Although the wave of distressed purchases that some envisaged never materialized, investors may still have a chance to invest in hotel properties stressed by the coronavirus pandemic given rising interest rates and the possibility of a recession in the near future.
“During COVID, we effectively launched the box on the road,” says Brian Waldman, chief investment officer of the Atlanta-based Peachtree Group. “Now we see more pressure. Now is the time to face the music.
Higher interest rates and deferred capital spending could finally push some owners to seek new financial partners or even sell their properties. This is unlikely to be the type of fire sale investors have been waiting for, with deep discounts from pre-pandemic prices.
“Now we see stressed owners rather than distressed assets,” Waldman says.
Less distress than thought
This must be frustrating for hotel investors who were looking for opportunistic plays. When the coronavirus pandemic hit and most of the US economy suddenly shut down, it seemed obvious that many hotel properties would fail. The hotels forced to close had no income from hotel guests, but they still had mortgage payments.
The funds raised equity and stood ready to buy assets seized by lenders and put up for sale at a discount. But it just didn’t turn out that way.
“There has been a lot less distress than people originally anticipated,” says Kevin Davis, CEO of New York-based JLL Hotels & Hospitality, Americas.
Many hoteliers held firm. A few struggling wallet sales made headlines. But most owners were unwilling to sell at the steep discounts buyers were looking for. “There was a big ‘bid-ask’ spread,” Waldman said.
Investors spent $165.3 million buying distressed hotel properties in the third quarter of 2020, or 7.1% of the total $2.3 billion spent buying hotels in that quarter, the data shows. of MSCI Real Assets. That’s more than double the $69.5 million investors spent buying struggling hotels in the first quarter of 2020, or 1.4% of the $5.1 billion total.
So far, most investors have spent buying distressed hotels amounting to $1.2 billion in Q3 2021, or 11.8% of the total $10.2 billion spent buying hotels. hotels this quarter, according to MSCI. In the second quarter of 2022, the investor spent just $296.2 million buying distressed hotel properties, or 2.8% of the total $10.7 billion spent buying hotels.
The federal government has provided a lot of help to hotel properties. The Federal Reserve immediately cut its benchmark interest rates to zero and began massive bond purchases to support capital markets and keep interest rates low.
“The Fed has encouraged lenders to work with borrowers,” says Davis.
Congress also passed billions of stimulus dollars to support the economy.
In addition, hotels have recovered faster than expected, especially hotels that serve vacationers.
Some giant wallets sold in 2021
Institutional investors have 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 purchased a portfolio of 48 hotels owned by Digital Bridge, the REIT formerly known as Colony Capital, which allegedly defaulted on CMBS loans on the properties. Additionally, in June 2021, Monarch Alternative Capital paid $360 million for ten full-service hotels in four states to bankrupt Eagle Hospitality Real Estate Investment Trust.
“The distress was very situational, not systemic,” says Davis of JLL.
No major 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 have been responsible for 21% of hotel dollars spent struggling this year so far – less than half their share of transactions in 2021.
“In 2022, there were no portfolio sales, so it’s no surprise that institutional investing has fallen,” says Alexis Maltin, vice president of real estate research at MSCI.
The next wave of distressed – or at least stressed – hotel sales
Many hotels could soon face problems that will force them to either sell their properties or at least raise more equity.
“This could be a significant investment opportunity,” Davis says.
Funding is the biggest challenge. Many hotels have five- or seven-year variable rate loans that are coming to an end and need to be refinanced. “Leverage goes down and interest rates go up,” says Peachtree’s Waldman.
The index for floating rate loans, the Secured Overnight Financing Rate (SOFR), has already risen more than 200 basis points since the start of 2022 – borrowers are already paying that cost on their old floating rate loans.
The overall interest rate for a new loan is likely to be even higher. Many top banks have pulled out of commercial real estate lending in recent months. “Banks have certain allocations to lend to commercial real estate. Once they’ve fulfilled their stipends, they’re done for the year,” says Waldman.
The remaining lenders add more to the interest rates charged to borrowers. “The cost of borrowing for a new loan can be 500 basis points higher,” says JLL’s Davis. “If you refinance today, the overall interest rate could very well be 8.5%.”
The higher interest rate will significantly reduce the amount of a loan a hotel can afford, even if the hotel is operating relatively well.
Hotels also often require considerable capital expenditure. “Most owners haven’t invested in cap ex during COVID,” says Davis. Now hotel brands that had allowed the owner to spend less on capital expenditure or even on brand standards, such as breakfast.
“It’s going to trigger opportunities for investors to provide bailout stock and/or preferred stock,” Davis says.