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The Hospitality Industry Is On Its Way Back, And Investors Are Returning As Well

The coronavirus pandemic put much of the economy on ice in 2020, especially the hospitality industry, but this year a thaw began, and investors are ready to start buying hotels again.

The Hunter Hotel Investment Conference was held last week in Atlanta, attracting more than 1,100 participants, according to NewcrestImage CEO and Chairman Mehul Patel. And the mood was buoyant.

“They were all looking for investment opportunities,” he said.

The Magnolia Hotel, Dallas

Patel and NewcrestImage have already caught the mood. Earlier this year, the Grapevine, Texas-based firm, which now owns and operates about 30 hotel properties, established a hotel investment fund that Patel said will eventually swell to $100M. He has already raised $35M, and new investors keep popping up, adding about $5M to the fund each month.

That appetite is a sign that 2021 could be a big year for hotel trades. Patel said he’s optimistic that good properties will be available. Some owners will be seeking exits after enduring more than one year of hardship, while other investors see the return of summer and leisure travel as opportunities to buy in a market that is finally on the upswing. In addition, construction costs are soaring, so hotel companies that want to grow don’t have many options.

“The only way they can grow is by buying more assets,” Patel said.

But don’t expect the hotel investment market in 2021 to be a free-for-all. Although a great deal of equity targeted toward hotels piled up between 2018 and 2020, about $60B, according to JLL Senior Managing Director Adam McGaughy, it’s going to take some time before the market fully recovers from the Covid-19 shock. Lenders are still leery of financing acquisitions, and buyers will likely stick at first with properties that benefit most from the return of leisure travel, especially drive-to resort destinations. Investors will also likely shy away from properties in top urban markets, once the most popular hotel investment target, until business and convention travel recover.       

“It’s going to depend on the quality of the sponsor, as well as the quality of the asset,” McGaughy said. “There is definitely a flight to quality.”

Big trades have started happening.

Host Hotels & Resorts, a Bethesda, Maryland-based REIT, bought in March the 448-room Hyatt Regency Austin in Austin, Texas, for about $161M in cash, and earlier this month it acquired the 444-room Four Seasons Resort Orlando at Walt Disney World Resort for about $610M in cash. Sunstone Hotel Investors, an Irvine, California-based REIT, in April bought for $265M the new 130-room Montage Healdsburg resort in Healdsburg, California, part of Sonoma County’s wine region.

“It seems the REITs are back in,” McGaughy said.

Total deal volume in the sector recently jumped. March saw a 180% year-over-year increase in transaction volume, according to Real Capital Analytics. The firm attributed much of that increase to the sale by Colony Capital of a nearly 200-hotel portfolio to a joint venture between Highgate Holdings and Cerberus. Without that transaction, investors buying individual assets in March spent $1.1B, a 56% year-over-year increase. But even that doesn’t represent a full recovery.

“That pace of growth is fantastic, but the level is still weak relative to historical averages,” according to RCA’s Q1 capital trends report. “From 2011 to 2019, the sale of individual hotel assets averaged $1.7B each March.”

Mehul Patel

Patel and his investors have also begun snapping up available properties. Earlier this year, they bought the 325-room Magnolia Hotel in Downtown Dallas from Denver-based Stout Street Hospitality.

One factor that helped excite interest in the hotel market was the expectation last year that many struggling and shuttered hotels going through foreclosure would become available at steep discounts, up to between 25% and 40%, McGaughy said. That would have meant fantastic returns once the markets revived and hotel guests returned after the pandemic subsided. But hotel stakeholders, especially lenders, eventually decided they didn’t want to see such turmoil. 

“What happened was none of [those assets] came to market,” McGaughy said.

“A lot of lenders have been fairly cooperative with their borrowers, including agreeing to no loan payments for six months,” Houston-based HVS Managing Director Eric Guerrero said. “They didn’t want to take assets back because they understood that Covid was responsible, rather than anything wrong with these hotels.”

The value of many hotels did plunge in 2020, according to an HVS study. The firm appraised a set of 140 hotels during the pre-pandemic peak, and then again in summer 2020. It found the hotels had a total peaked value of $6.6B, which fell to $5B in 2020, a 24% decline.

But even though with the hotel sector gathering steam no one expects to pick up superbly located assets at a 40% discount, Patel said securing hotels at smaller discounts is still possible. Lenders are still reluctant to finance acquisitions, so any group that can quickly close deals may find owners eager for a deal.

“There may be a window of opportunity,” he said. “We’re able to provide assurances that we’re ready to [transact] right now.”   

The price of Host Hotels & Resorts’ cash purchase of the Hyatt Regency Austin “reflects a 20-25% discount to pre Covid-19 pricing based on comparable publicly-disclosed hotel sales,” the company stated in a press release.

And HVS’ Emil Iskander, a Los Angeles-based senior vice president, said troubled hotels may still hit the market. Lenders largely held off during the crisis, but the loans still need to be repaid. Owners in many markets will spend 2021 securing agreements with their lenders, and they may decide to sell after looking at the numbers, especially in markets slow to recover, or lenders could still choose foreclosure.

“It’s too soon to say, ‘That’s the end of that story, here’s the next chapter,’” Iskander said.   

“Although new instances of distressed hotels have begun to taper, hotel assets continue to make up the majority of outstanding distress,” the RCA report stated. “Of the distress arising in 2020 or thereafter, hotel assets accounted for over 40% of the total U.S. market distress left unresolved at the end of the first quarter.”

Hyatt Regency Hotel at McCormick Place

Clearing away those obstacles will be especially difficult in markets such as Chicago, where high percentages of hotels are saddled with debt held by commercial mortgage-backed securities investors, according to McGaughy. CMBS loans package together multiple mortgages sold to bond investors, making them far more difficult to restructure than ones with a single lender, and in 2020 many ended up in special servicing.

Nearly 22% of CMBS lodging loans were in special servicing nationwide in April, the highest of any commercial real estate sector, according to a recent Trepp report. That’s down from 26% recorded for September, but far above the 1.94% from January 2020.

The owners of several Chicago-area hotels face new foreclosure lawsuits, while others have put off the day of reckoning. The 225-room Hotel Felix in Chicago’s tourist-dependent River North neighborhood faces a lawsuit after owners allegedly defaulted on a $47M CMBS loan, according to court records cited in a March report from Crain’s Chicago Business, and the owners of Holiday Inn Express Chicago Magnificent Mile at 640 North Wabash Ave. were also recently sued for allegedly defaulting on a $23M loan. But the $84M CMBS loan on the 27-story, 553-room Renaissance Chicago Downtown Hotel, which was sent to special servicing in September due to imminent default, was extended to July 2022, according to Commercial Observer, citing data from Trepp.

“It’s going to take a lot of time for owners to work out strategies with their lenders,” McGaughy said.

Chicago and other convention-dependent markets will still attract some investors this year, he added.

The fact that more than 1,000 people came out to the three-day Hunter hotel conference in Atlanta last week is just one sign that the convention business is on its way back. In addition, the Chicago Auto Show will return to the city’s McCormick Place Convention Center starting July 15, and dozens of other events are scheduled to take place in the lakefront complex during the second half of the year. That should give potential investors enough confidence to once again start checking out downtown hotels.

“Chicago has not fallen off the map,” McGaughy said. “If it’s a good quality property, people will flock to acquire it.”

A national recovery is also starting to take hold. The U.S. hotel occupancy rate was 57% in April, the highest since February 2020, according to a May 19 report from STR. About 55% of U.S. markets were in recovery or peaking, with about 35% still in a recession, and another 10% mired in a depression.   

The growing recovery numbers further bolstered investors’ confidence, Patel said. As more travel returns, hotels should become one of the top investment classes.

“You are riding the wave, so it’s the right time to invest in the lodging space,” he said. “Although it still depends on the market, the location and [the asset’s financial] situation.”

He added that he’s certain a full recovery is inevitable.

“The question is, is it 18 months away, or 24 months away?”