The hotel real estate was among the hardest hit during the pandemic, but things are starting to look promising again. The continued vaccine rollout coupled with additional stimulus funds has more people booking vacation travel. This has accelerated projected occupancy levels at U.S. hotels — for the second half of 2021, CBRE forecasts a 55.1% occupancy rate, up from 43% in the first half of the year. Full-year occupancy is expected to reach 49.1%, compared with 41.7% for 2020 and 67% for 2019. Hotel capital raising and the number of funds in the market are on the upswing, too.
What’s this mean for valuations and hotel finance, investment, development? We asked Juniper Square customer and hospitality executive Jatin Desai to provide an expert perspective on emerging trends as well as strategies to take advantage of the recovery. Desai is Managing Principal, CIO & CFO at Peachtree Hotel Group (PHG), a multi-billion dollar hospitality investment management platform that launched in 2007. PHG develops hotels from the ground up; acquires and adds value through renovations, repositioning, or rebranding; provides capital to other hotel owners; and manages properties for themselves and for third parties. To date, they’ve invested in more than 350 hotel deals, primarily with the four main franchisors (Hilton, Marriott, IHG, and Hyatt). They currently operate 65 hotels in secondary and tertiary markets throughout the United States, and serve as the private lender for 130 hotels. Early on, they invested in one-off entities and raised capital per deal; however, since 2014, they moved to a fund structure and now run 12 funds. Because PHG finances, owns, operates, manages, and develops extended stay and full-, select-, and limited-service hotels, Desai has in-depth insights on the overall hotel market as well as a unique borrower, lender, investor, developer perspective.
Here are a few highlights of what he had to say about the hotel real estate sector.
The hotel real estate sector has been through ups and downs before. Unlike the multifamily housing or office sectors with long-term leases, it faces demand disruption on a daily basis. It’s often the first real estate sector to fall in a recession and the first to come back in a recovery. When downturns inevitably happen, most in the industry rely on a playbook to figure out how to manage around drops in occupancy rates. During COVID, demand went to effectively zero, and that’s never happened before. Whether you looked at spot valuations, or lending, or transactions, everything ground to a halt.
Desai says, “In April 2020, our portfolio (of 65 hotels) ran at about 21% occupancy. Some had higher occupancy rates because they had government contracts or something like that in place, but many ran at 1% to 3% occupancy. We had some hotels that had only one guest.”
No one in the hotel sector has ever planned for a complete collapse of demand like that. Desai said, ”The bid-ask spread was incredibly wide.
2019 was a record year for the hotel industry (as were the three years prior), so we were coming off an amazing trajectory only to fall to zero demand. Transactions weren’t even contemplated or the spread between the buyer and the seller was so wide that nothing that was going to happen.”
Concerns continued to spread across the lending industry and quoting activity slowed as lenders of all types tried to assess risk. An extremely liquid hotel lending market suddenly froze. This change in sentiment is illustrated by 2020 hotel debt transaction volume, which decreased by an astounding 67% to $35.3 billion, a figure further skewed by the fact that most of the reported transactions were assumptions, modifications or extensions of existing loans versus new loan originations.
As the initial shock subsided, in-depth lender portfolio reviews commenced. Lenders, investors, borrowers, and operators tried to draw parallels to prior event-driven setbacks like 9/11 and the Global Financial Crisis. Desai continued, “Once PPP money came out, lenders were given flexibility to allow for forbearances. This allowed borrowers and owners to hang onto their assets so there were few forced sales. You could do analysis, but nothing was transacting so valuations went down, but only for a very brief moment. Today, high-quality assets in diversified markets that are expected to recover are trading at or near 2019 levels.”
Influx of capital
Capital poured into the hotel sector as GPs raised money to take advantage of expected distress. Although there is some distress out there, it peaked in the third and fourth quarters of 2020 when you saw banks selling assets of borrowers or owners who had run their liquidity down and needed to sell to raise capital. Desai said, “Unlike many, we’re fortunate in that we’ve been able to raise a fund and deploy it during this period, but there are a lot of groups out there that have never been in the hotel space that are trying to raise funds around the dramatic decline.” Much of that capital is still sitting on the sidelines.
While a recovery is in sight, many conventional lenders are reluctant to lend in the hotel space. “If you already had a lender, most continued to fund deals during COVID, so construction continued. If you were working on a new project and looking to find a lender, there were none to be had.”
The typical conventional lending market, even today, is difficult, Desai said. “During the early days of the pandemic, you saw spreads that were probably 300 points wider than they are today. Current spreads from private lenders are in that 650 to 750 range or, If it’s for an existing deal in construction, maybe 800. We’re a private lender and we see a ton of opportunities right now. We’re financing construction deals. When loans are coming due and there’s no conventional market to refinance, we’re taking them on. Most lenders continue to be reluctant to invest in the hotel space until they can get all their loans performing again. We don’t think conventional lending will come back anytime soon.”
There are three key performance metrics in the hotel sector: Occupancy, Average Daily Rate (ADR) — what you’re charging for occupied rooms — and the combination of the two, or RevPAR. The U.S. hotel industry reported year-over-year declines across all three metrics, according to 2020 year-end data from STR. In addition to all-time lows in occupancy and RevPAR, ADR hit its lowest point since 2011.
- Occupancy: 44.0% (-33.3%)
- ADR: US$103.25 (-21.3%)
- RevPAR: US$45.48 (-47.5%)
When COVID hit, average industry occupancy rates dropped down to the low double-digits. Many hotels initially looked at these COVID-related occupancy decreases like previous recessions thinking that, if you lowered rates, you could induce demand. It’s what happened following the Global Financial Crisis of 2008 and 2009 — hotels lowered their rates, occupancy climbed, and they were able to balance RevPAR. Desai says, “In this case, it was a race to the bottom. Hotels lowered their rates, but there was no demand because people were either unable or didn’t feel comfortable traveling. RevPAR plummeted because occupancy rates were completely depressed, but ADRs came down, too. PHG’s RevPAR fell north of 50% on average through 2020, even with spikes in occupancy and ADRs around the holidays.
“We did see strength in some corners of the industry, particularly in drive-to leisure markets around national parks, beaches and mountain destinations,” Desai said. “Those are the markets that you saw come back early on, so their RevPARs were a little bit better.
We’re finally starting to see upward trends in both occupancy rates and ADRs so I think RevPARs will only continue to increase.
CBRE and other research groups concur, with many forecasting a return to pre-COVID levels in the latter half of 2021.
The hospitality industry is inherently reliant upon having people who show up and work at the properties. Even before the pandemic struck, there were labor issues at hotels and those issues have escalated through COVID. Desai said, “PHG manages 65 properties, and we had to cut expenses, including labor. PPP helped us retain staff, but if there was no work to be done, hours were cut. It was an unfortunate reality of COVID.” Desai continued, “Our per-room labor costs were cut almost in half during the early parts of COVID. Now, we’re seeing occupancy rates rise, and we can’t find people to fill jobs. If you look at the overall industry, about two-thirds of open positions are not being filled.”
At PHG, they have tried a number of tactics to fill open positions — things like next-day pay or signing bonuses that they have never had to offer before. There are a number of reasons why people are reluctant to come back. Some are concerned about contracting COVID. Some have moved on to other jobs in other sectors. And with unemployment benefits extended through September, it continues to be hard to get people to come back to work.
Once unemployment benefits run out, Desai expects a large portion of the labor force will return to work, but it’s unknown whether they will return to work in the hospitality sector. While he doesn’t think the hotel industry will ever get to a point where it does away with front desk completely, the labor shortage is forcing some hotels to get creative. They are testing online check-in, digital keys, and other ways guests can bypass the front desk. Housekeeping is another area that Desai believes will change post COVID. “What we’re seeing at PHG properties is that many guests no longer want their rooms serviced daily. They prefer to just come in, they’ll stay, and then they’ll depart after their check-out days.”
“Today, we’re running around 60% occupancy at PHG, and the people that are staying at our hotels are primarily leisure travelers who have had at least their first shot and are willing to travel. Our busy periods are now Wednesday through Saturday. People are still working from home so many take an extra day or two and have an extended weekend while still working.
The long weekend occupancy spike is in every market — major metros, suburbs, beaches, everywhere. It’s what has been driving this recovery so far. Now the business transient traveler is slowly coming back, too. Obviously, group travel and big conventions will be last to return, but they’re starting. If you look at our forward bookings, group travel really picks up in the latter half of this year. In January and February of this year, only about 10% of our rooms were group compared to transient. If you look out past July, group reservations are in the 50% and 60% range, which is on par with 2019.
“As demand picks up, people are making more forward bookings, Desai explains. “During COVID, the booking window was really short. That made it very difficult to staff because we didn’t know if our hotels were going to have 10% occupancy or 60%. Today, the booking window is starting to elongate and our hotels are filling up.”
Desai summed up his thoughts on what’s ahead for the hotel real estate sector over the longer term. “There’s a ton of capital chasing deals right now. High-quality, well-located deals are getting great bids. Smart groups are banking on a recovery. They understand that as the rebound happens, things are going to return back to normal relatively quickly.“ Desai continued, “The hotel real estate sector had a ton of wind behind its sails in 2019. The pandemic obviously devastated the industry, but it hasn’t really broken the pre-COVID trajectory.
One stat that is telling is how much capital is in the market, not just from an investment perspective, but from a personal income perspective. Spending went way down in 2020, but income continued to climb, whether it was from government stimulus or stock market gains, there’s more capital to be spent. On top of that, the Fed expects that GDP will increase dramatically this year. The hotel industry closely tracks GDP. Given that there’s so much money in the market from a personal perspective and from a capital perspective, you’re seeing people bet on hotels coming back very strongly through the end of this year and into next year. I think that, by the end of this year, we will see transactions starting to happen again.”
While optimistic, Desai points to some signs of distress in the market today. “Occupancy rates are running at about 50% to 60%, which is still well below average. The industry is not bleeding out anymore, but it is not fully recovered. That said, things are improving. People are traveling again. More people are vaccinated. As offices reopen, prominent CEOs like Jamie Dimon are pushing to have in-person meetings. Business transient travel trends look particularly promising. As quickly as rates fell in 2020, they’re starting to increase. When we look out three to six months, we’re not only starting to see increases in demand and occupancy, but the rates we’re able to charge are increasing a lot faster than a typical recession. After the Great Financial Crisis, it took several years for rates to come back to where they were pre-Crisis.
With inflation increasing, and with the speed at which demand is picking up, I think ADRs are going to come back incredibly quickly. By the middle of next year, we’ll probably be at 2018 levels, with some leisure travel markets possibly surpassing 2019 rate records.
As we look forward, I think the leisure market will continue to get stronger. Hotel economists like CBRE and STR originally projected it would be 2024 or 2025 before we returned to 2019 levels. They’ve since said it could happen by 2023, and it might come even sooner.”
CBRE U.S. Hotel Performance Forecast
|% of 2019|
Sources: CBRE Hotel Horizons Report, Kalibri Labs
Desai concluded, “Regardless of how long it takes to return to pre-Covid levels, the hotel sector experienced an incredible fall and we’re starting to see a pretty incredible rise.”
To learn more about the outlook for hotel real estate, watch the full webinar reply here.