NATIONAL REPORT – JLL’s latest research states history
suggests falling interest rates will lead to hotel cap rate compression.
It said if interest rates continue to decline following the
Federal Reserve’s benchmark rate cut in September of 2024 (another 25bps were trimmed on November 7), hotel cap rates may compress in tandem, potentially
narrowing the bid-ask spread in the market.
JLL said this relationship could be influenced by the historically
observed strong correlation of 90% between the benchmark SOFR index rate and
hotel cap rates. For hotel sellers, this trend could be pivotal, as it
might result in higher property valuations.
Furthermore, JLL said a narrowing bid-ask spread could
potentially streamline transactions, with buyers possibly showing more
willingness to align with sellers’ price expectations given lower costs of
capital, particularly for floating rate debt.
Resultantly, the market environment could create
opportunities for sellers to optimize returns or strategically adjust their
portfolios, leading to increased hotel investment activity.
When asked if there is any variation on this thesis by hotel
segment, Ophelia Makis, senior research analyst, JLL Hotels & Hospitality
Group, told Hotel Investment Today that while variations depend on location and
brand, generally, the correlation between hotel cap rates and interest
rates is tighter for full-service hotels than for select-service and
extended-stay properties.
Transactions in that $50 million to $250 million range, typically the heart of the market, are at the lowest percentage of total transaction volume in over a decade. This ‘hole in the donut’ may present an opportunity moving forward.
Ophelia Makis
“Volatility in revenue streams, high investment and capex
dollars, and dependence on business and group travel make the
full-service segment more vulnerable to rate shifts,” she said. “As a
result, declining borrowing costs should increase demand for full-service hotel
investments to a larger degree.”
Makis said JLL thinks this is particularly relevant for
single assets transactions in the $50 million to $250 million range, which are
more sensitive to cap rates than sub-$50 million trades (which generally have
higher in place cash flows and lower debt costs) and above $250 million (which
have predominantly been purchased by global institutions and major REITs on a
low or no leverage basis).
“Transactions in that $50 million to $250 million range,
typically the heart of the market, are at the lowest percentage of total
transaction volume in over a decade,” Makis said. “This ‘hole in the donut’ may
present an opportunity moving forward.”
Hotel Investment Today also asked Makis if higher valuations
could be a detriment to bid-ask spreads.
She said it’s important to note that while the trend creates
the conditions for a narrower bid-ask spread, the timing is not necessarily
immediate. “Sellers can expect higher valuations, and buyers can afford to
borrow more at lower variable debt costs,” she said. “However,
this largely depends on the market, timing, hotel segment or branding,
among others.”