Where are we in the cycle? It depends …
11 MAY 2015 6:32 AM
No speaker at the Meet the Money conference claimed to know exactly where the hotel industry’s cycle stands, but they said it seems to be at different points for development, financing and operations.
LOS ANGELES—Hoteliers trying to determine where the hotel industry’s cycle stands must look beyond the macro level to see the underlying factors affecting the business, according to speakers at the recent Meet the Money conference.
Speakers throughout the conference said they learned the fragile nature of the industry during the past two downturns and are eager to ensure they get the most out of it this time around.
Mike Depatie, president of KHP Capital Partners, said it won’t be long before owners start to worry they’ll miss the peak of the cycle.
“The fear is starting to creep in … when is this party going to end?” Depatie said while speaking on the “Acquisition strategies that make and shake the market” panel. “What’s going to come, when it’s going to come, I don’t know. But it will come.”
Speakers agreed an unknown wild card is that capital for the hotel industry is last in during a good cycle and first out during a down cycle, which means the plug could be pulled at any time based on global events, Patrick Deming, managing director of Eastdil Secured, said during the “Acquisition” panel.
Kyle Jeffers, a commercial real estate banker at Starwood Property Trust, said during the “Playing with a full capital stack panel” that key questions asked during the current cycle include whether SPT likes the basis and the sponsor, and if a sponsor has the wherewithal to carry the asset if the new demand doesn’t materialize.
Speakers on the “Acquisition” panel boiled it down to a division of cycles that affect operations, development and financing that tell the true picture of the industry’s health. Speakers on several other panels also addressed that division of cycles.
Development remains in check
“On the development cycle, we’re further behind where we should be because of where fundaments are,” Deming said, noting that lenders are still hurting from the last cycle and are reluctant to release a lot of debt into the hotel market. “Many markets, especially here on the West Coast that are running extremely high occupancies, certainly could support new supply. It’s still in the very early innings of the development cycle.”
Colin Carroll, VP-investments for Ashford Hospitality Trust, agreed with Deming—but said the landscape looks familiar.
“We didn’t have a lot of new supply in the last cycle until the very end and it’s been slower to come back in this cycle than most people would have expected,” he said.
Financing is the biggest key
Speakers said determining the current point of the financing cycle is tough as deal flows are strong across the entire capital stack.
“In the financing cycle, there’s a lot of depth and there’s still a lot of discipline from lenders looking at cash flow and not lending on future projections,” Carroll said.
“The biggest difference now is where the index is,” Jeffers said. “The cost of capital is much cheaper.”
Cara Leonard, senior VP at Lowe Enterprises Investors, said underwriting has changed dramatically during the past three years—let alone from the last cycle.
“We’re not seeing senior lenders stretched to higher levels of the capital stack,” she said during the “Capital stack” panel.
“During the previous debt cycle, a lot of lenders on the bridge went higher on the leverage curve—they felt comfortable and got hurt by it,” added Tom Whitesell, managing director of construction real estate for CapitalSource, during the “Capital stack” panel. “They learned from it.”
But it’s not all self-discipline that’s creating the current landscape. Gary Swon, managing director at Societe Generale, said during the “Capital stack” panel that rating agencies and government regulations are holding lenders back and preventing them from getting aggressive in their underwriting and sizing.
“This rating agency critique we’re dealing with is very, very powerful,” Swon said. “It’s keeping us from keeping up with RevPAR growth.”
Barbara Morrison, CEO and president of TMC Financing, agreed.
“The rating agencies are the biggest difference today than what we saw in 2005,” she said during the “Capital stack” panel. “So long as that check stays in place it will have a steadying influence.”
That won’t strop lenders—and borrowers—from trying to be more aggressive.
“The good news for the borrowers is as lenders become more aggressive, it gives us more players to work with on the first piece and those players understand there is more competition,” Morrison said. “The borrower is getting a much better deal than they were three years ago.”
“For us to get to our yield we have to be more aggressive, we have to go up the capital stack to get the returns we need,” Jeffers said. “It’s really just a risk-adjusted question.”
Whitesell said 2009 is still a year that needs to be remembered as a gauge for performance and the ultimate test for financing a hotel.
“You still have to go back and look at what happened in that market in 2009,” he said. “Not necessarily to underwrite. ... You apply a similar ADR and a similar occupancy and see how your loan would perform and how long you can withstand that.”
He said building bigger reserves is one way to feel some comfort when thinking about the next downturn.
Operations: Where’s the rate?
“On the operating side, there’s quite a bit of room left to run on the cycle,” Carroll said, noting that occupancy’s role in RevPAR growth is stronger this year than most pundits projected it would be. “We have to watch cost creep and maintain the same diligence management to the bottom line that we did in the downturn.”
Deric Eubanks, Ashford Hospitality Trust’s CFO, said during the “Thoughts from the executive suite” panel that hotel values haven’t returned to previous peak levels in large part because operators haven’t driven rate as much as they could have done.
Planning for the downturn isn’t an easy task. Speakers agreed that being prepared to deal with it at a moment’s notice is essential.
“What derails this is probably something that none of us is thinking about today,” Swon said.
“I have no idea what’s going to derail this cycle,” Leonard said. “The one lesson I learned from the last cycle is there is no way to predict it.”
Morrison said the tipping point will be when lenders stop being disciplined and start making exceptions to their rules to accommodate a certain deal.
“It does feel like we’re in the latter part of the cycle,” Whitesell said. “At the same time, the economy seems to be doing very, very well. There’s this big demand out there that tells you the economy is pretty good.”