Rates will continue to mute new development

NATIONAL REPORT – For better or worse, development in the U.S. is expected to remain muted in the near term because ~7% to 8% borrowing costs are expected for the foreseeable future.

Even if the Federal Reserve trims rates by another 100 basis points this year, it shouldn’t materially change underwriting and decision-making about whether to build or not, experts told Hotel Investment Today.

Institutional lenders are also unlikely to move off the sidelines, according to Noble Investment Group Senior Vice President Dustin Fisher, because banks are still very much yield oriented lenders and there’s robust demand on new loan origination for better yielding products. “It wouldn’t justify moving into what’s viewed as a riskier deal profile,” he said. “They’re very selective on sponsorship – more so than ever, which only continues to rein in the pipeline for new groundbreakings next year.”

All that being said, Fisher hedged a bit, adding that deals are getting done. “We actually still continue to be surprised at the amount that gets done,” he said.

Rates have come down some versus eight months ago, but we’re still underwriting and then stressing those at a higher level than we’d love to see. We’d love to see them continue to work back down, but I do think it is the new normal that 6.5% to 7.5% is where we’re going to play for a while.

Grey Raines

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What is getting done is mostly relationship-driven lending.

Raines Company Managing Partner Grey Raines said their lending relationships fall to small and regional banks that never left the Florence, South Carolina-based business.

“Rates have come down some versus eight months ago, but we’re still underwriting and then stressing those at a higher level than we’d love to see,” Raines said. “We’d love to see them continue to work back down, but I do think it is the new normal that 6.5% to 7.5% is where we’re going to play for a while.”

Raines added that prior to the election, a lot of their investors on the sidelines were waiting to understand the country’s direction. “Now that we we’ve had that election, we at least understand a path we’re on, and folks are digging in and saying they want to be the next group out of the ground. We know that new wins. We’ve built out of downturns, and we think that having some new product will prove to be a long-term strategy that wins.”

Raines said they are moving forward with some projects and tabling others. “We’ve killed a couple deals that we just felt like the markets were going to either take too long to come back, or we just couldn’t get over some of the other hurdles, whether that was financing our construction costs or something else. So, we’ve zeroed in on the good deals and just push – whether that was lowering the leverage point a little bit to secure a little bit better rate or signing guarantees. That’s enabled us to find lending where I think some others have faltered.”

At Gencom, Chief Investment Officer Alessandro Colantonio said he is only seeing development financing becoming a little bit more palatable on repositionings.

He said their redevelopment financing for the Fairmont Southampton in Bermuda was done with relationship lenders who were sold on Gencom’s track record.

To make most any good lending deal, Colantonio added that it needs to be on projects in locations where they have already invested. “For us, whether that’s an expansion of Papagayo [Costa Rica] or Bermuda, where we already have footprints, it is going to be much easier for us than trying to go and do another greenfield, ground-up development where we haven’t already been.”

Managing development costs

Not only is development lending tricky, so are managing construction costs, which most agree at least are stabilizing.

As we see with anything in the economy, costs are always very fast to go up, and very slow to come down.

Alessandro Colantonio

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“As we see with anything in the economy, costs are always very fast to go up, and very slow to come down,” Colantonio said.

But as long as they stabilize, he said Gencom is happy. “If you can get costs to stabilize and continue to maintain good relationships with your lenders, that allows you to get more efficient financing because you have the track record.”

Noble’s Fisher contends construction costs are never coming down but are becoming more predictable, especially in the midscale and economy segments. “The lack of customization that goes into any of those projects is making the cost model more predictable. And when it’s more predictable, we can explain it easier to lenders,” he said.

However, on the more core urban projects that require a lot of customization, Fisher said he continues to be in awe over of where costs are today versus five years ago.

Steen Petri, managing director of Investments for HEI Hotels and Resorts, points to both the higher costs of both materials and labor stifling supply growth in many markets, adding that is also making it harder to pencil new acquisitions. “Labor cost will certainly remain a challenge and the current shortage of hourly workers for our industry is likely to become even more challenging if the incoming Trump administration moves forward with their deportation campaign promises,” he said.