The hotel industry has had smooth sailing the past 10 years, but it’s time to prepare for the obstacles that are sure to come in the next decade.
This economic cycle has been long by historical standards. Hotels have been improving their performance for ten years straight, despite headwinds including Airbnb, oversupply, rising costs and technological disruption.
As a hotel owner looking for vision into the capital markets, one might forget that we are in the midst of tremendous change and market evolution. We might forget because hotel performance continues to improve no matter what, keeping capital markets stable. But aligning financing with vision should not include a look backward at ten years of stability. It should look forward at the next ten years, which is unlikely to be stable.
I’ve been wrong for many years about the timing of rate increases and an economic cycle turn. Fortunately, this has given the market time to recover from the pain of the 2008 recession without immediate PTSD. But it’s time to consider that the threats the market faces will at some point materialize. Maybe that’s next year, or maybe that’s five years from now, but the rules of cycles haven’t changed, and at some point, we’ll see an impact from the various threats hotels are facing.
Capital markets are forward-looking, but underwriting isn’t. This is prudent and it should be used to the benefit of hotel owners. Property owners should think about right-sizing their debt levels for the next ten years, now, while all forms of capital are still readily available. Historical performance should inform desired debt levels but so should expectations about the next ten years. It’s best to take advantage of leverage without going too far.
The inevitable risks hotels face should be met head-on with capital structures that are put into place to withstand change and instability. Non-recourse, fixed-rate loans continue to be attractive late in the cycle, and 10-year terms surely will last through the next cycle without negative impact. Floating rate loans should be closed with caution given the expectation of rising rates.
In addition to current refinancing needs, debt maturities coming in the next few years should be reviewed now. It’s not prudent to face a balloon in the middle of a recession or industry headwind. With new supply affecting almost all markets and Airbnb being a threat worldwide, owners should model and stress-test their 10-year projections against debt service payments to ensure covenants will not be broken. This will help guarantee that debt levels are optimized for upcoming cycles.
Costs of property-improvement plans are rising faster than inflation, posing another threat to owners and lenders. Costs should be realistically assessed and reserved for, to avoid potential issues during loan terms. Technological change is affecting marketing and sales strategies and we should all expect that change will continue to disrupt existing hospitality-centric business models. Given the state of the economy (late cycle), capital markets (money is cheap), hotel performance (strong), and the risks (everywhere) we face, now is the right time to undertake a review of hotel debt strategy with a vision going forward at least a decade.
Zak Selbert is the founder and CEO at Vista Capital Company. Vista is a boutique real estate investment banking firm that specializes in arranging financing for hotels. Mr. Selbert can be contacted at 310-285-3803 or firstname.lastname@example.org.
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