Interest rate expectation reset taking hold

NEW YORK CITY - The reset of hotel buyer and seller interest rate expectations is starting to take hold, according to Kevin Davis, Americas CEO for JLL Hotels & Hospitality. Current rate levels, give or take a few bps, is settling in as the new status quo, and as a result, he said sellers who have been waiting for a better rate environment are coming to the conclusion that now is as good as any time to sell, and the same is increasingly true for buyers.

Davis is also noticing softening performance lower down the hotel segment scale, and the question now becomes how much of that percolates into the broader economy, and does that have a broader impact on operating performance across the industry? “If that’s the case, that introduces a completely different dynamic, which we haven’t experienced since 2021 in the midst of an incredibly strong recovery,” Davis said. “I’m not saying it’ll happen, but certainly there’s a question.”

Those two streams of consciousness were among those Davis offered when he sat down with Hotel Investment Today at the NYU International Hotel Investment Conference earlier this week. Here is more from Davis as we asked a number of looming questions surrounding hotel M&A and investment.

Hotel Investment Today (HIT): How will hotel deal activity be impacted by the 2024 U.S. presidential election?

Kevin Davis: It’s an interesting question and incredibly difficult to say.

From the perspective of economic policy and tax policy, exclusively, there status quo with the Biden administration, and they’ve been clear about what they would intend to do from an economic policy and tax policy perspective.

With Trump, he was president for four years. So, we have a sense as to how he will govern, again, from an economic and tax policy perspective.

From an economic and tax policy perspective, we have a clear idea of what each candidate would do because they’ve each been in the White House.

Expectation earlier were that we’d see five to six rate cuts. Now I think there’s an expectation that it’s anywhere from zero to two cuts. So, as a general matter, I think the markets are assuming status quo from a rate perspective and people are making investment, acquisition and sale decisions based on status quo from a rate perspective.

Kevin Davis

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HIT: Would you expect more deal activity under a Trump administration?

Davis: That’s a really complicated question.

What I will tell you is that as a general matter, markets don’t like uncertainty. There is some degree of uncertainty, obviously, with the elections coming up. So, does that put a slight pause on transaction activity? Maybe, but I don’t think it ultimately is going to be a big driver of the market.

HIT: What is your transaction activity forecast for the rest of this year?

Davis: Transaction activity will be keyed off of expectations around interest rates, which at this point, I think the market fully subscribes to higher for longer. There were certainly questions about that earlier this year with the Fed’s pivot in December. Expectation earlier were that we’d see five to six rate cuts. Now I think there’s an expectation that it’s anywhere from zero to two cuts. So, as a general matter, I think the markets are assuming status quo from a rate perspective and people are making investment, acquisition and sale decisions based on status quo from a rate perspective.

HIT: Do current expectations also include the ability to refinance in 12 to 18 months?

Davis: I think that assumption still holds. But I also don’t think that anyone is assuming that you’re going to see 150 to 200 basis points of Fed funds tightening over the next six to 12 months, and that’s different than what we thought. So, I would argue that as a result of reset expectations around rates we’re in the midst of another recalibration that's taking place. As those reset expectations are firmed up, you’ll start to see more transactions activity later in the year. But to be clear, my expectation isn’t as robust as it was when we had this conversation four or five months ago.

HIT: What do you make of the deals getting done today?

Davis: It’s a continuation of the trends that we’ve seen, which is a strong bid for larger resort, trophy, luxury assets. There also continues to be a strong bid for smaller select-service assets, but I would tell you that some of those select-service deals have become a bit tougher to get done because the financing market for those smaller deals isn’t as robust.

Those two extremes is where the deal activity has been concentrated. That was true six months ago, that’s true today, and I expect that will likely continue to be true. The one difference, though, is we have seen a strong recovery of group and business transient. Also, the urban markets have started to perform quite well. As a result, you will see more urban hotel trades, which may not be luxury, and may not necessarily be large. I think you’ll see more urban hotel trades take place over the next six to 12 months.

Clearly, you’ve had some investors that have dipped their toe into the market, but I think many investors still want to see what’s going to happen from a political regulatory perspective and with technology and AI, which I think is going to be a big driver in San Francisco as the market recover.

Kevin Davis

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HIT: With every commentary there is a caveat excluding the San Francisco market. What is your take on dealmaking there?

Davis: We’re certainly starting to see some green shoots in San Francisco. I will tell you that the market, though, continues to be wait and see. Clearly, you’ve had some investors that have dipped their toe into the market, but I think many investors still want to see what’s going to happen from a political regulatory perspective and with technology and AI, which I think is going to be a big driver in San Francisco as the market recovers… Most investors are still in wait and see mode based on the conversations I’ve had.

The people that are making bets in San Francisco right now generally have a longer-term investment horizon. These are not three- to five-year private equity bets as a general matter. These are five- to 10-plus-year investors and high net worth family office investors.

HIT: What is happening in the refinance market?

Davis: The private debt market, of course, continues to be active. The commercial banks continue to be incredibly selective.

I haven’t seen bank lending in hospitality change materially post-COVID. So, it’s not clear to me when the banks will come back in earnest. Again, to be clear, they are active – they’re just selective. A lot of the banks are dealing with issues in the office space, no surprise there. So, one would think that because hospitality is performing so well that you might see greater investment from the banks in hospitality, but we haven't seen it.

One of the questions surrounds Basel III regulations (designed to decrease damage done to the economy by banks that take on too much risk), which are being finalized. There’s a question around if and when they’ll be implemented, which will absolutely have an effect on bank lending. So, that could be contributing to a lack of significant investment or lending on the part of the banks.

HIT: What are you seeing on the new development front?

Davis: New development continues to be limited. There is financing is available, but in many cases, you can buy at a 20% to 40% discount to replacement cost. So, the math around new development just doesn’t make sense. I think that’s going to continue to be the case for the foreseeable future.

It’s not to say that development can’t get done. Some will get done. But I think it’s best projects, best markets, best sponsors when there’s a strong case for building a new hotel.