Hospitality & Leisure Trend Watch
The hospitality industry is facing an unusual challenge. With rising consumer demand, hotels are hitting — and even exceeding — pre-pandemic levels for revenue per available room (RevPar) and EBITA. Yet interested investors are finding it difficult to seize opportunities in the sector, not least because it has become difficult — in some cases, impossible — to obtain traditional debt financing.
What’s causing this unusual dynamic?
Attendees at this year’s American Lodging Investment Summit (ALIS) were cautiously optimistic about the hospitality industry in general — and luxury destinations and group business in particular. Considering recent and expected dynamics, that is no surprise.
In the US, RevPAR reached an all-time high in 2022, even as other asset classes in commercial real estate faltered. Moreover, consumers are increasingly acting on their pent-up desires for travel, and group and international bookings are coming back as China and other countries remove travel restrictions related to COVID-19.
Yet major hotel investors that are actively looking to deploy capital indicate that they have been unable to find deals. In part, they may be waiting for prices to come down. Indeed, prices may drop in the not-too-distant future — although maybe not in the way that investors once expected. Another factor is the limited availability of attractive assets. See the “Other factors” sidebar for more on these points.
In the meantime, interested buyers are actively looking to deploy equity capital but are stuck on the sidelines due to rising costs of debt and difficult, if not frozen, debt markets. Active lenders are carefully limiting loan-to-value ratios and managing their exposure to hospitality assets. Even the lenders that appear to be “open for business” are pricing buyers out of competitive deals due to associated debt costs. Thus buyers cannot easily access debt necessary to get a deal done in this environment.
Other factors: High prices, low inventory
High prices. The prevalence of strong operating fundamentals in the hospitality sector means there probably will not be a wave of distressed opportunities emerging from the COVID-19 crisis, as investors once expected. Many ALIS panelists do expect sellers to begin offloading assets at more realistic prices, but most expect that wave to start in the second half of 2023. This is expected to be driven by a number of factors, including rising levels of debt maturities ($35 billion worth of lodging loans are set to mature in 2023, according to Trepp, Inc.), mounting deferred maintenance and brand requirements, increased employee pressures, and fewer lenders interested in extending current loans.
Low inventory. The supply of attractive assets for sale is extremely limited, and the majority of new development projects that the COVID-19 crisis delayed are still 18 to 24 months away from hitting the market. In the current environment, there are not a lot of high-performing, competitively priced assets available — and low supply puts upward pressure on prices.
What can investors do to bridge the gap?To capture hospitality opportunities, we have helped interested buyers consider creative solutions that enable them to obtain financing, despite tight debt markets. These include:
- Using seller financing when traditional financing is unavailable or unattractive
- Helping buyers close on assets with an increasing reliance on equity or otherwise closing on all cash as a short-term solution with the goal of securing more permanent debt financing once the debt markets normalize
- Securing mezzanine debt, preferred equity, or similarly structured debt to fill in holes in the capital stack
- Exploring alternative lenders or regional banks
- Navigating existing relationships with senior lenders to allow for the assumption of an existing loan
As effective as these alternative approaches can be, they do present unique challenges for dealmakers. In particular, as owners resort to more novel financing structures, gaining buy-in from multiple stakeholders — including senior lenders, management companies, brands, franchisors, and hotel unions — can be more challenging and more important.
Potential buyers should involve legal advisors early in the process to discuss the various creative solutions available to them. This will help them increase the likelihood of getting a deal done and maximize their opportunities for achieving their investment goals.
Jacob M. BoyerAssociate
Benjamin C. TschannPartnerCo-Chair, Hospitality & Leisure
Adam E. KopaldPartner
James A. Crolle IIIPartner