The halfway point of 2015 marked further growth for the lodging industry. Hotel transaction volume increased modestly during the first half of 2015 as privately held equity funds and hotel companies continued their disposition strategies. From January to June of this year, transactions and property transfers trended upward to 807 hotels, caused by a substantial increase in portfolio sales. Single-asset transactions actually declined for the period, and there was no merger and acquisition activity recorded.
Because the industry is only halfway through the expansion phase of its real estate cycle, there is no immediate pressure for investors to sell because of the significant earning potential ahead. They are basking in the fifth consecutive year of double-digit earnings growth and, although the rate of growth is slowing, do not foresee a top-out of earnings for at least another three years. However, many equity funds are feeling compelled to sell at this time because their scheduled holding periods are expiring. Hotel companies implementing asset-light strategies are sellers as well. For them, securing profits from asset appreciation even though we are only halfway through the expansion phase of the cycle is a solid strategy. Fortuitously, the main buying groups—publicly traded REITs and other equity groups—have substantial near-term earning potential to satisfy their investors.
The nature of hotel earnings has also begun to change. In 2016, nationwide occupancy is likely to finish above 66 percent, the highest mark in more than 20 years. Considering hotel seasonality and guest-room booking cycles, the overall occupancy level is close to being maximized. Therefore, annual growth rates in the future are likely to be minimal. Average daily rate (ADR) will be the major driver of revenue per available room (RevPAR) in the future. ADR will accelerate as the overall economic recovery increases at a faster clip, employment levels bounce back, and both interest rates and inflation accelerate. Also providing comfort to investors is the fact that new supply, with the exception of a few markets, will continue to be benign because new guestroom openings will not exceed 100,000 rooms until 2017.
Individual investors are probably not sellers at this time unless a compelling reason arises. Because a dollar earned from ADR provides a larger percentage of profitability than a dollar earned from occupancy, holding real estate assets a while longer to reap the near-term earning improvements that lie ahead can be good strategy. The future value of their assets will be enhanced not only by the higher earnings but also by the historically low interest rates and stabilized cap rates.
Muted Selling Prices
Of the 807 hotel transactions and property transfers that occurred in the first half of 2015, 552 reported selling prices in the public domain. The average selling price per room (ASPPR) for these sales was $164,062.
A sample size of 552 hotel sales is usually large enough to properly blend selling prices from all chain scales within a normal bell curve distribution. Not this time, however; there is a significant skew. The sale of the 1,413-room Waldorf Astoria in New York City by Hilton (Blackstone Group) to the Anbang Insurance Group of Beijing for $1.95 billion had an unprecedented $1,380,042 ASPPR. This outlier drove the national ASPPR up by $24,335, from $139,727 to $164,062.
Eliminating the Waldorf from industry totals, the restated ASPPR of $139,727 is down significantly from the $156,002 recorded in 2014. This selling price decline is due to a shift away from larger CBD transactions in major markets toward the sale of smaller hotels with less than 200 rooms in suburban locations and secondary cities. This shift in transaction location and size is typically observed when the hotel industry recovery is complete.
Seller and Buyer Activity
Total investment in the first half of 2015 for hotels with a reported selling price was $11,816 million, about half the total for all of 2014. The Waldorf transaction accounted for $1.95 billion, or 16.5 percent, of the 2015 year-to-date (YTD) total. Given that the mix of transactions is shifting away from larger properties, this year may not see significant year-over-year growth in investment dollars, if any.
Privately held equity fund dispositions may exceed $10 billion this year to cement a new cyclical high. It may also be an excellent time for equity funds to sell, but they are finding it quite difficult to locate and buy new assets with appreciation opportunity that will merit a five- to seven-year holding period. This is especially important because 2017 will mark the start of the maturity phase of the real estate cycle.
With interest rates locked at record lows and lending still readily available for investors, it is also a perfect time for private hotel companies to complete their asset-light disposition strategies before the maturity phase of the cycle gets underway. Publicly traded REITs and private equity groups are the major investors on the buy side, absorbing the disposition volume of private equity funds and hotel companies implementing asset-light strategies.
This is still an opportune time for lodging investors: A recovered economy set to accelerate forward, operating statistics at modern-day highs, hotel earnings on an extended streak, interest rates at all-time lows, lending still readily available, and supply in check for at least another two years. There is plenty to be optimistic about.
Patrick “J.P.” Ford is senior vice president, director of business development at Lodging Econometrics. He can be reached at email@example.com.