As the Bay Area slowly recovers, strong hotel valuations and rising interest rates are keeping transactions relatively at bay.
Hoteliers say the worst is over in San Francisco since the hotel
market’s pandemic performance plummet, even if the city has recovered more
slowly than many of its other big city brethren. New supply remains low,
valuations are relatively strong, and demand is expected to make a big return. So,
for now, many buyers and sellers are in a holding pattern. Interest rate hikes
and looming debt maturities could change that, though, and quickly.
It hasn’t been all bad news in the Bay Area as of late. Fundamental
market performance has already improved in San Francisco. While still
underperforming some 30% to 40% from pre-pandemic levels, the market has
rebounded from the trough of the pandemic, when RevPAR dipped 84% below
pre-pandemic levels. Now, the city must fix its broader issues while awaiting a
full return of demand, to truly excel and become a compelling investment.
“A Bay Area recovery will happen as a result of several
changes, some self-driven, others not,” said Philip Maritz, managing partner of
Broadreach Capital Partners, Palo Alto, California. “The city has got to crack
down harder on street life, crime and the homeless to restore its reputation as
a pleasant visitor experience; tech travel and office occupancy need to rebound
more robustly; and inbound Asian travelers must return. When some or all of
these things happen, the Bay Area hotel operating, and investment climate
should return to its more normal state of attractiveness.”
Valuations holding
Despite a slow recovery, insiders say that hotel valuations are
not as straightforward in San Francisco as one might believe, especially in the
current climate. New York hotels, for example, rebounded from COVID more
quickly than San Francisco hotels, but discounting in New York City has been
deeper. San Francisco’s pricing reportedly still isn’t completely reflective of
the cuts in the tech space, reduction of corporate travel and continued lack of
international and Asian travel.
If hotel revenues had recovered, as they have in many other cities, prices might be even higher than they are now. Buyers are likely pricing-in optimism that the market will recover more quickly than it is.
Robert Kline
The city recently had some landmark hotel sales, like the
Ritz-Carlton in 2022 and Le Meridien in 2021, which traded in the range of $620,000
per room and $615,000 per room, respectively. Silicon Valley’s trades were more
in the upscale and upper upscale tiers, led by the San Jose Marriott and
Courtyard Sunnyvale, which both traded in 2022 in the range of $485,000 per
room and $475,000 per room, respectively. These relatively strong prices
reflect the enduring belief that the market—led by tech—is sure to bounce back
in a big way.
“San Francisco always enjoys a healthy amount of liquidity
for hotel transactions, even during the down times,” explained Robert Kline,
CEO of Chartres Lodging Group, San Francisco. “Logic would say that prices
should be lower given the elongated recovery, yet they have stayed fairly high
on a cap rate and per room basis. If hotel revenues had recovered, as they have
in many other cities, prices might be even higher than they are now. Buyers are
likely pricing-in optimism that the market will recover more quickly than it
is.”
That optimism, and its impact on pricing, may change in the
future. Downward pressure is now being applied on valuations by factors like rising
nationwide interest rates and inflationary operating costs, among others.
“It will be interesting to see if there will be increased
pressure going forward, as debt maturities and debt covenants come into play,”
said Maki Bara, president of Chartres Lodging Group. “However, this potential
downward pressure in pricing may be counteracted by an increase in market performance
from Asian travelers returning to the market.”
Rising interest rates, according to sources, have already had
a significant impact on valuations, recently reducing prices in San Francisco
by roughly 5% to 10%. Buyers will likely become more comfortable once rates
stabilize and spreads continue to contract. But, at the moment, sources say deals
with seller financing or assumable debt have been garnering more demand.
The great sell off?
On the buy side, experts are seeing activity from family-owned
entities and an increased appetite from Japanese and Korean investors. REITs
and some investment funds seem to be on the sidelines, or at minimum, are being
very cautious. Sources say that since the hotels in the market are still
trading off of discounted pre-COVID values, rather than actual current cash
flows, right now buyers can’t take on more than moderate amounts of leverage.
“On the buy side, it's primarily private equity groups, some
associated with operators and brands looking for distribution in the market,”
said Jon Bortz, chairman, president and CEO of Pebblebrook Hotel Trust. “But
it's a lot easier to sell smaller assets, which don’t require a lot of
financing, versus larger assets, which would be quite challenging to sell on
the market there today.”
As for recent hotel sales in both San Francisco and Silicon
Valley, sellers have been dominated by REITs looking to divest. Sources believe
that will also change and the market will see a more varied mix of sellers
going forward, as different reasons for selling emerge, such as debt maturity.
“We think the sellers are going to come in all directions:
all different types of owners; folks who don't have liquidity,” Bortz said. “We’re
selling voluntarily because we’re reducing our position in the market and we’re
reallocating that capital where we think we will have better intermediate to
long-term returns. But you have all types of assets, from the bottom end of the
market, all the way up to the luxury segment.”
Still, sources aren’t quite convinced an abnormally large
flood of San Francisco properties will suddenly hit the market, despite the downward
pressure from multiple directions. Both history and current trends signal
otherwise.
“Personally, I don’t think we’re going to see many ‘fire sales,’”
Bara added. “Each time that we predicted a huge influx of inventory resulting
from loan maturities, this didn’t end up being the case. In most cities, market
fundamentals are currently outpacing what we originally forecasted, making cap
rates appealing without discounting pricing.”
City on the rebound
The pandemic, unfortunately, was only part of the San
Francisco hotel market’s recent problems. The rampant homelessness and street
crime in the city has long been a deterrent to tourism, but the situation has
visibly improved in the past year-plus, according to several experts. And despite
its recent layoffs, the tech market isn’t expected to go anywhere, and its
resulting corporate tech travel is expected resume. New supply remains minimal,
posing little threat to existing demand.
The big question mark remains the amount of inbound
international arrivals—especially from Asia—but experts believe the return is
near. This crucial influx of demand can’t come soon enough to San Francisco,
which had come to rely on its many overseas guests.
“We think over the next two years, or really 18 months, we
should see a full recovery in that demand from Asia, along with probably a lot
of pent-up demand,” Bortz said. “A lot of people in Asia have family here whom
they haven't seen in three years or more, along with lot of a lot of folks
coming for technology and medical conventions. That's going to start to happen
over the next few months and grow fairly dramatically in the back half of the
year and through next year. So, the market will be in a good place to recover
the vast majority of that international demand over the next 18 to 24 months.”