The line of investors waiting for robust hotelflow is looking more and more like the ever lengthening line at Apple stores for the new iPhone. So why is the line moving so slowly? And when will it speed up?
The functional answer can be found in the definitions section of all those expensive made-to-order documents and sleeping aids called Appraisals. Deals are not flowing because the current "fair market value" is too low compared to the bloated capital invested in 2005-2007. It’s simple supply and demand in play; there are very few "willing sellers" and even fewer "willing buyers" at today's market values.
Ironically, with REVPAR (revenue) increasing at about 6 percent each year and supply constricted to all-time lows (less than one percent versus the historic three), now is actually the best time in decades to invest in hotels. Not only is investor sentiment at an all-time high, but there has never been more idle and hungry equity capital waiting on the sidelines.
Contrary to all the experts’ predictions and amateurs’ wishes, U.S. hotel deal flow in the first half of 2012 was only $6 billion; HALF what it was in the disappointing year of 2011. Everyone expected all those 2007 loans coming due to produce massive deal flow. What happened?
Well the much maligned “extend and pretend” model has worked, and effectively unmotivated sellers. Lenders and owners of existing hotels have no pressure to sell now and take a loss. Special servicers inand balance sheet lenders have seen values of their hotel collateral increase - REVPAR up, supply down. Lastly, the biggest gatekeeper on hotel deal flow, the FDIC, has waved its trillion dollar magic wand over the banks and let them hold loans that are worth substantially less than the hotel collateral. So the 22 percent of hotel loans in CMBS and 43 percent in banks are not yet producing deal flow. And with restructuring by lenders, most owners aren't motivated to sell now because they would lose their equity.
But the deal flow will come. To misquote Winston Churchill, "Never in the field of hotel deals has so much been owed by so many to so few with so little hope of repayment."
Recent Treppshowed $362 billion in commercial loans maturing this year. And for hotel loans maturing, so far only 43 percent have been paid off. That means almost 60 percent have been extended into the maturity storm of the next few years. Between 2012 and 2016 Trepp estimates $1.73 trillion in commercial loans will mature. About 10 percent are hotel loans. Even if REVPAR keeps up its 6 percent annual increase (unlikely) hotel values will not increase enough to pay off the extended balance, especially given the conservative underwriting likely to continue.
Investors should keep their powder dry until the FDIC rehabilitates banks enough to force them to take their real estate losses, and until the CMBS special servicers are forced to sell because they have run out of time under REMIC rules and their trusts' operating agreements. But one other dynamic may shorten the wait.
The Roto Rooter, which finally unclogs deal flow, may well be the expensive long overdue PIPs (required capital improvement updates by franchisors like Marriott, Starwood and Hilton) forced on to the current beneficiaries of extend and pretend. Bill Marriott et al. do not care if the loan is "current," but they do care if their brand is being weakened by hotels with worn carpet and vacuum tube TVs. All franchisors have declared the Great Recession grace period over and are threatening to pull the flag on outdated hotels.
The threat of losing a flag with the usual loss in hotel value of 40 percent will force lenders and owners to take action. And since most hotels are still worth less than the mortgage, the lenders will take back the hotel and sell.
Hotel deal flow will come pouring in sometime between late 2013 and 2014, so be patient and wait in line. In the meantime, investors need to focus on their existing assets by aggressively managing the property both with staff and with a management company. Getting proactively involved with management is the absolute best way to increase value. The number one measurement of how well a management firm is doing is examining the property’s market penetration vs. your competition. Today, if your hotel is not taking a greater piece of the pie on a consistent quarter-to-quarter basis, the management is not doing their job. Become more focused on operations, hold regular meetings with management, put cash toward capital improvements. If you can increase net income by just $8,000 a month, that’s another $100,000 a year—raising the value of the property by about $1 million. Focus on what you can control while you wait in that line.
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