By Daniel Lesser
Economists, politicians, and business leaders are split on whether the U.S. economy is heading for a recession, is already in one, or will merely experience a slowdown. With continued supply chain disruptions, geopolitical conflicts (most notably the war in Ukraine), and the Fed’s determination to continue increasing the federal funds interest rate, there is tremendous uncertainty around inflation and where the economy is heading. Mixed signals abound, however U.S. gross domestic product (GDP) increased for the first time this year in the third quarter, expanding at a higher-than-expected 2.6 percent annually. Unemployment remains low, wage increases are strong and while growth and earnings are slowing, most consumers and corporations are in good financial condition with healthy underlying credit.
Despite macroeconomic uncertainties and capital markets volatility, remarkably the post-pandemic related travel boom shows little signs of tapering off. Maintenance of pricing integrity during the COVID downturn has in part resulted in the first time that a lodging sector recovery is being led by average daily rate as opposed to demand and occupancy. While leisure demand continues to be strong, individual corporate travel continues to lag as many employees resist return to office initiatives. Some pre-pandemic meetings that were automatically deemed to be in-person have now shifted to virtual given the institutionalization and proliferation of Zoom and other online video meeting platforms. Group demand has largely recovered with many markets across the country experiencing demand equal to or above pre-pandemic levels. Although still well below pre-pandemic levels, inbound international travel has improved since the U.S. eased restrictions in November 2021 and lifted vaccination requirements in June 2022. To date, overall U.S. hotel demand and pricing power have remained resilient. However, labor shortages, rising cost of debt, supply chain constraints, and rising inflation of operating costs are challenging the sector. In addition to the need to replenish FF&E reserve accounts, many owners are being forced to execute deferred capital expenditure refurbishments to remain in brand PIP compliance.
The LWHA Q3 2022 Major U.S. Hotel Sales Survey includes 119 single asset sale transactions over $10 million which totaled roughly $3.7 billion and included approximately 17,400 hotel rooms with an average sale price per room of $212,000. By comparison the LWHA Q3 2021 Major U.S. Hotel Sales Survey included 88 single asset sale transactions over $10 million which totaled $4.8 billion and included approximately 18,400 hotel rooms with an average sale price per room of $261,000.
• Comparing Q3 2022 with Q3 2021, the number of trades increased by approximately 35 percent while total dollar volume declined roughly 24 percent, and sale price per room dipped by 19 percent.
By further comparison, the LWHA Q3 2019 (pre-pandemic) Major U.S. Hotel Sales Survey identified 41 transactions totaling roughly $3.725 billion including 13,100 hotel rooms with an average sale price per room of $283,000.
• Comparing Q3 2022 with Q3 2019, the number of trades increased by nearly three times while total dollar volume remained flat, however sale price per room was roughly 25 percent lower.
Noteworthy Q3 2022 observations include:
• Twenty-seven trades or roughly 23 percent of the national quarter total occurred in the State of California, followed by twenty trades or 17 percent of the national quarter in Florida. Combined, forty-seven trades or 40 percent of the national quarter occurred in California and Florida.
• Two Q3 2022 sales were consummated for more than $200 million each.
• The 198 room Rocky Gap Casino Resort in Flintstone, MD was sold by Golden Entertainment for aggregate cash consideration of $260 million. Pursuant to the terms of the agreements, Century Casinos acquired the operations for $56.1 million, and VICI Properties acquired an interest in the land and buildings for $203.9 million.
• IQHQ, a biotech REIT, acquired from GAW Capital Partners, the 416 room Hyatt Regency La Jolla at Aventine for just over $216 million or $520,000 per unit. The transaction included an adjacent 22,078 SF office building.
• Five Q3 2022 sales were consummated for between $100 million and $199 million each.
• Henderson Park acquired from Mandarin Oriental International Ltd. the 373 room Mandarin Oriental Washington D.C. for $139 million or $373,000 per unit. The property has been rebranded Salamander Washington D.C.
• The Irvine Company LLC sold the shuttered 541 key Hotel Irvine to Hyatt Hotels Corporation for $135 million or $250,000 per unit. The property, which previously operated as the Hyatt Regency Irvine until 2013, will upon completion of a renovation be again branded a Hyatt Regency.
• HN Capital Partners acquired from CTF Development, Inc. the 142-unit Rosewood Mansion on Turtle Creek for $120.5 million or nearly $849,000 per key.
• Electra America Hospitality Group acquired the 225 room Loews Boston Hotel for $116.7 million or $518,000 per unit and rebranded to property as Hotel AKA Back Bay.
• Choice Hotels International sold to Pyramid Hotel Group, the 255 key Cambria Hotel Nashville Downtown for $109.5 million or $429,000 per unit.
Institutional investment platforms, many of whom are lodging centric, dominated the Q3 2022 hotel transaction arena.
• Examples of buyers include: Baywood Hotels Inc., Chartres Lodging Group, Dreamscape Companies, LLC, Electra America Hospitality Group, Fairwood Capital, Henderson Park Capital Partners, Highline Hospitality Partners, Hyatt Hotels Corporation, MCR, Mission Hill Hospitality, Optera Capital, Prospera Hotels, Inc., Pyramid Hotel Group, RLJ Lodging Trust, and Wurzak Hotel Group
• Examples of sellers (some of whom were also buyers) include: Baywood Hotels Inc., Colwen Hotels, G6 Hospitality Property LLC, Gehr Hospitality, LLC, Highgate, Host Hotels & Resorts, Inc., Loews Corporation, Lowe Enterprises Real Estate Group, Mandarin Oriental International Ltd., Mckibbon Hospitality, McNeill Hotel Company, LLC, Optera Capital, Pebblebrook Hotel Trust, Robert Finvarb Companies, Vail Resorts, Inc., Waramaug Hospitality, and Wright Investments, Inc.
The era of plentiful and attractively priced debt and equity capital that drove the commercial real estate markets including lodging during the last several years has come to an end, and with it, the certainty of property values. Although rising interest rates make deals more challenging, the hospitality industry is uniquely positioned to minimize the impact of its borrowing cost with its ability to continually reprice room nights. The increasing cost of debt and general market uncertainty have caused challenges in terms of pricing assets in the market today. We are already beginning to see select trades taking place at discounts relative to recent highs. Robust fundamental operating performance has caused many sellers to continue demanding valuations reflective of 9 to 12 months ago, resulting in a widening of bid-ask spreads and a slowing of transaction volume. Capital remains available, although market uncertainty has induced hesitancy for risk-taking and tightening across both debt and equity.
Since the first federal funds rate hike in March 2022, capital markets have been disrupted, due to financial market volatility revolving around inflationary pressures and expectations of an economic recession. Whether these concerns are warranted or not, they have resulted in not only higher base rates in benchmarks, such as the Secured Overnight Financing Rate (SOFR) and Treasuries, but also wider spreads for permanent and bridge financing, and to a lesser extent, construction financing. Debt remains available and while more expensive than during the past year, on a relative long-term basis, the cost of borrowed funds remains low. A tremendous amount of equity earmarked towards the lodging sector remains available, and asset sales are anticipated to continue at a robust albeit reduced pace. In the near term, there will be upward pressure on cap rates and downward pressure on hotel values.
Existing debt facilities scheduled to mature over the next 12 to 18 months will create new venture opportunities while challenging many existing investments. Many owners will need to provide or source additional capital to bridge unavoidable financing gaps when dealing with maturing loans, while some sponsors will be forced to sell asset(s). Although the much-anticipated wave of COVID-induced distressed buying in the lodging sector never materialized, the notion of market participants “playing nicely in the sandbox” during the pandemic is over, and compelling investment opportunities will materialize in the near term. Sponsors who recognize that investment in lodging underwritten on a long-term basis, generally reap healthy returns.
