Part 2 of Hotel Investment Today’s report on the CMBS’ 2023
lodging loan maturities assesses the
second-half deal pace and the types of portfolios going on the block.
It’s hard to predict what’s likely to happen with CMBS
lodging loan default trends in the back half of 2023 when even the best minds
in the finance and investment community won’t hazard a guess about what’s going
to happen tomorrow—or before EOD today.
However, most experts contend that unless the Federal
Reserve dials back on interest rate hikes over the next nine months and troubled
banks can execute on some magical thinking to course-correct overnight, CMBS
lenders are less likely to be willing or able to exercise the level of
forbearance that kept significant numbers of assets from coming to market
during COVID.
It’s also expected that lenders’ decisions will come under much
closer scrutiny by federal regulators. Monday-morning quarterbacking to figure
out what went wrong in the banking industry could make refinancing far more
challenging, not only for assets poised on the borderline between
non-performance and default but also for single-asset and portfolio lodging
loans that are generating cash flow—just not enough.
As one lender commented off the record, “Even some of our best
clients are having trouble getting refinancing. It will be interesting to how
this plays out.”
In this second installment on CMBS 2023 lodging loan maturities,
industry experts weigh in on some of the possible scenarios that could build or
break hospitality investment portfolios this year.
More deals, less capital dislocation
Michael Bellisario, senior research analyst, R.W. Baird, sees opportunities
behind the current chaos: “The driver of any defaults, loan modifications
or extensions, or transactions will be dictated by performance more than the
type of debt on the property (i.e., CMBS). As of three weeks ago, borrowing
costs already were high and debt availability was constrained. The broader
capital markets’ volatility likely will result in a temporary pause for some
participants, but deals are still getting done today because underlying
fundamentals remain solid.
There is plenty of equity capital on the sidelines looking for a home, and we suspect more groups could buy all-cash and look to finance at a later date.
Michael Bellisario
"Fundamentals continue to trend positively, and when we get to mid-year,
most markets/properties should be operating near normalized levels (i.e.,
higher cash flows vs. today’s trailing 12-month numbers). The default numbers
could tick up a bit, but they are likely to remain low, in our view. The macro
backdrop could be a bigger driver than interest rates.
"For some of the hotel REITs’ near-term mortgage maturities, for example,
we’ve seen lenders provide extensions in exchange for a principal paydown
and/or a higher interest rate. If the fundamental performance is trending
positively, that’s an incentive for a lender to provide flexibility to a
borrower since most lenders don’t want to take the keys back. The consensus
view—and we tend to agree with it – is that higher interest rates, upcoming
capex requirements, and increasing brand standards will cause more transactions
to occur.
"Fundamentals continue to trend positively, and when we get to mid-year,
most markets/properties should be operating near normalized levels (i.e.,
higher cash flows vs. today’s trailing 12-month numbers). The default numbers
could tick up a bit, but they are likely to remain low, in our view. The macro
backdrop could be a bigger driver than interest rates.
"Looking out to the remainder of the year, it’s likely that
upcoming debt maturities could lead to more transaction activity, particularly
if interest rates stay elevated. There is plenty of equity capital on the
sidelines looking for a home still.
"The bid-ask spread is likely to remain wide, especially with the recent
increase in short-term interest rates over the last 30-60 days. The pace of
interest rate increases needs to slow before the bid-ask spread can narrow
meaningfully. However, there is plenty of equity capital on the sidelines
looking for a home, and we suspect more groups could buy all-cash and look to
finance at a later date.
"However, for some of the hotel REITs’
near-term mortgage maturities, for example, we’ve seen lenders provide
extensions in exchange for a principal paydown and/or a higher interest rate.
If the fundamental performance is trending positively, that’s an incentive for
a lender to provide flexibility to a borrower since most lenders don’t want to
take the keys back. The consensus view—and we tend to agree with
it – is that higher interest rates, upcoming capex requirements, and increasing
brand standards will cause more transactions to occur.
"Fundamentals continue to trend positively, and when we get to mid-year,
most markets/properties should be operating near normalized levels (i.e.,
higher cash flows vs. today’s trailing 12-month numbers). The default numbers
could tick up a bit, but they are likely to remain low, in our view. The macro
backdrop could be a bigger driver than interest rates.
"The most opportunity
will be the worst-performing markets since the onset of the pandemic (e.g.,
Minneapolis, San Francisco, and Portland). Here’s the challenge though: where
there is distress today (e.g., poor fundamental performance), do investors want
to be buying into those markets? Where there isn’t distress (say, resorts),
buyer interest remains high generally. There’s a price for everything though.
"History tells us there is always less stress/distress than we think will
materialize—the can gets kicked down the road quite a bit. On the margin, we’ve
seen owners focus more on newer vintage properties that require little to no
near-term capex and have upgraded amenities. New and shiny always beat old,
dull, and stinky.”
Rising debt cost, lower asset pricing
HVS’s president – Americas Rod Clough
and senior vice president, capital markets Emil Iskandar offer this forecast
for CMBS outcomes and lender strategies for 2023:
“We’re not expecting a direct, material impact on hotel CMBS loans
[because of the recent bank collapses]. However, bank failures will have a
negative impact on loans backed by office buildings where banks are tenants and
may disrupt the flow of
new debt capital available to borrowers in the near term.
"What we are seeing is that pricing on
weaker assets is largely impacted by the availability and cost of financing. If
we continue to see more lenders experiencing the same problems as these failed
banks, the cost of debt will rise and in turn push asset pricing downward.
"How distressed the assets that come to
market definitely will be depends on the local market
dynamics, the size of the hotel and the potential of its layout, and the
timeline for market recovery. Some hotels may be taken out of inventory and
converted to an alternative use, going to buyers with experience in pulling off
such endeavors. Other hotels may take part of inventory offline and re-imagine
the property as a smaller, select-service property with a leaner cost structure
to drive returns. Typical hotel investors will likely hold for five to seven
years before exiting, using the first few years to put the strategy into place,
and then riding the wave of planned returns for a few years before considering
selling.
"We think there will be a wave of conversions (to both new types of
hotels and other uses altogether), retrofits, and reimagining in order to
return profitability to these troubled assets. Lenders will not be as patient
as they were in 2020-2022, and swifter moves will start to occur to embrace the
newly established reality of the U.S. hotel market. It will be an exciting year
to watch how these assets evolve. Many of the newer brands will see a benefit,
but those that are both innovative and have a lower cost basis may see a
stronger uptick in affiliations.
"As we move farther and farther from the peak pandemic period, a
realization that what is here may be here to stay for a while is setting in.
Accordingly, acquisitions will pick up pace this year as: 1) buyers learn to
adapt to the new interest rate environment and recalibrate their return
expectations to this new reality, and 2) sellers realize that asset pricing
needs to come down from the peak 2018/2019 levels, which were set in what was
simply a different time for the industry, and now the industry has evolved into
something distinctly different.”
Sustained demand, lower headwinds
Brian Quinn, chief development officer, Sonesta International Hotels, said
that, barring a major contagion effect and continued bank failures, lenders and
borrowers in the hospitality sector look ready to stay the course, preventing
what others predict could be CMBS loan portfolios flooding the market as
refinancing efforts fail to pencil out.
"The increasing cost of debt will
result in equity accepting lower returns. The hospitality sector continues to
attract equity and investors," he said. "As for the kinds of assets or
portfolios that might be sold off, full-service hotels have seen pressure
before. They will continue to reinvent and renew themselves although in
specific instances some could be repositioned into upscale selective service or
even upper midscale/limited service. Conversion candidates have to demonstrate
they are the correct brand choice for the market, the guest and consumers overall.
The mid-market space is continually reinventing itself to react to changes in
demand and to refine the business model to drive flow through and profit for
ownership.”
Rising interest rates, increased pressure on operations
Dan Thorman, Aimbridge Hospitality’s senior
vice president, business development, predicts that owners looking for refinancing
will need to manage both macroeconomics and operations fundamentals to deliver
a solid track record to lenders.
“A rising
interest rate environment is likely to impact hotel owners in two ways: One, by
increasing borrowing costs, particularly for those with floating rate debt and
no or expiring interest rate caps and, two, by disrupting the current economic
growth and impacting operating fundamentals," he said. "We are in an environment where,
despite rising interest rates, operating fundamentals remain strong. The best
protection against these impacts is best-in-class management with the ability
to drive revenue in any economic conditions while keeping a firm grip on
expenses. Hotel owners will rely on operational experts who can continue
to manage all aspects of their expansive properties and amenities to maximize
those topline revenues, while leveraging our scale and efficiencies to
protect margins.”