What’s driving hotel real estate opportunities
 
What’s driving hotel real estate opportunities
21 APRIL 2016 7:14 AM

There is no one prevailing trend in hotel real estate. Acquisition and development opportunities and financing options depend on types of projects and markets involved, according to speakers at a recent Michigan State University event.

EAST LANSING, Michigan—No matter which direction the hotel industry is headed, there are plenty of development and acquisition opportunities available.

The degrees of opportunity depend on the projects and markets involved and financing requirements of borrowers. That was the conclusion of industry executives during a recent panel discussion at the annual meeting of the Michigan State University Real Estate Investment Management Advisory Council meeting.

“Like all real estate, the hotel industry is a local business,” said John Pharr, president of Strand Hospitality Services. “It all depends on where you are. I hear New York City is on a downward swing, but where I’m from in Myrtle Beach (South Carolina), we’re seeing more development today than we have in the past 10 to 12 years.”

Other panelists identified weak markets besides New York. Oil-dependent areas of the United States have been particularly hit hard, according to Andrew Alexander, president of Red Roof Inn.

“We’re in 450 locations, so we understand we’re in that part of the cycle where performance depends on the market,” Alexander said. “For example, if you’re in Laredo, Texas, you get hit twice: the slump in oil and the proximity to the border. And the downturn in the oil business is creating weakness in markets like Erie (Pennsylvania), Buffalo (New York) and across Pennsylvania and Ohio.”

Despite market-specific issues, the executives agreed the financing landscape remains dynamic for both hotel acquisitions and development. Like market performance, availability of financing depends on the types of projects, locations and borrowing requirements.

“Overall, we’re seeing a more conservative approach by many lenders,” said Jason Rabidoux, VP of business development for the West Coast at Davidson Hotels & Resorts. “The kind of year-over-year growth in (revenue per available room) we saw in the past several years is not going to continue at the same pace, so (lenders) don’t have that wave of RevPAR growth to bail them out if they make decisions that might be on the borderline.”

On the other hand, financing is readily available for smaller deals and in non-gateway markets, according to Edward Walsh, president of Alpine Realty Capital.

“Outside of (commercial mortgage backed securities), there is a very strong demand by lenders to do loans, whether it is banks, credit companies or life insurance companies,” Walsh said. “Local banks in particular are active, especially for midscale properties and for loans in the ($5-million) to $8-million range.”

While money is available, underwriting terms are tightening, said John Keeling, EVP of Valencia Group.

“Where we were once able to get non-recourse construction financing at 60% loan to cost, now it is 55% loan to cost,” he said. “You can get it, but the parameters have changed and it takes a little more equity to get the deals done.”

Michael Damitio, managing director at Geller Capital Partners, said not to count out CMBS as a factor in hotel lending, although that platform has also changed.

“The CMBS market is still open. Obviously, the rather bizarre, arcane practice of floating-rate CMBS is gone, probably rightfully so, and some of the mid-market players are on the sidelines now,” he said. “But I talked to one of our lending partners recently, and he said the company has been as active as it has ever been. A lot of it has to do with the fact that real estate is re-pricing rather quickly from where it was three months ago.”

Transactions and development
A number of factors are fueling a brisk market in hotel transactions, said the panelists. Maturing CMBS loans is spurring some activity, as are owners’ perceptions about the industry’s near-term future.

“Some owners have had their loans for 10 years or so, and the option is to refinance or sell, and many are looking to sell,” Walsh said. “Other sales are driven by the need for renovations. A lot of hotels that opened in 2005 and 2006 are coming up for 12-year renovations, and that’s causing owners to think about selling.”

There is more of a problem on the buyers’ side of transactions, Walsh said. Many buyers are concerned about the slowing pace of RevPAR growth and are reluctant to pay too much for assets.

“Today, buyers and sellers are close to equilibrium in pricing, but if there is any downturn at all, purchasers will begin to back off and the pricing gap will start to widen,” Walsh said.

While the appetite for new hotel development is strong, some developers remain cautious, lessening the potential for widespread overbuilding, said Ryan Meliker, managing director and senior real estate investment trust and lodging analyst at Canaccord Genuity.

“It will be the demand side of the business that will lead this cycle to conclusion, rather than the supply side of the equation,” he said. “Over the past three or four years, demand has grown at about 3% or 4% annually, and while supply growth is picking up it will probably be 2% this year and 2.5% in 2017. Now by 2019 or 2020 all bets are off, but I’m optimistic that developers will be smart enough not to push supply growth up to 4% or 5%.”

Keeling said he sees external forces—and the upcoming presidential election in particular—having an effect on new hotel development.

“I think the election in November is important for our industry,” Keeling said. “If we get a regressive-type administration that thinks the way to bring prosperity is to tax the rich and support the unions, then the economy will slow down and (the hotel industry) might see a downturn. On the other hand, if we get someone who is all about reducing taxes, reducing regulations, encouraging investment and not putting burdens on repatriating funds to the U.S., then we might see (gross domestic product) growth greater than 2%, which could have a huge impact on our industry.”

Because of this uncertainty, Keeling said some owners and developers are taking a wait-and-see attitude about acquisitions and new hotel construction.

Damitio said he expects natural market forces to control the pace of hotel development.

“Developers will develop as long as lenders will lend,” he said. “For that reason, it will be the lenders that will act as the governors on future development, and they have already started to do so.”

Paul Novak, executive director of lodging acquisitions for Whitman Peterson, said oversupply shouldn’t be an issue in the hotel industry because of where developers are building. With the scarcity of good development locations in major primary and secondary locations, developers are turning elsewhere.

“You’re seeing a lot of smaller hotels going into remote or offbeat locations away from a prime location or going into tertiary markets,” Novak said. “Most of them are smaller properties—80 or 100 rooms—so I’m not concerned about oversupply, either now or in the next few years. The likelihood is development may actually slow down for the next few years, either because of rising interest rates or a slowdown in demand.”

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