During the first of a two-part ALIS Summer Update webinar series, experts said sequesters and market volatility aren’t affecting their optimistic outlook on hotel investment.
REPORT FROM THE U.S.—It has been nearly six months since the Americas Lodging Investment Summit in Los Angeles and despite sequesters and market volatility the positive sentiment among hotel private-equity leaders has only strengthened.
During the first of a two-part ALIS Summer Update webinar series, private-equity investors agreed it’s a great time to invest in the hotel market.
“I’m surprised the hotel market has weathered the sequester as well as it has,” said Tyler Henritze, senior managing director at The Blackstone Group LP. “Since January we’ve seen new sources of capital and new buyers.
“When looking at operating performance, with a few exceptions—some of the larger group-dependent hotels—we’ve seen very good performance, which has slightly exceeded expectations.”
The panelists discussed recent market volatility, however none could predict what effect, if any, it would have on the hotel transactions market.
“It’s hard to say how it will impact buyers’ and sellers’ expectations,” Henritze said.
Michael Medzigian, chairman and managing partner of Watermark Capital Partners, said there “has been a lot of dislocation” In the commercial-mortgage-backed-securities space.
“We’re seeing the drying up of CMBS liquidity,” he said. “It’s hard to say what happens next in that space. If I were a CMBS lender right now, I’d be moving to close pretty quickly because there is a lot of risk in next few months.”
Medzigian and the other panelists said short-term liquidity could hinge on decisions made later in the day Wednesday by the Federal Reserve and a subsequent speech by Federal Reserve Chairman Ben Bernanke. The U.S. dollar had rallied to three-year peaks earlier in the week in anticipation that the Fed may start slowing its $85-billion-a-month bond purchases later this year.
Even in Europe, where the hotel recovery has been hampered, Starwood Capital Group has observed a shift over the past six months. Kevin Colket, VP of acquisitions at Starwood Capital, said hotel investment in Europe is “clearly risky” but that debt is more available every day.
“There is incredible competition between lenders competing for yield and that has really driven down debt cost,” he said. “That first occurred in the U.S. and now Europe is seeing the same thing. There are still opportunities to buy at reasonable (capitalization) rates and have enough spread to generate cash-on-cash returns.”
The future risk, Colket said, surrounds interest rates. The question isn’t if rates are going to rise, it’s by how much and when, he said.
Always the last type of debt to return after a downturn, even new-construction loans are becoming available in the majority of markets, the experts said. Colket said commercial banks have been lending for new construction for “quite some time”—but only to the right borrowers.
“We enjoy a privilege because we’ve been there before, so when banks were being selective we were among the first guys they’d come to,” he said of Starwood Capital and his peer panelists.
Some of the major hospitality lenders are beginning to drop their recourse requirements, Colket said.
However, Medzigian said overall new development isn’t quite feasible in today’s market. Some developers, such as Starwood Capital, may be able to make the numbers work by including residential components to their project, he said. Otherwise, new development is tough.
“I understand why (Starwood Capital) is doing it in the places they’re doing it. If you’re building a brand and selling residential that makes sense,” he said. “Otherwise, it’s hard to rationalize new development. Most development we see around us is people who don’t have a fund, who can’t go out and buy.”
Starwood Capital has at least three new development projects under construction today: a 1 Hotel in Brooklyn and two Baccarat properties in New York and Rabat, Morocco. Each of those brands are building their debut properties.
Bill Reynolds, senior managing director with MCS Capital, pointed to another territory where new construction makes sense: public-private partnerships.
“Public-private partnerships are about the only place in the world I’m seeing people build new full-service hotels,” he said. “The lenders are commercial banks, and they’re local.”
Reynolds said his firm is developing two new hotels financed partly with public money—one in a university town and another in a major, second-tier city.
“Public incentives are the game changer that would make the deal work,” Medzigian added.
In terms of hotel investment in the near future, Medzigian said this period of recovery is one of the only times in the market where “it’s a good time to be a buyer or a seller.”
“One thing we’re seeing that I did not see six months ago is the lender spreads are low,” Medizigian said. “We’re seeing some quotes where before you were getting one year of interest only and today that’s three, four years and I’ve heard stories of even more.”
“What I got wrong was the acceleration,” Reynolds added. “The biggest surprise to me is the speed in which lending picked up.”
Outside of rising interest rates, which Medzigian said could hasten deal activity because owners might choose to sell rather than refinance, perhaps the biggest hindrance in the near future is rising supply.
Reynolds said the secondary markets where MCS is looking to buy and develop are experiencing significant supply growth. Specifically, supply growth is coming mostly in the form of select-service product, which provides a unique set of challenges for full-service owners and operators. Brands such as Courtyard by Marriott and Hilton Garden Inn were previously referred to as “ankle biters” when compared to full-service hotels, Reynolds said, but now he said that term is unfair because that segment is hitting home with consumers as much, if not more, than full service.
“A consumer trend to select service in the mid- to upscale category—that’s now a bona fide consumer product,” Reynolds said.
“You’ve got to be careful about new supply,” Colket added. “Understand the demand generators and what can change.”
Overall, the panelists remain optimistic on the future outlook. However, a downturn will come eventually and investors must be prepared.
“I continue to be very bullish on the (hotel) space; we have a good cycle in front of us,” Medzigian said. “With that being said, the liquidity in the debt markets is going to be fragile and will react to outside stimulus. We’re underwriting assuming debt that’s less than we can get today.”
“Eventually there’s going to be an end to the cycle and when things fall, they fall pretty fast,” Colket added. “Underwrite on the downside.”