The Current and Future State of the Hotel Industry: Opportunities & Strategies

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The hotel industry is one of many facing uncertainties due to COVID-19. As Cushman & Wakefield helps navigate our clients through this unprecedented time, we will continue to mirror hotel investors’ long-term goals and the anticipation of the future upside. Below we highlight the U.S. hotel industry’s current landscape, opportunities and strategies, and as we continue to look ahead.

At-A-Glance

  • Hotels in U.S. are struggling to stay afloat and many of them have closed their doors. However, hotels near airports, highways and medical facilities are performing better than most along with economy hotels and motels as they accommodate guests at lower price-points with a residential-like base of demand.
  • In this time of need, hotel owners, managers and brands are supporting local communities by providing rooms at no charge or at a reduced average rate to first responders, medical personnel, isolating individuals and those without a permanent residence.

Investment Opportunities

to previous downturns, cash is king. Substantial capital is poised in the market from private equity firms and opportunistic funds to execute on hotel investments when they become available. Investors and lenders have learned from the recovery of the Great Recession and are poised to act quickly. Owners and investors view the scale of available cash to be the strongest resource to weather the Covid-19 pandemic.

Current hotel investment opportunities include:

  • Note sales from private REITs and other lenders offering mortgages at discounts
  • Properties that are closed and in need of a PIP but now have little cash flow
  • Land banking of entitled construction projects that are unlikely to get funding in the current environment
  • Compassionate/Relief capital – providing additional capital to maintain the cash flow structured as preferred equity

Financing Strategies

  • Borrowers are actively working with their lenders to amend bank credit facilities to provide extension options for the next 6-12 months, waive or modify certain covenants and establish interest reserves for near-term debt service.
  • While CMBS negotiations are difficult due to the regulations of the issuances, special servicers have specific rules to follow and commercial banks and balance sheet lenders have more flexibility.
  • If a hotel loan includes participation from multiple banks, borrowers are advised to work with senior lenders as funding will be extremely difficult to replace. Regardless, further creative financing or preferred equity will need to be negotiated with the senior lender.
  • PACE financing may be available for construction or newly opened projects. A PACE assessment is a debt on the property in which the payment is made via a voluntary tax assessment. Some PACE loans can be prepaid while others cannot.
  • Some private groups are offering ground lease financing – converting the land held in fee to a ground lease.

Operational Sourcing of Cash

Hotel owners are pursuing various avenues to increase cash reserves including:

  • Working with the property manager, lender and/or brand to access the reserve for replacement for expense and payroll obligations.
  • Negotiating with hotel franchise companies to have short-term reductions in fee payments and renegotiating upcoming PIP projects in exchange for franchise and management agreement extensions and repayment programs. Some franchise companies are providing temporary licensing suspensions to allow hotels to work with local counties and cities to accommodate populations most affected by the pandemic.
  • Applying for SBA and other government sponsored payroll protection and lending programs.
  • Working with property tax assessors in an attempt to defer payments during the crisis.
  • Leveraging federal assistance through loans and grants that are expected to benefit all product levels of the hospitality industry.
  • Utilizing programs such as the CARES Act and the Families First Coronavirus Response Act that aim to help hotels through payroll programs, tax benefits and family leave policies.

Perspective on Recovery

  • Numerous hotels have closed for a notable period of time, and the hotel market is operating at an all-time low. This is an unprecedented response in contrast to prior downturns.
  • The timing and process of hotels reopening is still uncertain even with the June and July 2020 projected reopening dates.
  • While previously expecting a quick V-shaped recovery, market participants are now expecting a more extended U-shaped recovery given a couple of factors.
  • One, some hotel markets were declining pre-COVID-19. Two, remaining uncertainty around the timing of the return of travel and demand for rooms.
  • Looking forward, lodging that is easily accessible by car from major population centers are expected to be first beneficiaries of pent up leisure travel demand.
  • Conversely, group demand is expected the slowest to recover due to concerns and possible regulations around large groups of people.
  • As projects continue to halt due to construction financing pullback, proposed supply may be less of an issue in certain markets. That said, currently under construction and delayed hotel openings will remain a threat to existing hotels reopening.

As valuation and advisory professionals, we understand our client’s needs. While the process for hotel analysis and appraisal is currently more difficult, our approach continues to rely on thorough due diligence and analysis of each individual asset and market, as well as the consideration of information gathered from research and ongoing discussions with lenders, brokers, owners and managers.

Elaine Sahlins | Cushman & Wakefield

The Impact of COVID-19 on Hotel Values: Analysis of Current Conditions

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For many hotels, the initial effect of COVID-19 was staggering as many hotels in the U.S. closed in early- to mid-March with the trend continuing to accelerate. The long-term impact on U.S. hotel performance will vary by market, and the duration of the initial decline and the subsequent recovery remains uncertain.

Hotel owners and investors are looking to estimate potential impacts on their assets and asking the following key questions:

  • How long will the hotel markets continue to deteriorate?
  • If a hotel is closed, how long will it stay closed?
  • When the hotel market bottoms out, how long will it take to get back to pre-COVID-19 occupancy levels?
  • When will daily average rates get back to the 2019 average rate?

Our hotel appraisers and consultants within Cushman & Wakefield’s Valuation & Advisory platform continue to provide prudent guidance based on the most up-to-date information available, while regularly adjusting assumptions, forecasts and overall outlook.

To assess the current conditions, we are exploring sensitivity analyses with different variables. As with any hotel analysis, the assumptions and findings differ by property type and market and require thoughtful forecasts based on the variables for each asset.

As an example, we have prepared a sensitivity analysis of a competitive, select-service hotel affiliated with a nationally recognized brand that is located in a top-25 urban market using circumstances and data as of March 2020. The baseline scenario assumes no impact from COVID-19, in addition to four potential long-term projections assuming different impacts and outcomes from the current pandemic.

For this analysis, we have taken the following into consideration:

  • Operators will adjust property operations and staffing for reduced occupancy and/or closure. All the non-baseline scenarios show a recovery to a consistent stabilized occupancy level.
  • The actual resulting net income of a hotel with an impacted RevPAR depends on the asset’s operating structure, management strategy and market dynamics.
  • Some vacant hotel rooms are being donated or subsidized for use by healthcare workers and other affected populations, so the specific circumstance for each property would require customized modeling.
  • In the forward-looking scenarios, the overall decline in room revenue results in a longer-term contraction of net operating income. The recovery of the average daily rate back to the same level at or near the average daily rate achieved in 2019 dollars represents a real loss in revenue over the long term.
  • The contraction of value can be significant in the short term but is likely to accelerate during recovery. External factors including availability of financing, the pool of potential buyers and alternative investments need to be taken into consideration when examining property value.

Baseline Scenario (Pre-COVID-19) – This scenario mirrors the projections that we had assumed at the beginning of 2020 where there was no significant impact anticipated from COVID-19. The underlying premise of this forecast is that the hotel markets were expected to moderate relative to 2019 and that the impact would largely affect the average daily rate.

Scenario 2 – This scenario assumes the current COVID-19 pandemic will directly impact hotel performance beginning in March 2020 and that the market and the property will begin to recover in early 2021. Scenario 2 is modeled to show a rebound to the hotel’s 2019 average rate with a five-year recovery to the 2019 average daily rate.

Scenario 3 – This scenario also assumes the current COVID-19 pandemic, but assumes a more optimistic timeline assuming that 2020 is the nadir and that the average rate returns to 2019 levels in four years.

Scenario 4 – This scenario also assumes the current COVID-19 pandemic, but assumes the hotel will close between mid-March through the end of the second quarter of 2020 and that the average rate will recover in five years back to 2019 levels.

These analyses are not intended to be an actual indication of income, expense or value changes, but a way to benchmark the impact on value. We expect circumstances to be in flux for some time,however these types of analyses could provide some guidance for hotel investors and market participants.

The Road to Recovery

At this point in time, the unknown duration of the pandemic creates uncertainty for the path to recovery. The turnaround of a market and hotel’s performance will depend on several factors, including but not limited to:

  • The length of the shelter-in-place orders by governments and businesses
  • The discovery of therapeutics and/or a vaccine for COVID-19
  • Behavioral changes and/or social distancing requirements following the current stay-at-home environment
  • The timing of when group gatherings will become acceptable again
  • Meeting size restrictions on groups
  • Business travel restrictions post-COVID-19
  • Status of proposed hotels and completion of new supply under construction

Leisure travelers are likely to be the first guests that initially come back to hotels. As with the recovery after the financial crisis, drive-to getaways and staycations are expected to be the largest uses of hotel rooms in the early months post-pandemic. Business travel is expected to return secondly, depending on businesses’ available budgets for travel and available airlift. Meetings and groups were the first lodging segment to decline from the pandemic and are anticipated to be last to recover. However, until we see the bottoming out of current trends, it is difficult to determine an absolute recovery pattern.

In the last downturn from the financial crisis, the hotel investment market paused for approximately two years before transactions restarted. While numerous opportunistic funds were lined up for deals, hotel owners who were able support their investments did not sell until they achieved desired pricing. Although hotel revenues for many assets are expected to decrease more severely than the last downturn, the declines are somewhat offset by the CARES Act relief package issued by the US government. However, it is uncertain if hotel owners will be able to sustain the same kind of holding pattern as that of the last economic downturn and how the CARES funding will impact the profit and loss statements for individual assets.

While the current issue is a public health crisis and not a financial crisis, we are witnessing another break in transaction activity. Before the downturn from COVID-19, the hotel market performance was softening. Despite the expectation of moderating hotel fundamentals, the low interest rates sustained acquisitions and refinancing of hotel assets. Assuming the continuation of the low interest rates, hotels may begin to trade once the COVID-19 pandemic is contained and/or testing therapeutics/vaccine is widely available and the bottom is marked. Pricing for hotel trades at this future date is likely to be higher than the sensitivity value changes as nadir of the cycle will have then passed.

With RevPAR and net operating income recovering each year, the net present values increase can be expected to provide investment opportunities going forward. As a benchmark, we have used consistent discount and terminal capitalization rates to evaluate the potential changes in net present value shown in the following chart.

Assuming interest rates remain low, investment demand for hotel assets may also drive lower equity yields, resulting in even quicker and more exponential growth of value.

Because of the uncertainty about recovery timing and the expectation that a full recovery will take several years, we anticipate that modelling assumptions will also change periodically. It is likely that sensitivity analyses are modified as circumstances change to continue to gauge a range of outcomes.

Elaine Sahlins | Cushman & Wakefield