Sleep or Sell: Factors that Shape Your Investment Decision
- Apr 17, 2013
In recent years it has become clear that determining real estate value is not just about the anticipated cash flow measured against perceived risk, but a matter of supply and demand as well. The current imbalance of high demand for hotel assets (buyers) and minimal supply of hotel product (sellers) drives value as much or more than the forecast and cap rate methodology.
For several years, a large amount of equity has been slated for hotel investments. Public REITS, which typically use more constrained levels of leverage, benefited from the low cost of equity capital during the first half of 2012, and are again in a strong position to acquire assets in 2013. However, the difference today is that with the re-emergence of debt availability for hotel acquisitions, private equity groups can now leverage their own equity to justify cap rates below eight percent. This allows them to join the growing list of hotel competitive bidders.
Private equity, combined with eager off-shore investors seeking assets in the U.S. has created the perfect storm for a sellers’ market. This led to a record number of hotel transactions for Jones Lang LaSalle at the end of 2012, and also resonated throughout the industry as evident below:
With the elections behind us and the threat of capital gain increases a clear reality; it appears that many hotel owners are currently resigned to holding onto their properties and riding the growth wave to increase their asset values. A bright future for the performance of hotels based on strong fundamentals of a growing economy (sequestration aside) and minimal new inventory, leads most owners to conclude that holding their asset is their best alternative. However, well-positioned, well-branded, well-performing hotel assets can only improve so much with just ADR growth to propel performance.
Owners looking to maximize returns must consider the facts, and keep in mind that inflation and interest rates have never been lower. At some point sellers will come to this realization at once, inflation and interest rates will rise and price/value will decline. Those who get in front of this trend can benefit from immediately maximizing value on their existing performing assets.
In particular, investors with assets in gateway and urban select service markets can reinvest those funds in underperforming secondary and suburban markets, or into resort assets that have more upside in occupancy and performance growth in the future. While income growth has a fundamental benefit to value, a market that numbers five to ten buyers for every seller is the fundamental that Adam Smith would suggest is what truly drives value in the marketplace. As appraisers, we must make sure to reflect this dynamic of the current marketplace in our hotel valuations.