By Robert Mandelbaum
Much has been written about how U.S. hotel owners and operators are profiting from the current strong lodging market conditions. Revenues have returned to pre-recession levels and are expected to experience real growth through 2017. On the bottom-line, net operating income (NOI) is in the fourth of a six year period of double-digit growth.
Also benefitting from the strong market fundamentals are the institutions that have loaned money to today’s hotel owners. Since 2009, the combination of rising profits and declining interest payments has led to a reduction in the number of hotels in default, and a rise in debt coverage ratios.
To measure the ability of hotels to cover their interest payments, PKF Hospitality Research, a CBRE company, (PKF-HR) analyzed the performance of a same-store sample of U.S. hotels that reported a significant interest payment annually from 2008 through 2013. We then estimated the 2014 revenues, profits, and interest expenses for the sample.
The data came from the firm’s annual Trends® in the Hotel Industry survey of hotel operating statements. For each year we compared the relationship between the interest payments reported, and the NOI generated from the operations of the hotel. For the purpose of this analysis, NOI is defined as income (profits) before the deduction for capital reserve, rent, interest, income taxes, depreciation and amortization.
Profits Rise
Since the depths of the recession in 2009, the NOI for the average hotel in our firm’s annual Trends® in the Hotel Industry has increased by an estimated 74 percent through 2014. This places unit-level profits above their 2007 previous peak levels and has enhanced the ability of U.S. hotels to cover their interest payments.
In 2014, we estimate that interest payments are averaging 30.4 percent of NOI for the properties in our research sample. This is down from a high of 48.8 percent in 2009. Interest payments measured as a percent of NOI were lower for full-service hotels (30.3 percent) versus limited-service hotels (32.3 percent).
With interest payments declining as a percent of NOI, the interest coverage ratio has increased from a low of 2.05 in 2009 to 3.29 in 2014. For comparison purposes, PKF-HR’s annual Hospitality Investment Survey reveals that lenders have loosened their total debt coverage requirements somewhat within this time period from a high of 1.5 in 2010 to a low of 1.35 in 2012.
By property type, we estimate that full-service hotels are achieving a higher interest coverage ratio (3.31) in 2014 compared to limited-service properties (3.09). Because of this, the lenders that participated in the Hospitality Investment Survey are currently requiring higher debt coverage ratios for limited-service mortgages.
Not only have hotels had the ability to cover their interest payments to a greater degree, but a declining number of properties are now unable to achieve sufficient levels of profits to cover their interest payments. In 2009, only 14.5 percent of the hotels in our research sample were unable to cover their interest payment. In 2014, this number has declined to an estimated 9.0 percent. Fewer limited-service hotels (4.9 percent) find themselves in default in 2014 compared to full-service properties (7.5 percent).
Interest Falls
Contributing to the decline in properties unable to cover their interest payments has been a reduction in the amount of interest paid by a hotel to its lender. By year-end 2014 we estimate the average interest payment made by the hotels in our sample will be down 14.3 percent from 2008 levels. Interest payments have declined at full-service hotels (-14.9 percent) to a greater degree than limited-service properties (-6.9 percent). Measured as a percent of total revenue, interest expense is down from 10.9 percent in 2009 to 8.5 percent in 2014.
We attribute the decline in interest payments to a combination of refinancing and declining interest rates. Per the Hospitality Investment Survey, the interest rates for a hotel loan have declined from a high of 7.53 percent in 2009 to a low of 5.54 percent in 2013.
Future Coverage
As of September 2014 PKF-HR is forecasting double-digit gains in unit-level hotel profits through 2016. In addition, Moody’s Analytics, PKF-HR’s economic forecasting agent, is projecting a relatively low inflationary environment for the next few years. Combined, we foresee a continuation of healthy interest coverage ratios, and declining levels of deficiencies.
Everyone will benefit from the favorable financial environment in the foreseeable future. Revenues are up for operators. Profits are up for owners. Defaults are down for lenders.
