By H. Keith Thompson
I have been a hotel broker for 33 years and during all past cycles, the markets would simply swing from being either a seller’s market or a buyer’s market and then after a correction, swings back again. Using a swinging pendulum as a metaphor for the hotel real estate market today, the pendulum has almost stopped swinging. In my history as a hotel broker, the only time the pendulum almost stopped swinging was just after 911 and this new interest rate cycle we all find ourselves in today. In 2023, new transactions in the hotel space are down 50-70 percent depending on the brand and the market.
Today it is neither a buyer’s market nor a seller’s market. Debt interest rates today are double + what they were mid-2022 and depending on who you listen to, I believe we are in this heavily elevated rate cycle though 2024 and possibly beyond. Those hotel investors that are waiting for interest rates to return to pre-cycle levels will be waiting for years and possibly never. We are in a new normal. I hear people talking about the 25-year interest rate averages in an attempt to lessen the impact rates are having on commercial real estate now, but those arguments are not filtering down to the investor level.
The whole inflation cycle is complicated to fully understand but all will agree that it is not transitory as some people wanted us to believe. If you own a restaurant, your prices today are 50-60% greater than pre-pandemic levels and, in many cases, double. Hypothetically, if rates returned to 2019 levels and inflation was tamed, ask yourself, will that same restaurant owner return his pricing to pre-pandemic levels. The answer is of course, a resounding, no. Same with homes, housing, rent, utilities, property tax, prescriptions, and food to just name a few areas. We are in a new marketplace today, that in my humble opinion, has significantly shifted.
The era of cheap money and free money, I fear will have a very long-term effect on the national commercial marketplace and in particular, hotel real estate. In most cycles in the past, a buyer could purchase a hotel for a cap rate roughly 300 bps over his debt interest rate. If the buyer’s interest rate was say, 4%, the buyer could buy a hotel in the 7% cap rate range on NOI and make money. With interest rates today, that puts disposition values in the high single-digit to low double-digit cap rate levels not seen since the mid to late 90’s. There is a gap spread today between value expectations with sellers still wanting 2019 values and buyer’s only willing to pay today’s value. On average, hotel values nationally are down 15-25% due solely to the cost of the debt stack. I personally believe this gap spread will close in 2024 as many hotel loans are coming to term and owners must decide to refinance at today’s rates or sell. The problem with waiting, it could be a 3–5-year decision or possibly longer.
Over the past 30 years there have been six down cycles in hotel real estate. Until recently, once a down cycle stabilized, there were generally five to eight good years before the next thing happened. Starting with the pandemic, tough economic cycles seem to be happening in a much faster sequence. While we all hope for a fast return to economic stability, given the current threats to our economy and global unrest, recovery from this down cycle may extend well beyond the current estimates.
