Uncertainty and questions surrounding the hotel industry are issues to contend with, but speakers at the Hunter Hotel Conference said it’s business as usual.
ATLANTA—Flattening asset values and rising cap rates reflect the overall conditions of an uncertain hotel industry—even if performance metrics indicate a business cycle that remains afloat, according to panelists at the 28th annual Hunter Hotel Investment Conference.
Grasping the depth of the unknown is among the most difficult aspects of this point in the cycle, according to speakers on the “Hotel values in a changing market” panel.
“The greatest change from a year ago is the level of uncertainty. … There are all types of uncertainty … political, economic, supply-and-demand,” said Hank Staley, SVP for CBRE Hotels. “This year there doesn’t appear to be a consensus on anything.”
“The soft start to the year has increased the uncertainty overall,” said Kasia Russell, managing director and senior partner for HVS. “We’re still expecting a strong 2016, but our guard goes up a little more in ’17.”
Economic issues are definitely affecting hotel values in select markets, panelists said.
Staley pointed to energy sector markets as a prime example but said that sector can be broken into two types of markets based on the time they’ve been exposed to the energy industry. Markets such as Houston and Oklahoma City fall into one camp, while hotels in the Dakotas and western Pennsylvania fall into a different class because their reliance on oil and gas is a recent phenomenon.
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Supply and the pipeline
A robust pipeline that includes more than 140,000 rooms under construction in the United States, according to HNN parent company STR, adds to the uncertainty, according to panelists.
“We definitely look at new supply because it significantly affects valuation,” said Jay Burnett, VP of real estate for JHM Hotels. “Supply growth is a market-by-market thing. Where it is concentrated, it’s definitely a big deal.”
Russell agreed and said market-specific supply has a “huge impact on valuation.”
For example, northern California and the Pacific Northwest have experienced a large addition of high-end product coming into the market. Its effect on valuation is an ongoing calculation because the type of demand it generates remains a big question, Russell said.
- More: The Californian hotel industry saw record numbers for new development and transaction pricing in 2015.
Kate Henriksen, SVP of investment and portfolio analysis at RLJ Lodging Trust, said supply is a market-by-market phenomenon. With 13,000-plus rooms under construction, New York City’s supply story is the biggest issue—even larger than any fluctuation in international visitors to the market. That’s why RLJ doesn’t put all of its eggs in the same basket with the Big Apple.
“The benefits of having a geographically diverse portfolio is the markets can play off of each other,” Henriksen said.
Russell said it’s easy to draw conclusions about values given the current landscape.
“With addition of new supply there’s no doubt that there will be some compression of (net operating income), which affects values,” she said.
The number of renovations and property improvement plans being conducted throughout the industry also is affecting values, according to the speakers.
Renovations are an important part of the valuation equation, especially when new supply affects a hotel, Burnett said.
JHM is more inclined to perform a PIP prior to the sale of an asset because management has a bias toward the company doing the work. It can help maximize the property’s value, Burnett added.
“It’s a strength for us,” he said.
RLJ, on the other hand, prefers to sell and have the buyer complete the PIP because it has a better use for the capital involved and the cost of disruption during a PIP can cloud the valuation, Henriksen said.
“You have to ask, ‘How would that hotel really have performed if there wasn’t a renovation going on?’” Henriksen said.
How cap rates are affected
All of this has an impact on cap rates, which are somewhat unpredictable given the current uncertainty in the market, speakers said.
Cap rates in primary markets in the Pacific Northwest and northern California are “holding strong in the 5 or 6 range,” Russell said. “Where we show a different story is in the secondary markets.”
“Value equals current value plus future benefits,” Staley said. “You can make a strong argument, at least theoretically, that there should be some upward pressure on cap rate for next 12 months because there are fewer buyers, rising interest rates and the NOI expectations have been lowered a little bit across the board.”
Staley said he expects a slight increase in cap rates because publicly traded real estate investment trusts are all but out of the acquisition market as their executives try to figure out how to stem the large drops in their stock prices.
“That particular segment makes a difference,” Staley said.
Russell said she’s in the same camp.
“There’s not much more upside we can squeeze out of these properties,” Russell said. “There is new supply entering the market and some softening on demand and (revenue per available room). Generally speaking, (cap rates) will go up.”
Henriksen, whose company is among the publicly traded hotel REITs, is optimistic.
“One area you’ll see (cap rates) go down is the publicly traded companies,” she said. “As the year goes by, people will gain confidence based on guidance and investors will come back into it.”
With some uncertainty surrounding values, it’s no surprise that transaction volume might suffer because buyers and sellers can’t agree on a price.
The dislocation of public company stock prices has been the biggest issue for the transactions market, Henriksen said. That uncertainty has led to a greatly increased cost of capital, which makes acquisitions more difficult.
“That’s why we’re focusing on disposition,” Henriksen said.
Burnett admitted he’s “more of a half-empty guy” and has adjusted his thinking accordingly as the uncertain environment takes hold. That includes looking at how potential acquisition targets performed during the worst of times.
“That causes us to value things a little lower,” Burnett said. “At same time we’re being hit by rising construction prices, so we factor in the cost of a PIP for everything we buy.”
That combination can be detrimental to deals, according to Staley, who said most abandoned deals he sees are because of high construction costs, not a lack of financing.
However, it can be an opportune time to start kicking the tires on deals, Burnett said.
“Coming into a softer period of the cycle historically has been a good opportunity for us to increase acquisition activities,” Burnett said. “We’re not seeing it yet, but it’s not really a leading thing. It’s more of a reaction.”
The consensus of the panel was that buyers should be looking to acquire assets in markets that have low supply growth.
Burnett pointed to Tampa and the Gulf Coast of Florida, as well as Asheville, North Carolina, as examples.
Henriksen said supply is a big consideration, but so is catching a market on the rebound. Even with a robust supply pipeline in place, Houston is a good target because it is coming off low performance metrics, she said.