ALIS Executive Suite Q&A: Kevin Davis, Americas CEO, JLL

As part of the Americas Lodging Investment Summit’s Patron sponsorship program, ALIS organizers asked JLL’s Kevin Davis nine timely questions as we prepare for the 22^nd 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?

 

DAVIS: Inflation has impacted the US hotel market both directly and indirectly, and the impact is profound. Because we re-lease our rooms every night, the industry has benefitted from inflation with the pricing power to push ADRs to record high levels in some markets and at many properties. We’ve also seen sky-high spending on food-and-beverage and on ancillary servicers as travelers have had more money in their pockets and have been willing to spend. To the downside, we’ve seen a run-up in labor costs, food costs, and energy costs, which have partially offset increased revenues. From an indirect perspective, inflation has been the primary driver for the Fed’s aggressive increase in the Fed Funds rate, which has substantially increased the cost of debt and has put downward pressure on hotel asset values.  

 

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?

 

DAVIS: Muted supply growth going forward is a good thing for our industry, particularly in some of the darling markets in the southeast, which have seen robust supply growth. I’d like to see a stronger recovery in hotel profitability industrywide before we begin to see a major ramp-up in new supply. Theoretically, less new supply will be good for existing hotels, which should perform better, all other things being equal, which will result in stronger asset pricing.

ALIS: What’s the message to hotel owners, investors, and developers from the lending community in general as 2023 approaches?

 

DAVIS: The most important thing for owners to know is that there is debt liquidity for hospitality, it has just gotten a lot more expensive. We have not run a single hotel financing campaign where no one showed up – we are getting bids on everything we are taking out.  However, the index is over 200bps higher compared to earlier this year and credit spreads are 100-200bps wider, resulting in all-in loan coupons, that are 300-400bps higher when compared to early 2022. Unfortunately, the index will likely increase as the Fed continues to raise the Fed Funds rate. My hope and expectation is that we will see compression in credit spreads early next year once the market believes the Fed has inflation under control.

 

ALIS: What is the outlook for CMBS markets as the recovery from the pandemic continues to solidify?

 

DAVIS: The CMBS markets will move in conjunction with the broader capital markets. If we begin to see tightening in other credit sectors, I’d expect CMBS to tighten, and vice versa. What’s unfortunate about hospitality is that our industry fundamentals are improving, while the CMBS and capital markets have been deteriorating. The reason is that the broader inflation and capital markets dynamics are driving the hotel financing/CMBS markets, not industry fundamentals. 

 

ALIS: What hotel asset type will be the most popular to trade hands in 2023? Why?

 

DAVIS: 2023 will be the year of big box and urban hotels. We correctly called the start of this trend in 2022, and we expect that it will gain steam in 2023 as urban markets and group meeting demand recovers quickly. Markets such as New York and Boston have been among the most liquid in 2022 and based on the deals that we are working on, and the inbound calls, we definitely see an acceleration of this trend. We are also working on several big box dispositions, and we expect that owners will sell into an improving demand environment. 

 

ALIS: What’s the most common question you are hearing from clients, and how do you respond to it?

 

DAVIS: Among the most common questions is whether we believe the record NOI levels achieved by many drive-to resort assets will be sustainable. I do believe that many of these assets will be able to maintain the majority of the post-COVID rate/NOI gains, with only a modest bit of slippage.  For example, this summer, we did see some softening in operating performance of many drive-to leisure assets in 2022 as travelers had more options to travel abroad. However, I believe that we’ve set new pricing thresholds at many assets and travelers have become conditioned to higher rates. Consumers are experiencing sticker shock everywhere else in their lives - at the grocery store, at the gas pump, with their energy bills, etc. – so they are less likely to balk at higher hotel rates.  

 

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?

 

DAVIS: As economic growth slows, we should begin to see an improvement in the labor situation for hospitality in 2023. The challenges presented post-COVID have been related to significantly increased costs and difficulty providing high levels of service. The higher costs obviously negative affect the NOI line which is not good for valuations. However, paradoxically, the difficulty in getting labor has forced hotels to operate extremely efficiently, albeit at the risk of guest satisfaction, but these efficiencies have produced strong profitability at some properties that will be hard to replicate.

 

ALIS: What’s the most under-estimated challenge the hotel industry faces, and why?

 

DAVIS: Funding PIPs and keeping properties in good physical condition will be challenging for some owners, who will be pressured by high construction costs and significantly higher debt costs now and when they refinance. There’s a lot of talk about distress due to the capital markets dislocation, but very few people are talking about the implications on the physical condition of the assets, many of which already have deferred maintenance due to COVID.

ALIS: What’s the most under-estimated opportunity for the hotel industry, and why?

 

DAVIS: there’s a great opportunity for us to design product to better appeal to longer term travel and travel by families. Perhaps it’s remote/hybrid work and pent-up demand following COVID, but people are taking longer trips and length of stay has increased. With the rise of short-term rentals, many travelers are opting for STRs for longer trips and family travel. I believe traditional hotels can get some of that demand back with extended stay product that offers more apartment style living and can accommodate people that are traveling for several weeks or months at a time. We’ve seen the launch or expansion of several brands that aim to capture this demand, but I believe that there’s a lot of remaining white space.