Hotel investors are enjoying one of the strongest markets in years. But this cycle is not likely to match the duration of the last upcycle for hotels, according to Manhattan-based investment advisory firm Hotel Investment Strategies.
From the third quarter of 1995 through the third quarter of 2000, the hotel sector racked up 21 consecutive quarters of growth. But Hotel Investment Strategies principal Ross Woods expects the current cycle to last only 14 quarters, ending in mid-2008. What’s different this time?
“Hotel values never bottomed out as low as they did in the early 1990s so there’s less room to grow,” he says.
For now, hotel returns are robust, up about 21% this year, and they will likely remain in lofty territory for another few years. “The cycle is absolutely critical for investors. The problem is that many people confuse short-term buoyancy to be the long-term trend,” says Woods.
Hotel investors know that, in comparison to other property types, lodging can turn on a dime. And, notes Woods, inevitably appreciation returns, which measure increases in property values, revert back to their long-term average of minus 0.5%, the lowest average appreciation return of any property class.
To be certain, the short-term prognosis, however, is good: Income returns should average about 8.5% through 2010, which compares favorably to the long-term average of 9% that Woods has tracked since 1981. He also believes that there is “about a 70% chance” that income returns between 7.6% and 9.3% will be achieved over the next four years.
“With capitalization rates likely to increase by about 96 basis points over the next two years and new operating income moderating, the growth in capital appreciation is expected to decline but remain positive until late 2009,” says Woods.
One lagging indicator of strong hotel performance is a drop in sector-specific CMBS delinquencies. According to Fitch Ratings, the hotel sector led an overall decline in CMBS delinquencies with a 61% drop during the first nine months of 2006. Multifamily delinquencies took second place with a 24% decline followed by retail (15%) and office (12%), reports Manhattan-based Fitch Ratings. A loan secured by a CMBS is considered delinquent once a borrower is 60 days overdue on their debt payment.
“Hotel performance improved significantly in 2005 and the improvement continued through third-quarter 2006 albeit at a slower pace,” says Fitch senior director Patty Bach.
Hotel properties accounted for 16% of all CMBS delinquencies at the end of 2005. By the end of last month, however, they represented just 9% of all delinquencies. Bach says that improved market performance has allowed many leveraged hotel owners to pay off their delinquent loans.
Real estate investment trusts (REITs) that own and operate hotels are also benefiting from heavy trading. According to SNL Financial, lodging REITs were up 21.63% during the 52-week period that ended yesterday. Only multifamily REITs generated a higher total return of 42.75% during that period.