A recent article on a hotel industry website claimed we are all having misperceptions about the hotel industry. The article went on to claim, “the general economy does not totally apply to the hotel industry.”
Another recent article claimed that people who travel mostly have college degrees, so the hotel industry will not be materially impacted by unemployment. It cites Moody’s Analytics talking about how employed people will see more income and savings going forward. Mark Zandi, who runs Moody’s Analytics, in a BusinessWeek actually said instead “One of the key reasons the recovery has stalled is that real incomes have fallen.” Additionally the article claims that corporate profits are just fine, so travel will continue, completely ignoring the banks who are one of the biggest event sponsors and who have suffered major shrinkage of their business with more shrinkage to come due to Dodd Frank. Lastly, the article says that if we keep rates low, travelers will come regardless of the economy.
Great. We have now unhooked the hotel industry from GDP, the economy, rates driving net operating income and reality. Hotel revenue just rises like a ghost out of the swamp, and those of us who think the economy directly impacts hotel demand, as it has throughout the past hundred years, are all misperceiving how demand drivers work. Well, lenders seem to have the misperception that the economy does indeed matter.
There are commercial mortgage-backed securities loans available, but they continue to be problematic. Credit Suisse just terminated its entire real-estate finance group that did CMBS. Various stories are floating around New York that other groups are either out of business, have small allocations for hotels, or are only writing top-quality loans. All are likely accurate.
It’s the debt markets, stupid
The issue is not just the predictions of the hotel business facing a coming slowdown—despite some people in the industry claiming the hotel industry is immune from reality. It mainly has to do with the debt markets. As long as the chaos of Europe and the U.S. Congress debt talks continue, the debt markets are in too much flux. Bond buyers have become very skittish and mostly only want the senior tranches of CMBS debt. Subordination levels now can run up to 30%, so there is a large slug of subordinate debt to place out of a current CMBS pool. What was once 5% is now up to 30%. So the issuing banks not only have to place five or six times the amount of subordinate paper as they did in 2007, but they have to do so into a very uncertain and fearful market. There is a problem placing the BBB tranches. CMBS issuers need to move the paper, not hold it on book.
Add to that some serious questions: Is there going to be another recession and therefore a downturn in revenue per available room? Or will we skate along the bottom with only 2% growth in RevPAR? Anytime there is such uncertainty, it becomes much harder to place the junior tranches of the bond issues. Right now, it is not as bad by far as 2008-2009, but it is very choppy waters.
Tracking CMBS
There is no way right now to predict where the CMBS market will be early next year. Not much is going to happen the rest of this year in terms of new pools coming to market, so pricing will remain uncertain with few, if any, good issuance benchmarks. Even the one or two pools in play right now are put together by up to four banks joining in a single pool because no one bank wants to warehouse loans for more than a brief moment. They can’t risk the interest spread market moving materially against them while they hold the paper. Even though they can hedge, there is no perfect hedge for CMBS loans.
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As a result, there are no aggressive efforts by banks to add more paper quickly. In fact, some banks will issue applications, start the processing and then drag the closing as long as possible in order to try to close a bunch of loans all at once before quickly doing a pool issuance jointly with several other issuers to minimize the time the paper is held on the books.
Waiting on Washington
If you have a good cash-flowing asset in a strong major market and if you are a solid sponsor, then it is likely a loan can be had if you work with someone who has the right relationships. It is possibly not going to be a CMBS execution right now, but there are other lenders. If you own a lesser brand property in a secondary location, chances are there is not a CMBS execution for you at all. That does not mean there is no loan possible. Just that it will be harder to get, probably a little more expensive and possibly less proceeds.
Depending upon the fact set for your hotel, there may or may not be a loan at all.
Until the Europeans finally decide to get their act together, and until German Chancellor Angela Merkel starts to act like a leader—which is likely never—and with Obama calling for class warfare, legal and verbal attacks on banks and us fat cats, and refusing to compromise to get jobs increased, we should not expect the bond market to stabilize.
That is not a political statement. It is simply how the capital markets view things objectively.
Markets hate political and economic uncertainty. That causes volatility, which is at an extremely high level right now. There is no leadership anywhere in the western world. It is filled with politicians who seem to have no idea how business and the capital markets really work. In a very lengthy discussion with a friend of mine who is a very well known White House advisor, I can tell you first hand: The administration has no clue at all how the mortgage market really functions nor how to fix it.
In short, the capital markets have no confidence that anyone in Washington or Europe has a clue how to fix the economic mess. Until that changes, there is small hope that the bond markets will feel a lot better and CMBS lending will regain a substantial volume.
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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