Summer 2022 Hotel Capital Markets

Summer Hotel Capital Markets Commentary: Sizing Up the Recession

Michael Bowen, CFA

7/13/2022 3 min read

"For myself I am an optimist - it does not seem much use to be anything else." - Winston Churchill

Hotel performance is back on track according to virtually every industry report.

According to CBRE, US RevPAR has exceeded 2019 levels for most of 2022, and as of May, ADR is up more than 14% compared to 2019. Hotel transactions are up, loan delinquencies continue to fall, and frontline operators are adapting to new trends with lightning speed. Like most other sectors, the hotel industry is contending with serious labor shortages and supply chain headwinds. Despite these challenges, savvy operators are driving rate (often outpacing inflation) and protecting the bottom line admirably.

Owners are benefiting from the ability to reset rates daily and from the persistence of pent-up demand. After adjusting for the various geopolitical and operational headaches that every industry is facing, it really isn't a bad time to own a hotel. But the story is a little more complicated if you are searching for hotel capital. Everyone has seen the headlines about recession risk. Bankers are probably the most nervous. Analysts at Jones Lang LaSalle note that "all major lender types - banks, debt funds, life insurance companies and CMBS - continue to quote hotel loans" but the cost of capital has increased anywhere from 25 basis points to over 150 basis points this year.

Debt capital providers are becoming more selective and are reducing leverage. They are following the typical playbook at the beginning of a trough in a normal business cycle. However, are we in a normal business cycle?

Banks and investors are voting on that crucial question with their checkbooks right now. Lenders aren't wrong to ponder the potential effects of a recession. Hotels can be severely impacted under the usual circumstances. But the last 24 months have been anything but usual. Yes, our country faces high inflation, due in part to the stimulus money from 2020 and 2021. Yes, there is still a war going on, yes, the pandemic is still real, and all of these forces continue to agitate commodities, materials, labor and logistics.

But the one thing these forces are not (yet) perturbing is travel demand. "All these economic things point to something slowing down...But from a data perspective and what we actually have on the books, it's still saying it's going to be [a] strong [fall 2022] and that we're going to keep rolling" said Nolan Wrentmore of Aimbridge Hospitality at HSMAI's 2022 Revenue Optimization Conference, placing particular emphasis on the strength of group and workforce travel.

On the leisure side, a July 2022 report from Destination Analysts recognizes that higher gas costs are causing American travelers to think twice about a road trip. But it also notes that 62% of travelers are prioritizing "leisure travel [as] 'high' or 'extremely high'" in their budget, and that most are currently holding on to their fall 2022 travel plans. The consensus is that the fundamental drivers of travel demand are intact.

The pandemic travel restrictions fueled a surge in pent-up demand, and the fuel of that fire hasn't burned out; indeed, 86% of Americans plan to take at least one trip in the next 12 months according to Destination Analysts. Equity investors are taking note of this, and many believe that these positive trends will counteract or even prevail against a broader recession. The checks they are writing indicate a level of conviction that is not necessarily shared by their bankers. "[Investors] believe RevPAR is going to keep going up" despite the risk of a broader recession, Michael Bluhm of Morgan Stanley said at the recent International Hospitality Industry Investment Conference in New York.

Asked to respond about the impact of a recession, panelist Rob Hays, CEO of Ashford Hospitality Trust, responded with "Who cares?". Some lenders might roll their eyes at that level of confidence, but as the data suggests, there is reason for optimism. In this very unique environment, persistent fundamentals may buffer the industry from the worst effects of a potential recession. Lenders who recognize this crosscurrent are quoting leverage of 65% to 75% for existing properties, and even 80% of cost for new construction according to recent terms we've seen.

In our view, the debt capital market for hotels is liquid, and there is a higher-than-usual chance it will remain so through this particular cycle. Though they will tighten their underwriting, banks cannot afford to miss out on the new business that is supported by proven operating fundamentals. Equity investors are certainly not on the sideline. Savvy investors recognize the risk of recession, but they are primarily using the headlines to negotiate better deal terms.

In their hearts, they are still buying into a growth story as we head into the second half of 2022.

Need some ideas on structuring your hotel ownership finances? Contact me and let's have a conversation!

Michael Bowen, CFA

Vice President CFO