Lack of supply, negative leverage limiting hotel transactions

NEW YORK – As uncertainties persist, the question facing investors today is whether to curb the purchase of hotel assets.

Speaking to the NYU International Hotel Investment Conference 2022Lonny Henry, global president of investment banking at JPMorgan, said C-bodies, like Marriott International, “are all trading at near all-time highs; much higher than their prices in 2019. And c This is the first time in two, three years communicating that they are buying back shares.”

It signifies an ode to confidence in a company’s capital structure, he said. However, on the REIT side, Henry said it’s trickier.

“While we have recovered essentially everything we lost in 2019 and EBITDA will likely return to 2019 levels by 2023, valuations are somewhat mid-cycle. [and] stock prices have largely recovered compared to 2019 [but] they’re still down 30-50% from where they were seven years ago,” he said, adding that stock prices of full-service hosting REITs peaked in 2015. “That’s when we started to have an inflection in the RevPAR deceleration. , which is usually a signal to investors that things are slowing down; we also had a high offer.”

The good news is that there is no supply problem, Henry said. There are, however, several factors that make underwriting difficult, including inflation, interest rates and a highly unpredictable war in Ukraine.

Despite what hotel companies are saying about the strength and strength of their business for the rest of the year, equity investors are nervous, he added. Equity investors express this in particular by increasing risk premia.

In addition, the cost of debt term has now doubled since the start of the year and credit spreads “even for the safest class of CMBS, which is AAA”, have increased by 100% or 115%, Henry said.

“As a buyer of a hotel, generally speaking today, unless prices are repriced, you have negative leverage; you’re essentially funding debt service with reserves. In an environment where we have all these headwinds, I feel like the trading market is sort of suspended,” he said. “You have a public market with a lot of volatility and prices that are trading quite tightly. While in the beginning REITs started buying and recycling capital and using their balance sheets, I think they’re holding back a little bit here and taking the lead in the debt market.”

Tyler Henritze, senior managing director and head of strategic investments at Blackstone, said his company had been bullish during the pandemic and executives were disappointed there hadn’t been more opportunities to invest.

The resort, economy and upscale segments have seen strong momentum, Henritze said, and “we would absolutely benefit today from investing more in the hotel space.”

“I think in an inflationary environment what we avoid is real estate investments which are more like bonds – think office buildings leased for 15 years, you can’t do much in an inflationary environment,” he added.

Hotels, on the other hand, are essentially daily leases, Henritze said.

“You have the option to stay in line with inflation or outpace it,” he added. “What we see today with rates is that rates are significantly outpacing inflation.”

The challenge of investing in hotels today is the debt market, Henritze said. This is an environment where base rates have widened significantly and rapidly, but so have spreads.

“It has created a real challenge over the last couple of months in terms of getting deals done,” he added.

Christopher Jordan, managing director of Wells Fargo Corporate & Investment Banking, said debt markets have become increasingly problematic for investors, both in terms of cost and availability.

“The broadening of the spread is true, it’s unusual. It’s more of an anomaly,” he said.

Jordan said there’s a lot more control over coverage levels and loan rollover risk today. In the past, these measures were not barriers to funding.

“I’m also a bit worried about overall liquidity in the second half. I think it’s going to get a bit more difficult to find price and availability, despite the fact that the fundamentals are very good,” he said. he adds. “Liquidity is a bit of a wild card.”

JPMorgan’s Henry said alternative lenders and direct lenders are a big part of the lending landscape today. The CMBS market, however, gave some borrowers a sticker shock.

“Something is going to snap. Either cap rates have to go up, and I think sellers are going to have to be more realistic, or credit spreads are going to have to tighten,” he said.

Leeny Oberg, chief financial officer and executive vice president of business operations at Marriott International, said if someone is selling or buying a hotel, “I think we always have a pretty big gap between supply and demand.”

“Frankly, from an earnings perspective, it’s pretty remarkable how in many markets hotels have been able to catch up on profitability through productivity improvements. And we all know that room margin, we’re cutting a large part of the ADR to the bottom line,” she said.

In terms of refinancing, Oberg said there is money to be had for properties that generate cash and carefully manage renovations.

Majid Mangalji, chairman of global investment firm Westmont Hospitality Group, said one of the biggest surprises to come from the pandemic was asset values. Banks have also suffered many blows and in past crises there have been more opportunities to acquire assets.

“Everyone is ignoring 2020 and 2021 like it didn’t happen in terms of valuations,” he said. “We thought we were at the beginning of the end of the pandemic, but what happened were the headwinds of interest rates, inflation and other geopolitical issues.”

Refinancing now comes with higher interest rates, Mangalji said, as well as some owners eliminating replacement reserves or postponing some principal payments.

Despite these headwinds, he said the hospitality industry was resilient and most people were optimistic about recovery.

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