As part of the Americas
Lodging Investment Summit’s Patron sponsorship program, ALIS organizers asked
Eastdil Secured’s Andrew Holt nine timely questions as we prepare for the 22nd
annual event January 23-25, 2023, at the JW Marriott/Ritz-Carlton Los Angeles
L.A. LIVE. Following are his responses.
ALIS: How has inflation and
the threat of a recession affected the U.S. hotel transactions market?
HOLT: The recent turbulence
in the broader capital markets has created a slowdown in overall lodging transaction
activity, particularly in the summer months as inflation and interest rates accelerated.
Despite the capital markets volatility, hospitality fundamentals have exceeded
2022 expectations and 2019 levels for most hotels. Fears of recession and the rising
cost of labor have offset some of the enthusiasm surrounding rapid revenue
growth, but hotel cash flows in general have an upward trajectory. Among the
biggest challenges in this environment are the increased cost of debt and the
rise in the forward interest rate curves, however, this has also helped slow new
supply. The combination of these factors has in some instances contributed to a
widening in bid/ask spreads.
impacts and recessionary fears, investor sentiment for hospitality remains highly
positive. Lodging historically has been a favored sector during rising rate
environments and has been the top performing real estate asset class during the
past four Fed rate-hike cycles. We are seeing a rotation of capital from other
asset classes into lodging and an appetite from existing investors to increase
exposure, which are both trends that bode well for the US hospitality transaction
ALIS: Most forecasts show
supply growth checking in at about 1% each year for the next two or three
years. How will that affect transactions volume?
HOLT: Investors view slower
supply growth as a notable tailwind for hospitality investment, especially when
balanced against a forecasted increase in demand. Escalating construction and
labor costs are expected to further slow the pace of new supply, while construction
financing for hotel projects remains challenging as well, creating additional
barriers to entry. Increases in replacement cost and very moderate supply
pipelines are providing support for per key metrics and placing a premium on
newer build assets with limited future capital requirements. On a national
basis, hotel performance growth has typically outperformed during periods of
slow supply growth.
ALIS: What’s the message to
hotel owners, investors, and developers from the lending community in general
as 2023 approaches?
HOLT: The lending market for lodging
is open and functioning with active new loan originations from select banks,
debt funds, life companies, CMBS, and alternative sources. For the right deals,
we’ve seen increased lender depth on recent acquisition financing
disciplined and are more focused than ever on in-place cash flow, quality of
sponsorship, a strong business plan, and limited asset-level encumbrances. Some
of the larger money center banks are currently constrained for new originations,
which has created a challenge to fill the more senior portions of capital
stacks or lower leverage whole loans with efficiently priced capital.
Given the perceived
risk profile of hospitality, credit spreads for hotel loans have historically priced
at a premium to other asset classes. With credit spreads relatively flat over
the past two to three months, the rise in benchmarks has forced borrowing rates
for moderate leverage (~65% loan-to-value) floating rate loans into the high
single digits. For perhaps the first time ever, lodging has emerged as a
favored asset class for lenders compared to traditional office (a segment of
the market that historically represents the largest concentration on lenders’
books). 2023 could present an environment where credit spreads may tighten, potentially
opening a window for more attractive all-in rates.
ALIS: What is the outlook for
CMBS markets as the recovery from the pandemic continues to solidify?
HOLT: The CMBS market remains
a viable option for specific portions of the lodging market, namely large
transactions ($250 million+ loans) in the form of floating rate single asset,
single borrower securitizations, as well as smaller balance loans ($10-75
million) for fixed rate CMBS conduit pools. Compared with pre-pandemic levels,
CMBS spreads and all-in coupons are significantly wider today. The CMBS market
is very sensitive to the broader capital markets. We’ll likely need to see spread
tightening in other portions of the credit market (namely investment grade corporate
bonds) to see a notable improvement in all-in CMBS coupons, and we could see
certain CMBS lenders look to be opportunistic in 2023 to fill voids in the
current lending market.
Over the past few
months CMBS lenders have successfully sold a backlog of recently originated
loans off their balance sheets to the end user bond buyers. This has created
some new confidence and lending capacity as evidenced by a few new large CMBS
loans originated over the past two months and has provided additional
visibility on loan pricing during a period of volatility.
ALIS: What hotel asset type
will be the most popular to trade hands in 2023? Why?
HOLT: Over the past two years,
the most sought-after acquisition targets have been destination resorts, well positioned
select-service, and assets in Sunbelt markets with favorable demographic and
employment profiles. While growth in lodging fundamentals is moderate in these
markets and valuations in many instances are well above pre-COVID levels, we would
expect these segments to continue to make up a large chunk of the transaction
market given the very attractive yields and more favorable operating
markets – including urban, corporate transient, and big box hotels – have
become more appealing as they have enjoyed more rapid growth over the past six
months and are now on much firmer footing. We see very compelling opportunities
to buy these assets at attractive per keys and yields based on prior peak years.
If the recovery continues in these markets, we are expecting additional “contrarian”
bets followed by a more normalized level of trading. While this trajectory is
dependent on return-to-work and business travel recovery and will not apply to
all urban markets, we expect that hindsight could prove attractive acquisitions
were made in the first half of 2023.
ALIS: What’s the most common question
you are hearing from clients, and how do you respond to it?
HOLT: At Eastdil Secured, our
connectivity across asset classes and culture of collaboration is one of our
key differentiators. I’m often involved in broader discussions with my office,
multi-family, industrial, retail and debt colleagues with investors that target
many different product types and geographies. Multi-sector investors often ask,
“why invest in hotels” and “why now”? Importantly,
many of these investors are focused on finding a place with current income and
inflation protection given the global instability. We are quick to point out
that lodging represents a safe haven with the ability to effectively mark-to-market
overnight (versus long-term leases) and adapt to rapidly evolving market
ALIS: The ongoing labor
shortage has presented issues for hotel owners. How has it impacted
transactions, and do you see that impact growing or shrinking during 2023?
HOLT: In terms of the
transaction market, the ongoing labor shortage has created a larger subset of
investors who are keenly focused on opportunities in markets with business-friendly
environments and policies. We expect
this trend to continue into 2023 and perhaps become magnified in certain
markets in the event specific ballot initiatives are passed and the projected
labor shortages persist.
Hotel operators have
proven to be nimble and creative in responding to these challenges, including
implementing strategies that have increased profit margins. In some instances, profitability levels are
at record highs and prompting buyers to carefully study their long-term
sustainability when underwriting transactions.
ALIS: What’s the most under-estimated challenge the
hotel industry faces, and why?
HOLT: While broadly discussed, we still believe labor represents one
of the most critical challenges for the future of the industry. Restrictive
immigration policies and declining labor participation rates are likely to continue
to exacerbate the current issues. The challenges are most acute in older,
full-service hotels within urban markets that tend to utilize a more mature
However, the lodging industry has pressed forward
over the past two decades in the face of these challenges, and we are confident
they will continue to find creative long-term solutions. One silver lining to a possible
recession would include a rebalancing of the labor market, which could serve to
course correct this ongoing trend.
ALIS: What’s the most under-estimated opportunity for the hotel
industry, and why?
HOLT: The opportunity to invest in high-quality assets and
cultivate relationships within leading global innovation hubs remains highly
under-appreciated. More specifically, key West Coast markets, such as Seattle,
San Francisco, Silicon Valley, and Portland, have fallen down the list rather
dramatically as priority target markets for institutional investors. While
understandable given lagging post-COVID growth and, at times, difficult
regulatory environments, these markets are poised to be long-term growth
engines and attract some of the best talent worldwide with a corresponding long-term
appreciation in quality real estate.