Unlike the operating side of the hotel industry, the real estate recovery hasn’t been as clearly defined. Transaction volumes rose again in 2011, values have grown faster than anyone expected and overall industry sentiment appears positive starting the new year, yet the forecast for 2012 remains partly cloudy.
The biggest concern is a debt capital market still regaining its footing. This summer’s debt-ceiling debate and ongoing concerns over the European sovereign debt crisis have proven how tenuous the economy is.
In August, plummeting stock prices slowed transactions, even halting a few nearly done deals, and hotel real estate investment trusts were forced to pull back after a frenzy of activity in the first half of 2011 drove trading prices to almost pre-recession levels. The commercial mortgage-backed securities world that was just beginning to ramp back up paused and the financing finally flowing from many lenders slowed.
Another dark cloud hangs over the industry: A potential wave of defaults and foreclosures looms this year as a result of the massive loans originated in 2006 and 2007 at the peak of the cycle and the lack of replacement capital now available. Other owners not overleveraged may face a different kind of distress: Once patient franchisors are no longer looking the other way on property improvement plans and financing for that remains extremely limited.
Even those thick clouds overhead offer a silver lining. Savvy investors will target buying notes and distressed assets, further fueling the recovery of the transaction market and helping unwind the massive amount of distress left in the system. New construction and supply growth are at historic lows, making now a great time to own and buy hotels. The future does look bright, even with a debt capital market still in flux.
Capital market comeback
“Lenders are coming back into this space and everything is moving in the right direction,” says Matt Comfort, an executive vice president in Jones Lang LaSalle’s real estate investment banking office. “There’s a lot of potential for major issues with the global economy, but things aren’t stable now and there’s a lot of uncertainty and fear and the debt capital markets are operating through that. Lenders are quoting and originating deals.”
In the first half of the year, before the Dow Jones Industrial average plummeted more than 1,100 points on Aug. 4 & 5 on the heels of Standard & Poor’s downgrading the U.S. credit rating, the CMBS market was in the midst of a revival.
“New shops were coming in, bidding was very active, leverage was going up and pricing was dropping,” Comfort says. But when the economy flat-lined, albeit briefly, it reignited fears of a double-dip recession and lending ground to a halt.
“The year will be remembered by tremendous peaks and valleys,” reads the December U.S. Delinquency Report from Trepp, an analytics firm tracking the CMBS industry. “The market found its sea legs late in the year [spreads narrowed 20 to 40 basis points in December alone], but not without some collateral damage from the volatility. Many issuers pulled back or closed their doors entirely, leading many CMBS prognosticators to reduce their forecasts for 2012 issuance.”
Almost $30 billion of domestic CMBS was issued last year, well below the nearly $250 billion reached in 2007, but much better than the $10 billion in 2010 and the $3 billion in 2009.
“CMBS will set the tone for 2012 with pricing and proceeds,” says Comfort, who predicts at least another $30 billion in issuance in 2012 and possibly as much as $60 billion.
Traditional lenders are also becoming more active and will consider underwriting more hotel deals as the economy and their balance sheets continue to improve. “It’s been a turbulent year, but one of price discovery,” Comfort adds. “A lot of lenders got their feet on the ground and we’ll continue to see more of that healing.”
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