President Barack Obama and Speaker of the House Nancy Pelosi are determined to shift America to a model much closer to Europe, where there is a massive redistribution of wealth from all of you who work so hard to earn it to those who don’t. The result is a massively growing deficit, a weakening dollar, and higher taxes and interest rates. None of this is good for the small business owner, like hotel owners. The weak economy and high unemployment likely will keep inflation in check for awhile, but there is no way in modern economics that the government can continue to spend the way it is, and to pour on the monetary stimulus which has occurred, and to not have a weaker dollar and inflation in a few years.
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Joel Ross
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While hotel operators generally will say they like inflation because they can raise rates quickly, keep in mind there are two sides to this. Costs will inflate along with wages and interest rates inevitably will rise. Just look at the yield curve, which is at the steepest upward slope ever. This means eventually interest rates will be high. That will be necessary to save the U.S. dollar from collapse, which would be a true crisis.
With the dollar as the world reserve currency, the U.S. enjoys a discount on its cost of capital because everyone needs to hold dollars. If Congress continues to create massive deficits, and if the Chinese and others really do start to create an alternative reserve currency, then the cost of capital in the U.S. will rise over time. To support the dollar and to stave off the coming inflation, the Federal Reserve will be forced to raise rates. As we see from the deals being cut to get a health-care bill passed, those of you who run a hotel and earn a good income will have your taxes rise substantially to pay for all of this.
A hit to value
The result is that while revenue per available room may rise over time during the next several years, it does not necessarily mean you will have higher net operating income because of rising costs, and it surely does not always mean values will rise proportionately. As interest rates rise, cap rates rise to compensate investors for the risk premium they demand to invest in equity versus debt. Discount rates used to calculate internal rates of return also rise. In short, values might decline in a rising interest-rate environment. Will RevPAR rise faster than interest rates and inflation? That is unclear.
Combined with these issues, it is not at all clear when unemployment will turn materially positive. Many people are telling me that employers are reluctant to hire new staff until the future of health-care, labor rule changes and taxes becomes clear. It appears that health-care will cost employers more. Hilda Solis, the U.S. Secretary of Labor, has said she is determined to heavily enforce every rule and to strongly support unions. Medicare taxes are going up under the health-care bill. Based on what we saw in the automotive bailout and the new special rules for unions in the health-care bill, unions clearly are in a position to win their agenda. The result is a widespread reluctance to add full-time employees when nobody knows what new financial and legal obligations that will create. This means it will be a longer, slower process to reemploy the unemployed. We have a long way to go.
Commercial mortgage-backed securities hotel loans are skyrocketing into default: 9.13 percent of hotel loans are in default or delinquent, up 1,175 percent from last year. Most are 2005-2008 vintages. 2007 hotel delinquencies are now $8.1 billion, and 2006 are $5.6 billion. These numbers will continue to climb rapidly during the next two years. The rating agencies do not expect this to even level off until 2012. Sellers take note. The worst is yet to come as maturities, extensions and other restructures fail, more properties go into default and foreclosure, and more owners simply hand over the keys.
Long road to recovery
The servicers will have no choice but to take the keys and foreclose more often and then dump the properties on the market. There is no way they can handle the number of assets getting dumped on them. Keep in mind, special servicers handle all property types, not just hotels. Extend and pretend will not solve the problem given the expected slow recovery for the economy and the massive destruction of values that has occurred. If you are waiting for 2007 values to reappear, you will have a very long wait—longer than you can continue to feed it.
I am sure at the Americas Lodging Investment Summit this month in San Diego you will see nice graphs with pretty colored lines headed upward. But there are so many unclear macro issues in flux at the moment that you should take these projections as just a wild guess by people who want things to look optimistic. There is no way anyone really knows where the economy or the hotel industry are going during the next several years. The bottom is not here yet, and the upward slope is completely indeterminate. My own view is that the industry will bounce along the bottom for several more months and then slowly slope upward. We are not going back to the glory days of 2007 anytime soon.
To those who commented that I will eat crow when they open their newly developed hotel next year, I suggest that we see a year later if you still own it, or the bank has foreclosed. Why anyone would build a new hotel for the next several years escapes rational thinking.
