dramatic example of recent rapid price appreciation is evident by Chesapeake Lodging Trust’s US$77-million acquisition of the Boston Marriott Newton. A joint venture between The Procaccianti Group, Charles River Realty Investors LLC and Rockpoint Group LLC previously acquired the asset in June 2009 from Host Hotels & Resorts for US$28 million and subsequently executed a US$26 million renovation for a total basis of US$54 million. The recent trade of the hotel represented a gain of roughly 40% in one year’s time.
An analysis of the variability in the amount and cost of hotel equity and debt, combined with fluctuations in net operating income, further illustrates the recent rebound in values. During the past five years, changes to a typical hotel capital structure coupled with varying return requirements for debt and equity impacted hotel prices as exemplified in the following table.
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The top part of the chart demonstrates the fluctuation of the “Weighted Cost of Capital” and highlights hotel capitalization rates bottomed out in early 2007 when typical loan-to-value ratios were upwards of 80%. Coupled with the availability of sub 6% interest-only financing and single-digit equity dividend rates, hotel capitalization rates declined significantly from 2006. They then rose dramatically during the past two years, only to ease back close to where rates stood during 2006.
Measuring the implied value of US$1,000 throughout each point in time illustrates that merely through changes in typical hotel capital stack structures between debt and equity and the required returns for each position, U.S. hotel values declined roughly 38% off peak levels during late 2008 through late 2009.
With the recent loosing of the credit markets—hotel capitalization rates are back to 2006 levels—values continue to be roughly 25% off peak based merely upon changes in hotel capital stack structures and returns. Thus far the analysis does not factor in any changes in net operating income.
The following table layers into the analysis changes in NOI up and down at increments of five percentage points to determine the implied value of US$1,000.
The third table again illustrates that simply for the change in the capital stack structure and the returns for each position within the stack (with no change in NOI), hotel pricing bottomed out at roughly 38% during the past two years. More recently, hotel pricing increased 12 points to approximately a 25% decline from peak. Layering into the analysis declines in NOI as experienced by most hotels during these past several years, an asset that hypothetically experienced a 25% decline in profits, combined with capital stack changes, resulted in a decline of upwards of 50% from peak during the past several years. The table further illustrates if the same asset’s NOI today is only 10% lower than the peak, based upon current capitalization rates, the property value would be down roughly 34% from peak, or 20 points higher than the recent bottom. In addition to supporting the notion of the recent rise in U.S. hotel asset values, the analysis clearly demonstrates the volatile nature of hotel investments.
A rebounding, albeit tepid, economic recovery is driving the rebound of fundamentals of the U.S. hotel sector. An anticipated rise in profits along with muted new hotel supply during the next five years is fueling deployment of equity earmarked for investment in U.S. hotel assets. The loosening of credit markets and the emergence of a variety of hotel lending sources are further stimulating U.S. hotel transaction activity. It appears the “Up” cycle has begun, and many anticipate epic appreciation of U.S. hotel assets during the next several years.
Daniel H. Lesser has specialized in real estate appraisals, economic feasibility evaluations, investment counseling, and transactional services of hotels, resorts, conference centers, casinos, and timeshare properties on a worldwide basis for the past 28 years. He currently serves as the senior managing director-industry leader of the Hospitality & Gaming Group at CB Richard Ellis (CBRE). He can be reached at (212) 207.6064 or Daniel.lesser@cbre.com.
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Click image to enlarge.
