Hotel Capital Markets Show Unprecedented Recovery
- Jun 01, 2010
To put it lightly, it has been a very interesting 36 months in the hotel capital markets. From the heady days of 2007 to the trough — in terms of both emotion and liquidity — of 2009, we have seen it all. This much we can say: Recovery has begun, and at a pace that many did not expect.
The past three years saw a nearly unprecedented correction in the capital markets, resulting in severe challenges for even the most savvy of financial engineers. Debt vanished, equity was scarce and sellers were rare. But in late 2009, things slowly began to change.
As is often the case, the public markets led the way. The most stable of the lodging REITs began to have significant success raising debt and equity, putting them in a position to clear up balance sheet questions and begin stockpiling capital for the expected flow of acquisitions. Following behind them were a series of IPOs, primarily blind-pool REITs lead by seasoned management teams.
On the private side, the equity was in most cases already raised, but many investors were exceedingly cautious through late 2009, believing that inaction was the proper course given the overall uncertainty regarding hotel sector performance.
Debt, of course, was the big question. While some of the well capitalized REITs had access to debt via the bond market, the vast majority of players found that most, if not all, of their traditional debt sources were out of business. The CMBS window was closed, banks were off limits and life companies were on the sidelines. But, as in the public markets, a thaw began.
In 2009, the primary sources of debt were either smaller local and regional banks, who would make small recourse loans, and newly raised debt funds, who would make larger, non-recourse loans. Everyone, however, spoke of 50 percent to 55 percent leverage and wide spreads, resulting in rates of 8 percent to 10 percent or more in most cases.
As we fast forward to today, the first two quarters of 2010 have brought about the most significant changes.
Equity investors are back, and have begun to bid aggressively for quality investment opportunities. All believe in the macro-economic and hotel sector recoveries that are underway, and all are looking past trough earnings to invest in assets on pro forma. The reality is, capitalization rates are a bad metric in the hotel sector given the significant swings in cash flow; investors are much more focused on basis and return today. Quality assets in good locations are drawing significant attention and surprising pricing. Simply put, market sellers can transact.
On the debt side, the number of active lenders has multiplied, resulting in competition for deals and substantial improvement in pricing and terms. Life companies and major banks have joined the local banks and debt funds to create a real market of financing alternatives. Leverage has moved from the mid-50 percent range in 2009 to the mid-60 percent range, or higher, in 2010. Pricing has recovered sharply as well, benefiting from spread compression and the overall pullback in interest rates. Moderate leverage deals today can be priced in the 6 percent to 7 percent range, while higher leverage deals today have multiple bidders, where in 2009 there may not have been any.
In summary, today’s hotel capital markets reflect the realities of the broader economy: recovery is underway, and it’s getting a little easier to do business each day. While we are certainly not anywhere near the frothy levels seen in 2006 and 2007, transactions and financings are getting done. That’s great news for all of us who want to put the past thirty-six months behind us and get back to business.