After a few rough years, occupancy in the hospitality market is back to long-term average levels, a very good sign for the sector. Lenders are increasing their focus on the hospitality market again, and Class A properties in good locations are trading at single-digit cap rates, some as low as 5 percent.
To get an inside look at the current market and the future expectations of the sector, I invited some hotel industry experts to Studio One for a show titled “Hospitality 2014”. Most operators had a tough go of it during the recession, but are now seeing improved occupancy rates and positive rate growth. (I guess you can check out any time you like, but you can never leave.)
Increase in Occupancy
The return of demand and a lack of supply have returned pricing power to hotel managers, which means room rates have increased, said Mark Woodworth, president of PKF Hospitality Research. That “has led to some very attractive year-over-year gains in profitability,” he added.
A key milestone in occupancy was reaching the long-term average. Scarcity becomes an issue in many markets when occupancy reaches this level, Woodworth said. “In 44 of the 50 cities Smith Travel Research tracks, more rooms were sold last year than ever before.”
Luxury hotels tend to recover first in terms of occupancy and revenue per available room (RevPAR), Woodworth said. Economy properties have recovered the slowest because demand for lower-priced hotels correlates with changes in employment, which has lagged.
Boutique hotels are emerging as a new trend in the market. “The personal, unique experience you receive at a boutique hotel isn’t going to be available at a chain hotel,” said Hugh Kelly, clinical professor of real estate at New York University and the 2014 CRE Chair for the Counselors of Real Estate Association. “Boutique hotels can deliver a more personalized, 24/7 experience.”
Group meeting volume is down, but the segment is being replaced by leisure and corporate travelers, said David Marvin, founder and president of Legacy Property Group. “Many Americans and international travelers are seeking urban experiences for vacations. Urban offerings are much more interesting now, and offer easy access to attractions and cultural facilities. The leisure and corporate travelers are almost eclipsing the declining ‘meeting’ travelers,” he noted.
Lending & Investment
Liquidity has become more prevalent in the domestic lodging industry. “The terms we are seeing on debt, while some might still say are onerous compared to 2006 and 2007, are better than they were a year ago,” Woodworth said.
Having “skin in the game” is key for lending to hotel owners and operators because the hotels can be volatile. For hotel lending, the loan-to-value ratio is about 60 percent, so investors still need to have some private equity, Kelly said.
“Hotels are a unique investment because they are as much a business as they are real estate,” the NYU professor added. “It’s all about matching the skills of an excellent operator with skills of a great real estate investor. Flags are critical. As an investor, you are renting the name and expertise of a chain that’s doing business worldwide, and their advertising is going to benefit your facility.”
Cap rates are holding steady, Woodworth said. “There are three drivers of cap rate change: underlying interest rates, income growth and volatility. Volatility is not a threat, profits are growing at a great clip and interest rates are going to rise, but we predict cap rates will stay flat for another year or two. Investors today have comfort that we have a good two- to three-year run ahead. It’s a great time to buy a hotel.”
When asked about challengers for the sector, the fingers pointed at Obamacare and minimum wage issues. The labor market remains a great concern for hotel owners, Marvin said. “The number of people it requires to run a hotel makes it very labor intensive. We have wrung out the inefficiencies in the hotel world because of the challenges of the recession. There isn’t a lot more slack to give. Labor headwinds might affect our bottom line.”
The average cycle for hotel products is approximately seven to 10 years, Woodworth said. “I recently asked around at the American Lodging Investment Summit, and the consensus was that the outlook for 2017-2018 is average with a bias toward negative,” he added. “If you are preparing to build a hotel, you’ll be opening close to the 10-year point in the cycle. It has implications on how you are going to structure your capital stack.”
“Historically, what has brought an end to the good times is an economic contraction, a stock market crash, high oil prices or bubbles bursting,” Woodworth continued. “With respect to these, there are no threats on the horizon. People are becoming more confident that the good times we have been experiencing are going to persist.”
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