SAN DIEGO, California—Like almost everyone else attending the Americas Lodging Investment Summit, participants of a panel that addressed the current state of transactions in the hotel industry believe the sector is set up for a slew of deals involving distressed properties.
As debt maturities reach a crescendo during the next few months and money for refinancing is nearly non-existent, hotel assets could begin flooding the market soon.
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| Panelists Art Adler and Kevin Mallory discuss the current transaction outlook during a breakout session at the Americas Lodging Investment Summit. |
“We see it as a tremendous opportunity to buy assets not typically on the market,” said Bill Hodges, president and CEO at Hodges Ward Elliott, an Atlanta-based brokerage firm. “We’re encouraging our best prospects and buyers that this is probably the best time to buy some of these assets with these prices.”
Rob Koger, president of Molinaro Koger, a Washington, D.C.-based broker, said there’s never going to be a better time for deals.
“If we’re heading into a depression, you should sell everything. If not, you should buy,” Koger said. “You generally make the best deals when visibility is worst and financing is worst.”
The biggest obstacle for deals in the current environment is the inability to establish an asset’s value because the industry’s fundamentals have been knocked out of whack by the worldwide economic meltdown.
While determining the sales price for an asset is a science-in-progress, Kevin Mallory, senior managing director for CB Richard Ellis, said the ALIS conference provided some clarity to a murky picture involving financing.
Mallory said his company believes it understands what lenders and special servicers are seeking in terms of distressed assets that likely will hit the market.
“We’re spending a lot of time helping them understand what they are catching,” he said.
Determining value
So what is the best way to determine an asset’s value during this downturn?
Moderator Jeffrey Horwitz, partner with the law firm Proskauer Rose LLP, said the trailing 12 months performance has become irrelevant because of the abnormal performance of the hotel industry, especially during the past four or five months.
“Everyone knows ’09 is going to be a bad year,” Koger said. “Buyers aren’t looking to the trailing 12, they’re looking to the forward 12. You have to apply cap rates to an NOI that’s significantly lower.”
While most conference attendees bemoaned the fact that there is little financing going on in any real-estate sector, the panelists said there is some behind-the-scenes shuffling.
“There seems to be a lot of action in secondary markets buying other people’s notes,” Horwitz said.
Art Adler, managing director and CEO at Jones Lang LaSalle Hotels, agreed.
“There are single loans on individual assets in which somebody in first position” wants to sell, he said. “They’re willing to sell it at a deep discount to get it off their books. That activity will be picking up.”
However, owners and prospective buyers shouldn’t believe that any sale is going to be easy during the next year—mainly because most debt on hotels built during the past five years has multiple layers involving a number of lenders.
“The conversations with special servicers are very difficult,” Mallory said. “You have a competing interest in CMBS debt that’s out there. The special servicers are going to have a difficult time managing that.”
Adler said one of the things complicating matters is that some lenders are still trying to clear up issues that arose before the economic meltdown hit.
“There were loans made by large institutions that they intended to securitize and are still sitting on the pile on their desks,” he said.
Plenty of opportunity
But opportunists are waiting.
Buyers with their own capital, including pension funds and offshore high net-worth investors, will pounce on assets as long as the deal fills their needs. Those needs typically include between a 15-percent and 20-percent IRR. Those types of investors will acquire a property in this environment with the idea of financing the deal a year or two down the road when capital markets should be getting back to normal, according to panelists.
“There’s still a significant amount of capital on the sidelines for hospitality,” Hodgessaid. “But it has to be very compelling (for them to make an offer). This is an opportunity you’ll probably not see again, but you need to be selective.”
Koger said he expects distressed hotels to hit the market slowly.
“Ninety-nine percent of the lenders are going to give the borrower time,” Koger said. “The lenders we’re finding don’t want the assets, so they don’t control the deal even though they’re basically in the equity.”
Because a lot of the debt on the books today is a floating rate based on LIBOR, many property owners will be able to continue paying their loans. However, if the operating environment gets worse or lasts for an extended period, all bets are off, panelists said..
“There were (US)$55 billion of CMBS issued in hotels in 2006 and 2007,” Adler said. “It comes due in 2011, 2012. What are industry fundamentals going to be at that point? That’s what’s going to force the hands of the lenders.”
There is a new twist to loans that most owners aren’t used to, panelists said. Recourse has been a dirty word to many borrowers—particularly those involved in large deals—during the past decade, but the panelists said those owners better get used to having to pledge their personal assets if they want a hotel loan.
Larry Wolfe, with Wells Fargo, said the behavior of special servicers still has to be determined and foreclosure is not their first choice because it immediately destroys the value of a property.
“One thing we’re finding with servicers is that they prefer to not foreclose and possibly work on the sale or modify the loan,” he said.
Smaller deals will rule
In the meantime, the industry can expect mostly smaller deals under US$20 million to dominate the headlines, panelists said.
“In the market today, smaller is better. It used to be larger is better,” Adler said. “Smaller deals can get financed by local banks, community banks. That segment of the market has been impacted a lot less.
“We’re going to see new development in that area,” Adler said. “Premium select-service hotels, Holiday Inns, Hilton Garden Inns. They trade to smaller, more entrepreneurial owners.”
“The buyers in that segment tend to be full-recourse buyers,” Mallory said. “You have the guarantee programs, the SBA and even the Department of Agriculture helping out.”
“The bigger the deal gets, the harder it is to do,” Koger said. “Pricing gets very challenging for owners to pull the trigger right now.”
“We’re moving toward clarity,” Mallory said. “We’ll see meaningful transactions outside lower and midscale segments by the end of the year.”
The panelists said they expect to see operators and brands stepping in to help buyers on deals in situations that give them a strong position.
“If it’s a transaction whereby they have an opportunity to get into a strategic location, we’re going to see brands looking to keep their powder dry,” Adler said, adding that sliver equity or mezzanine financing are among the most likely vehicles. “They’re looking at it not only on a return on equity position, but also a long-term management contract.”
“If they have cash, they have the opportunity to trade up,” Horwitz, referring to brands helping franchisees improve their location in a market.
