Although the wave of distressed buying that some predicted never materialized, investors may still have a chance to cash in on hotel properties stressed by the coronavirus pandemic given rising interest rates and the possibility of a recession in the the near future.
“During COVID we effectively kicked the can down the road,” says Brian Waldman, chief investment officer for Atlanta-based Peachtree Group. “Now we are seeing more pressure. Now it’s time to face the music.”
Higher interest rates and deferred capital expenditures may finally prompt some owners to seek new equity partners or even sell their properties. It’s not likely to be the kind of fire sale investors had been expecting, with deep discounts compared to pre-pandemic prices.
“Now we’re seeing stressed owners instead of distressed assets,” says Waldman.
Less of a worry than anyone thought
It must be disappointing for hotel investors who were looking for opportunistic plays. When the coronavirus pandemic hit and much of the US economy suddenly shut down, it seemed clear that many hotel properties would fail. Hotels forced to close their doors had no income from hotel guests – but they still had mortgage payments.
Funds raised their own capital and were ready to buy assets seized by lenders and offered for sale at a discount. But it just didn’t play out that way.
“There’s been a lot less disruption than people originally anticipated,” says Kevin Davis CEO of JLL Hotels & Hospitality, Americas, based in New York City.
Many hotel owners stood their ground. Several sales of distressed portfolios made headlines. But most owners were unwilling to sell at the deep discounts buyers were demanding. “There’s been a lot of ‘offer-ask’ proliferation,” says Waldman.
Investors spent $165.3 million to buy distressed hotel properties in the third quarter of 2020, or 7.1 percent of the total $2.3 billion spent to buy hotels in that quarter, according to data from MSCI Real Assets. That’s more than double the $69.5 million that investors spent to buy distressed hotels in the first quarter of 2020, or 1.4 percent of the $5.1 billion total.
So far, the most investors have spent to buy distressed hotels was $1.2 billion in the third quarter of 2021, or 11.8 percent of the total $10.2 billion spent to buy hotels in that quarter, according to MSCI. . Through the second quarter of 2022, the investor spent just $296.2 million to buy distressed hotel properties, or 2.8 percent of the total $10.7 billion spent to buy hotels.
The federal government gave a lot of help to hotel properties. The Federal Reserve immediately cut its benchmark interest rates to zero and began massive bond purchases to prop up capital markets and keep interest rates low.
“The Fed encouraged lenders to work with borrowers,” Davis says.
Congress also approved billions of dollars in stimulus to support the economy.
In addition, hotels have recovered faster than expected – especially hotels that cater to leisure travelers.
Some giant wallets sold in 2021
Institutional investors spent hundreds of millions each to buy several large portfolios of struggling hotels in 2021, totaling more than $1 billion in sales. In August 2020, KKR bought a portfolio of 48 hotels owned by Digital Bridge, the real estate investment trust formerly known as Colony Capital, which had reportedly defaulted on CMBS loans for the properties. Also, in June 2021, Monarch Alternative Capital paid $360 million for ten full-service hotels in four states from bankrupt Eagle Hospitality Real Estate Investment Trust.
“The concern was very situational, not systemic,” says JLL’s Davis.
No large distressed hotel portfolios have traded so far in the first half of 2022, according to MSCI. Institutional investors are no longer the dominant buyers — instead they’ve been responsible for 21 percent of dollars spent on struggling hotels this year so far — less than half their share of deals in 2021.
“In 2022, there have been no portfolio sales and so it’s no surprise that institutional investment has fallen,” says Alexis Maltin, vice president of real estate research for MSCI.
The next round of sales of struggling – or at least stressed – hotels
Many hotels may soon face problems that will either force them to sell their properties or at least raise more capital.
“It could be an important investment opportunity,” says Davis.
Funding is the biggest challenge. Many hotels have five- or seven-year, variable-rate loans that are reaching the end of their term and need to be refinanced. “Leverage is falling and interest rates are rising,” says Peachtree’s Waldman.
The index for floating-rate loans, the Secured Overnight Funding Rate (SOFR), has already risen by more than 200 basis points since the start of 2022 – borrowers are already paying that cost on their old fixed-rate loans. variable.
The comprehensive interest rate on a new loan is likely to be even higher. Many major banks have pulled back from commercial real estate lending in recent months. “Banks have certain allocations to give loans for commercial real estate. Once they meet their allocations, they’re done for the year,” says Waldman.
The remaining lenders are adding more to the interest rates they charge borrowers. “The cost of borrowing for a new loan could be 500 basis points higher,” says JLL’s Davis. “If you are refinancing today, the interest rate can all be 8.5 percent.”
The higher interest rate will greatly reduce the size of a loan that a hotel will be able to support – even if the hotel is doing relatively well.
Hotels also often require a significant amount of capital expenditure. “Most owners didn’t invest in equity before during COVID,” says Davis. Now hotel brands that had allowed the owner to spend less on capital expenditure or even brand standards – like the breakfast spread.
“This will create opportunities for investors to provide bailout capital and or preferred capital,” says Davis.