With U.S. interest rates continuing to make headlines, hoteliers are contemplating the best way to pivot their investment and acquisition strategies. For those hoteliers who entered the industry following the financial crisis, this is a completely new territory to navigate as inflation rises and rates reach unprecedented heights. In this situation, the hospitality industry in particular is faced with a unique set of challenges and hidden opportunities. With the cost of money increasing, many hoteliers may find themselves reevaluating new investments and acquisitions. Given that a considerable amount of money is still on the sidelines, we can expect some significant shifts in strategy and pricing of investments. By managing expectations and anticipating what’s to come, hoteliers can make smart investments, minimize risk, and find constants in a time of uncertainty.
Return on investment is now going to look very different. Whereas ownership and investors used to be encouraged by the rate of return, this rate is diminishing slightly amid our current economic landscape. With the majority of hotels currently priced at a premium, there is not as much additional value. In an ideal market with low interest rates, hotel investors can expect to see quicker and higher returns on their investments, which also appreciate in value. With the cost of money increasing, a lot of the value that hoteliers were seeing has now diminished, pulling purchase prices back. For example, an offer that was upward of $20 million in 2021 may now be in the ballpark of $17 million to $18 million.
With higher interest rates and inflation, we can expect to see a lot more pullback. The pent-up travel demand that has built up over the last few years has led to strong performance in rate and occupancy for hotel owners. We can expect to see this performance decrease slightly as the demand tempers itself with people returning to work full-time and costs continuing to adjust with inflation. Realistically, interest rates are not going to be reeling back any time soon.
In the coming months and possibly years, hoteliers should brace themselves to be in a given investment for a significantly longer time to realize moderate gains. Those who would have normally stayed in an asset for three to five years before selling on strong market numbers should now expect to stay in it anywhere from five to 10 years. If hoteliers don’t commit to staying in a deal for a longer period of time, they will end up settling for a smaller return than they may have experienced over the last decade.
A Challenging Environment for Acquisitions
As interest rates go up, the acquisitions and transactions world will inevitably slow down. As people stay put in their assets for longer than they typically would, the volume of transactions will subsequently subside. However, for those acquisitions that do take place, investment capital will be extremely important—both in terms of the money going into the deal and what is needed for capital improvements. If the property requires an extensive renovation, that cost needs to be factored into the overall acquisition cost. Even though room rates may go up, the expenses behind the scenes are also adjusting accordingly. With hoteliers not getting the capital and time needed to complete a renovation, it creates a lag in maximizing the return on an investment. Factoring the lag into the timeline is key.
At the end of the day, the cost and time associated with capital improvements has gotten extremely large. With the increased cost of labor, supplies, and materials, there is going to be a higher premium on hotels.
The Debt and Lending Market
In terms of the debt and lending market, there is a clear retraction. Many people are pulling back because rates are going up and prices are high. We’re also seeing a significant amount of concern that properties are not going to debt service at some point. People are asking themselves if it’s really worth the investment as they look to other options that may bring about a better ROI. For those in this situation, it’s best to consider another asset type and diversify.
Taking into consideration the amount of equity that goes into each deal will also be crucial. Deals that may have previously been done from an 80:20 loan-to-equity ratio may need to be done differently. For example, one way to keep the debt down is by putting in more capital. On the flip side, we’ll likely see banks reconsidering ratios as well as determining how they should change their requirements for investors to have more capital in the game.
Looking ahead, a number of deals may be coming to fruition in the fourth quarter of this year, but much of the activity is incumbent on a volume of commercially backed loans that are coming to a due date in the fourth quarter. Given this, we can anticipate a bit of a bubble in the industry, as many properties with larger CMBS debts default. Those assets will need to be transacted, but unfortunately, the debt may not correspond or correlate to the market value.
Many new-generation hoteliers and investors are seeing extremely high interest rates for the first time in their professional careers. For those who are in that position, it’s important to remember that these rates are nothing new. We’ve seen them rise and eventually fall back down. It’s also important to do your research, whether that’s reading old case studies of what the industry went through in the late ’80s and early ’90s, or talking to someone who lived through it.
The hotel industry is resilient. Ultimately, to successfully navigate the waters, you have to be able to understand the balance between your capital, debt, and time, and thereby capture a full view of what the new hotel business landscape holds.
Suraj Bhakta is CEO of NewGen Advisory, an AHLA Premier Partner. He also serves as chief legal counsel to the parent company, NewGen Worldwide.
5 Market Trends to Watch
- Diminished Rate of Return: In the coming months and possibly years, hoteliers should be prepared to stay in a given investment for a significantly longer time to realize moderate gains.
- Pullback in Purchase Prices: The increase in cost of money has diminished much of the value hoteliers were seeing, which has in turn reduced purchase prices.
- Fewer Acquisitions and Transactions: The volume will inevitably subside as investors stay in their assets for longer than they typically would.
- Costlier and Slower Renovations: The cost and time associated with capital improvements has risen greatly due to the increased cost of labor and materials, along with supply chain delays. This creates a lag in maximizing ROI.
- Retraction in Debt and Lending: Many lenders in the hospitality space are pulling back because rates are going up and prices are high.