IREFAC: The industry effects of capital shifts, pricing
 
IREFAC: The industry effects of capital shifts, pricing
30 JANUARY 2018 10:10 AM

Members of the Industry Real Estate Financing Advisory Council share their takes on where the U.S. hotel industry stands at the start of 2018.

LOS ANGELES—The U.S. hotel landscape is a much different place than it was at this time last year, and hoteliers are far more uncertain about the year ahead.

Members of the Industry Real Estate Financing Advisory Council met at the Americas Lodging Investment Summit to discuss the latest developments in the hotel industry and how that could affect owners and developers.

Capital investments
Some of the largest transactions talked about at ALIS this year were products of decisions made in China, said Michael Shannon, chairman of KSL Capital Partners, but Chinese investment has slowed over the past year as China’s central government has restricted outbound capital.

That decision has had “a huge impact” on hotel investment in the U.S., Shannon said. Two of KSL Capital’s recent acquisitions in Outrigger and Apple both opened up when the two had been the targets of a Chinese investor.

“When (Chinese capital) went away at the very last moment, it became a much more level playing field for a lot of us with domestic capital,” he said. “Will that continue to be the case, or will they selectively come back and engage around the world in M&A? That’s a question we should all talk about.”

The United Kingdom’s Brexit decision had a large impact on capital flows there, Shannon said, and there are a number of unintended consequences, particularly on the value of the pound.

The U.K. was once viewed as a safe haven, a place for Middle East investors looking for a solid investment in the London marketplace, he said, but that slowed after Brexit.

“Now we’re starting to see people moving to the U.K. betting the other end of Brexit will be positive, even if it takes two to three years to settle,” he said.

Germany has been growing because of the negative interest rates on their bonds, said Mark Elliott, president of Hodges Ward Elliott, so any yield whatsoever has attracted them to the U.S.

Japan has also started exploring U.S. real estate investment, both in general and specifically in hotels, for the first time in 25 years, he said.

“They got burned so badly in hotels in a short period of time,” he said. “They’re trying to find their way back with a safe way to invest—maybe a smaller profile way to invest.”

For a period of time, Marriott International saw no new deals or investment coming out of Japan, said Tony Capuano, Marriott’s EVP and global chief development officer. Now, the company is doing a record number of in-country deals with Japan, he said, and an increasing number of owners are coming forward with a profiles of U.S. and European assets they’re interested in.

“(They’re yield expectations are) a little more sensible than in ’89,” he said. “They have a much longer term investment here.”

The economy
Revenue per available room is strengthening, Elliott said, and so is the U.S. gross domestic product.

“I think we will see accelerating GDP with accelerating RevPAR,” he said. “Then halfway through the year, (public companies’) stock prices will be majorly reset to the upside, and they will be almost forced to issue equity again.”

The country is experiencing 2.7% GDP growth, said Jeff Horowitz, global head of real estate, gaming and lodging corporate and investment banking for Bank of America Merrill Lynch, and looking at rates over a period of time, they’re trading above that one-third of the time. Most have been treading water, and while many would like to buy, they don’t see much out there, he said.

Over the past five years, other real estate classes have compressed 100 basis points while hotels have expanded by 50, Elliott said. One of those is wrong, he said.

“I would argue we’re underpriced,” he said. “As an industry, we’re so snakebit and worried about the end of the cycle, that people have no convictions. … We’re all worried about the end of the cycle. Our view—we’ve said this the last year and a half—this cycle doesn’t end in recession, it ends in a soft landing.”

The challenge in real estate today as a local business is politics, Shannon said.

“We just don’t know when the administration will start a global trade war or create a tariff, and that has a big impact on regional economics,” he said. “If you own a single asset in the market and you are dependent on import or export or a particular industry—if you thought you were gold in Colorado last week until the solar tax ban and a few other things—you just don’t quite know.”

Nontraded REITs
The nontraded real estate investment trust business has come back again, Elliott said, and each time it does, there’s a little more regulation and more sophisticated sponsors. Watermark has been active, Blackstone created one and Starwood Capital is about to enter the field, he said.

What was interesting about the Blackstone entry wasn’t just that it helped legitimize this particular vehicle, but that it punched through into the wirehouse environment, said W. Michael Murphy, head of lodging and leisure capital markets at First Fidelity Companies, which has been opposed to any of that kind of product over the last number of years.

“That’s huge,” he said. “Rather than going through the smaller broker dealers, to go through a wirehouse that has millions of customers selling that product to.”

Companies like Blackstone have done feeder funds through individuals for many years, and this is another vehicle, Shannon said, but he is worried about individual investors not being fully informed or fully understanding the business. In the past, some of those investments ended poorly with brokers taking advantage of their clients through misrepresentation, he said. He advised to be careful when getting involved with the uneducated individual consumer.

Horowitz said his company has worked on both sides, working with nontraded REITs as well as with private wealth management people. His company made two deals in this space, raising about $1 billion for JLL and is now selling for Blackstone.

For the type of investor his company sees, the tickets are about $150,000, well above the amounts previously associated with nontraded REIT tickets. These individual investors are the ones who don’t want to see things go up and down every day, he said.

“They want yield and not to pay attention to it all the time,” he said.

As more credible people in the hotel industry have entered the nontraded REIT space, the space has become more ethical and has gained legitimacy, Shannon said. He cited how reputable, publicly traded companies with internal controls and reputational risk controls, such as Marriott and Disney, helped the timeshare industry.

“We saw those industries get much better in terms of the kind of information, the illustrations they gave to buyers,” he said.

Blackstone will do the same for the nontraded REIT world, he said.

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