As the U.S. hotel industry approaches pre-recession levels of operating performance, many of our clients are asking, “Is now a good time to invest in the lodging sector?” According to the respondents of the 2013 edition of PKF’s Hospitality Investment Survey, it is a good time to be a hotel owner and investor. While opinions vary among industry professionals regarding the root cause of this positive sentiment, we at PKF believe that several factors are attributable to the overall positive outlook for hotel real estate.
Revenue per available room (RevPAR) grew 6.8 percent in 2012, and is forecast to experience gains in excess of the 2.9 percent long-run average through 2016, with many major markets expecting growth in the 6 to 7 percent range. This is the result of below average supply growth, stabilizing occupancy levels, and robust average daily rate (ADR) increases.
According to the Hospitality Investment Survey results, interest rates for hotel development and acquisition purposes remain at historically low levels. This combination of attractive interest rates, increased availability of capital, and the healthy industry performance demonstrated in 2011 and 2012 has made the lodging sector particularly attractive to investors.
As special servicers and banks work out their troubled lodging assets, fewer distressed properties remain to have their loans modified or sold. Recent transactions in the market reflect opportunities to reposition existing properties, still at below replacement cost levels.
Multiple survey respondents indicated that there are few quality hotels available for sale, causing interested parties to bid aggressively. In this low interest rate environment, the dividend yield from an existing hotel investment looks very attractive given the risk.
Income levels for hotels continue to experience healthy gains. According to PKF’s 2013 Trends in the Hotel Industry report, the average hotel in the survey sample increased its net operating income (NOI) by 10.2 percent in 2012. With strong market fundamentals expected over the next few years, NOI is forecast to increase by 11.6 percent in 2013 and 17.7 percent in 2014.
Conducted in spring 2013, the results of our annual Hospitality
Investment Survey indicate that for the most part, the investment criteria we track experienced little change over the prior 12 months. The one metric that continues to improve, however, is capitalization rate. Lower interest rates, higher dividend expectations, and confidence (in the form of lower risk premiums) are driving capitalization rates lower. With more equity and debt coming into the market, cash buyers with a pocket full of money are finding fewer deals to execute, pushing yields lower.
In 2013, the overall capitalization rate (OAR) for all hotels decreased to 8.38 percent, a 35 basis point decrease compared to the 2012 results and the lowest OAR recorded since the inception of this survey. As location in real estate always matters, OARs for hotels vary to a wide degree based on location and barriers to entry. According to multiple survey respondents, contributing factors to the improved OAR include a decline in distressed related transactions, sophisticated buyers aggressively bidding on high-quality assets, historically low interest rates, solid industry fundamentals, and the positive forecasts published by multiple industry research firms (including PKF).
This year’s survey also indicated that discount rates, or unleveraged internal rates of return (IRRs), for hotels decreased 37 basis points to 11.05 percent. This further demonstrates that a majority of investor sentiment is positive, and the hotel sector is not viewed as risky as it was just a few years ago as investors are willing to accept a lower return just to get in on the action.
The survey indicates just a slight decrease in the holding period. Many respondents indicated that a shorter holding period is anticipated due to a possible increase in supply and potential upward pressure on interest rates.
Debt service coverage ratios increased slightly, though they remain near 2007–2008 levels. Many survey respondents, particularly investors active in the limited-service segment, indicated that new-
construction financing is becoming more available in second-tier and tertiary markets.
Interest rates also fell in 2013 to 5.54 percent, a drop of 104 basis points compared to last year. This is by far the lowest interest rate we have recorded since we began conducting this survey in 1995. Several respondents report that good sponsors with solid balance sheets are able to secure rates between 400 and 600 basis points above the one-month London interbank offered rate (Libor). Loan-to-value (LTV) ratios experienced minimal change compared to last year, though at 64.63 percent remain below the historical Hospitality Investment Survey average of 66 percent.
While many of the results in the 2013 Hospitality Investment Survey were relatively unchanged compared to last year’s survey, two of the most important criteria continue to improve: access to capital and interest rates.
Investors and lenders surveyed continue to be bullish regarding the next few years and, due to the lack of high-quality assets being marketed for sale, expect the transaction activity of well-branded assets in second-tier and tertiary markets to increase over the next 12 to 18 months.
So are we there yet? As real estate cycles go, the positive RevPAR and NOI expectations for the lodging sector during the near term will allow property values to continue to grow. If one believes increasing NOI, limited supply growth, and improved access to capital are the destination for the lodging investor—then yes, we have arrived.
Scott Smith, MAI is senior vice president in the Atlanta office of PKFC. Bill Morton is senior consultant in the Indianapolis office of PKFC (www.pkfc.com).