A lot of people like to call me Dr. Doom for all of my cautious columns during the past year or so. Well, I really am not so doomsday (even now), but I think now you see the black swans that I have been forecasting have come home to roost and they are swarming and splattering everyone.
Let me start by saying the S&P downgrade is not the end of the world, and is more a political statement than anything else. Nobody’s mortgage or credit card payment is going up. Treasury rates are at record lows and are likely to stay down for a long time. They are going even lower as the economy slows. Mortgage rates are at record lows. That will help housing.
The real issue is the political system is broken and Europe is coming apart. Unemployment is estimated to really be 16%, not the official 9.1%. The media have grossly misstated what the S&P downgrade means, and have scared most people into thinking their mortgage and card payments will rise, and that is very bad for consumer spending—right at the height of the summer travel season. Between Obama claiming rates will rise, they are falling, and social security checks are in danger—which they are absolutely not—and the stupid reporters on TV who know nothing repeating this garbage, the public is frightened. That is the real issue for the hotel industry.
Effects on the hotel industry
The U.S. government was never going to default on paying interest on Treasuries. There was no chance of that happening. It was all irresponsible political hype by the administration, the media and others. The National Labor Relations Board wants to shut down a new Boeing factory that would create thousands of high paying jobs, the EPA wants to add billions to the cost of doing business, and Dodd Frank-proposed regulations that we have seen so far would cripple commercial mortgage-backed securities lending. Elizabeth Warren, the White House and Treasury advisor tasked with setting up the Consumer Financial Protection Bureau, wants the banks to pay US$20 billion in “fines” for mistakes in mortgage papers, taking US$20 billion away from lending. Why would any company hire when all this is going on?
Add to this what Scott Berman so perfectly stated about the rigors of travel and the failure failure of the hotel industry to maintain assets and customer service, and it’s no wonder you can’t raise rates unless you have a newer quality asset and you provide high quality guest satisfaction. If you have an older asset and you don’t renovate it, you are going to get crushed by the newer assets down the street in a continued limited market demand. As time goes by during the next year, the new assets will take your business. They will do fine. They will get the premium average daily rate. They will get the road warriors. If you have a top brand and a new asset, you will do well. There will be a growing bifurcation in many markets as older assets continue to lose customers and then really have no money for renovations. That is a death spiral. Then the lender will foreclose and your equity is gone. Expect to see much more of that over the next year or two.
The capital markets know this even if you don’t. That is why these days the first question from lenders and equity sources is, “how old is the asset and what is the brand?” Maybe the Small Business Administration and some local banks don’t understand, but I am referring to the market in general. You need to invest in your hotel. It is a consumer product just like any in the supermarket. Unless you are the best tasting and best packaged on the shelf, the consumer will buy the competition. The lenders and equity will support the top product, and will not fund the lesser quality one. If you have a newer asset and a top brand you have a good future.
The next couple of years are going to be dog-eat-dog competition for a limited market. You need to be at your best now. In 2007 you could be anything and get away with it. There was so much consumer demand from excess spending that it worked. Not anymore.
A rough ride
Many in the hotel industry are in for a rough ride going forward. There is a lot of older product and lesser branded product. There will not be money to pay for needed renovation for many assets. All the over-building during the mid and late decade is going to come home to roost now. Maybe nothing will get built for a few years, but the new guy in the market is going to eat your lunch unless you keep up your asset and be very good hosts to your guests. You cut costs. Now you need to figure out how to provide a very good customer experience effectively and cost-efficiently. Now it is all about operational expertise, revenue management, customer service, and maintaining the asset.
Don’t get lulled by the silly projections of big value increases I have seen in industry publications. They claim their projections were conservative to date. However, they use a very small number of mainly larger deals (over US$10 million) in mainly coastal cities as the index, and real-estate investment trust buys. They are comparing to the bottom of the bottom in 2009. They have nothing to do with most of you. They are misleading. I learned in statistics class in college that given a target, I can manipulate the numbers to hit it. Projections of huge value increases during the next four years do not apply to many of you with ordinary older assets. These projections are just hype and are disconnected from reality in the world. If you have a good asset and you run it professionally, your value will rise nicely. If not, you will go nowhere.
Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that is available through his website, www.citadelrealty.com.
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