Participants in the Michigan State roundtable discussed a broad range of topics related to hotel real estate and financing.
While the pace of the hotel industry’s rebound may at times seem to be excruciatingly slow, it is very real, particularly if you look street corner by street corner.
“I think we were all hoping for a quick rebound, but it hasn’t happened,” said Steve Kisielica at a recent roundtable discussion among members of the Real Estate & Development Advisory Council for The School of Hospitality Business at Michigan State University. Kisielica is principal of Chicago-based Lodging Capital Partners. “From the beginning to around the middle of last year we saw a mini bubble. The REITs were active and were bidding up asset values, but that changed as the economy bumped down and growth slowed. But fundamentally things are certainly better. Hotels are doing better, the economy is improving and we’re seeing a real rebound.”
Kisielica and others on the roundtable are particularly optimistic about the favorable supply and demand dynamics at work in the industry. As Hilton’s Matt Sparks said, “This is the first time in my career where we’re approaching stabilized occupancy in most markets and yet there is very little new supply. I think the opportunity for RevPAR growth over the next two years, specifically as it relates to rate, is going to be unprecedented.”
More than 30 alumni and friends of The School of Hospitality Business at Michigan State gathered last month to talk hotel real estate.
Sparks is senior vice president, luxury & corporate development, for Hilton. He and more than 25 members of the Advisory Council met in East Lansing, MI in late March to learn more about the School’s curriculum and activities and its Real Estate Specialization. Lodging Hospitality moderated a roundtable on hotel industry real estate and development issues during the meeting.
When We’ll Build Again
The optimism over improving industry fundamentals led the group to a discussion of when new lodging development will begin again in earnest. While analysts like STR forecast very low levels of supply growth, these executives, who for the most part work on the Main Street levels of the business, see select opportunities for new construction.
John Pharr, president of third-party management company Strand Development, said in recent months he’s heard more talk about potential development, particularly in the Carolinas, where he’s based and where business has come back strong.
“All of a sudden we’re talking to developers we haven’t seen before who want to come into these markets,” said Pharr. “They may not yet have the capital, but they’re beginning to plan ahead.”
John Keeling, executive vice president of Houston-based Valencia Group, says his firm is launching a new collection of Lone Star Court properties, four-star, full-service boutique properties reminiscent of roadside motels popular in the middle of the last century. The firm broke ground in March on the first Lone Star and others are planned for 20 or so college towns and/or state capitals mostly in the Sunbelt.
“If you’ve got the right product and the right story and the right concept, financing is there. It’s not easy, but it’s there,” said Keeling, who adds the firm was able to get 55% loan-to-value financing with a 6% non-recourse construction loan for the Austin property from a local bank.
Others on the panel were a little less optimistic that the pace of new development will pick up anytime soon. While some financing is available, the terms are difficult for some developers, particularly in the select-service arena, to justify.
“Loans with 65% leverage aren’t going to help them very much,” noted Ed Walsh, president of Alpine Realty Capital. “For the most part, they don’t have the means to put together the equity needed—three to five million dollars—for these kinds of deals. We’re not going to see supply growth in very measurable terms throughout most of the country until they can get adequate leverage.”
As another example, CBRE Hotels Senior Vice President Larry Kaplan recounted the story of a “prototypical small-time developer” who worked three years to find a local bank to lend him money at 75% leverage to build a Hampton Inn & Suites in a suburban location.
“That’s exactly my point,” said Walsh. “In the past, that developer might do one project a year; now it’s taking him three years to get one hotel developed. Until developers are able to do two or three properties at a time, we’re not going to see substantial [increases in] supply.”
The booming energy industry, particularly shale oil exploration, has helped hotels in a number of markets, including eastern Ohio and western Pennsylvania, noted David Sangree, president of Hotel & Leisure Advisors. “Many of these hotels are experiencing the highest occupancies in their histories, and a lot of developers are interested in building there,” he said. “The question, of course, is how long will this boom last. Will it be over in a year or will it go for 20 or 30 years?”
Do You Want to Buy a Hotel?
While the pace of new hotel development is uneven, the flow of transactions will continue this year as it did in 2012. Jones Lang LaSalle Hotels recently forecast the volume of select-service hotel portfolio sales will double this over 2011. But, as with development, the transactions landscape is difficult to quantify. A big unknown is hotel debt tied to the CMBS market, much of which is scheduled to come due this year and next.
David Johnstone of Miller Global Properties said the CMBS market never materialized because deals on the lot of the big assets were worked out.
“That CMBS market never seemed to materialize the way everyone expected,” said David Johnstone, managing principal and chief investment officer for Miller Global Properties. “I think what’s happening is for the bigger projects, deals are getting worked out.”
Andrew Kern, managing director of Rockwood Real Estate Advisors, brought a unique perspective to the issue since one of Rockwood’s sister companies, CW Capital, is a CMBS special servicer. As he explained, most of these assets fall into one of two categories: hotels with real value and ones that never should have been financed in the first place. The latter group holds little chance for recovery and will be expunged from the CMBS portfolios. Those assets with value and upside potential—especially those in top-tier markets—will be retained, possibly repositioned and sold sometime in the future.
“A lot of people put together their war chests hoping to pick up some of these assets, like they did back in the RTC (Resolution Trust Corp.) days,” said Kern. “It hasn’t happened for several reasons. For one, back in the RTC days, these were typically single assets. Now, they’re comingled with a gazillion others in a trust with several levels of bondholders. At some point, however, the servicers will be forced to sell these assets. but it won’t be the same feeding frenzy we saw during the RTC era.”
Rockwood Real Estate Advisor’s Andrew Kern doesn’t expect a feeding frenzy of transactions like what happened in the RTC days.
After engaging in a buying spree during the first half of 2011, public REITs have been mostly quiet since. They’re now creeping back into the market, but these days seem to be more analytical about potential deals. Geoffrey Ryskamp, an asset management analyst with Pebblebrook Hotel Trust, said his firm is opportunistic in its acquisition strategy.
“We’re not looking to buy hotels in specific markets just to fill those markets or spend a billion dollars so we can get to 40 hotels instead of 20 hotels. Everything is transaction by transaction,” he said. Another issue in transaction volume, said panel members, is the differences that still exist between bid and ask: what buyers are willing to pay and at what price owners are willing to sell.
“We’re trying to buy. We’ve got $800 million on our credit facility and a bunch of cash but the bid/ask spread is too far apart,” said Jeff Clark of Host Hotels. “We’re sitting on the sidelines waiting for the kick-the-can phenomenon to stop and the prices to come closer to what we’re willing to pay.”
Tier By Tier
While most public REITs and other large institutional players look for hotel acquisition deals in first-tier center-city markets, many of those on the roundtable believe there is plenty of opportunity outside the gateway cities.
As John Weeman, president of Partners in Development, put it somewhat tongue in cheek: “I love secondary and third-tier markets, but I’m not telling anybody why.”He then spoke of a project he’s working on in conjunction with a municipality that wants a full-service hotel but can’t afford to develop one. “So we’re building a Hilton Garden Inn and a 25,000-square-foot conference center the city pays for and suddenly my 65% (loan-to-value) loan acts like a 90% loan because I got three and a half million dollars worth of free money from the city.”
According to Clark, even Host Hotels, which typically buys upper upscale and luxury properties in first-tier locations, is looking to dabble in smaller markets. “We have a business plan to spend $50 million to $100 million teaming up with local developers to do deals in secondary and tertiary markets to develop hotels and convention centers,” he said. “It’s a growing market.”
What Could Go Wrong?
Despite the general optimism among the roundtable participants, they all realize factors beyond their control could reverse the gains the industry has experienced. For some, it’s the geopolitical factors on a worldwide scale.
“There are a lot of global economic factors coming into play,” noted Ted Tomaras, global chief financial officer and COO, Americas for Jones Lang LaSalle Hotels. “The Euro Zone crisis may have been averted for now, but at this point we still have Italy and Spain to worry about. And China’s growth won’t be anywhere near what many thought it would be.”
Job losses and travel cutbacks are another worry. Companies with properties in Washington DC and other markets with a heavy concentration of government workers are concerned. Pharr of Strand Development, which has some properties near military bases, said the Pentagon last year issued an order for a 20% cut in military travel. “I was in the Air Force Reserve for 37 years, so I know when the military says cut, they mean it,” he said.
Even improvement in the U.S. economy and jobs growth doesn’t guarantee additional corporate travel. “Sure, we’re seeing growth, but the caveat is that companies have learned they can get along with less so they’re in no rush to rehire people,” said Drew Dimond of Dimond Hospitality Consulting.
Gas prices are another worry. And while some panelists think $5 to $6-a-gallon gasoline will put “a crimp in summer travel plans,” other believe the America consumer is more resilient.
John Weeman cited a report from the state of Michigan that showed a spike in gas prices a couple of years ago actually contributed to an increase in overall travel. “[The study] found that instead of taking three weekend trips, some people were vacationing once for 10 days,” he said. “And besides, I believe people will take a cut in their grocery and other household budgets before they’ll take a cut in their vacations.”
The roundtable participants were split on what effect the outcome of this year’s presidential election will have on the economy and the hotel industry. To some, like David Johnstone of Miller Global Properties, a change in administration means capital gains taxes will remain the same, and “that’s good for those of us in real estate.” Hilton’s Matt Sparks isn’t sure it matters.
“I believe the impact either candidate or either party has on the overall economy or the business environment is overrated. Over time, perhaps they can influence nuances, but the downturn happened regardless of who was in office, and the recovery happened almost regardless of policy. What happens from here on out will be the result of factors much bigger than who’s in office.”
Keeling of Valencia Group may have had it right when he said, “Uncertainty is the problem. They can raise taxes, lower taxes or keep them the same. The idea of putting a tax cut in place that expires in a year or two doesn’t really do any of us any good because we have to plan beyond that. We’re not getting one- or two-year mortgages.”