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Now is a challenging time to be a hotel operator because U.S. and international business and leisure travel has come to a virtual standstill. Responding to the COVID-19 pandemic, millions of Americans are sheltering at home and connecting online rather than face to face.
But investors with a tolerance for risk should look for opportunities created by current market dislocations, particularly in sectors that are likely to rebound in the next 12-18 months. The hospitality sector is a prime example.
Today, many hotel owners and operators are looking for debt/capital to carry their properties through this unprecedented black swan event. Other owners are ready to sell their assets at prices that reflect the depressed state of the market. In fact, now may be an excellent time for investors to review their portfolios and consider increasing their exposures to this commercial real estate sector.
A Difficult Year
For the hotel industry, 2020 is shaping up to be the worst year in many decades. Surveys by global research firm STR found a 67.5% drop in occupancy, a 39.4% drop in average daily rate (ADR) and an 80.3% drop in revenue per available room (RevPAR) in the last week of March, compared with the same week in 2019. Overall, STR is projecting a 50.6% decline in RevPAR for the U.S. hotel industry in 2020, with a rebound in 2021 as the economy picks up steam and travel resumes.
Another recent study by CBRE paints a slightly more optimistic picture, with a 46% drop in RevPAR at U.S. hotels in 2020 (as of the time of this writing). “Our current expectations are that as early as Q3 2020, activity will begin to stabilize, and a recovery is expected to be underway by Q4,” the firm wrote.
Our underwriting at Driftwood Capital is equally optimistic, albeit with a slightly longer time frame for adjustment. We are anticipating a return to 2019 figures approximately two years from now, in the first quarter of 2022, and are targeting return percentages in the mid 20s IRR or higher for deals that we underwrite with our funds.
While the exact timing of a rebound in the hotel market is impossible to predict at this point, it seems likely that Americans who have been sheltering at home for weeks or months this spring will leap at the chance to travel again once stay-at-home orders are lifted.
Immediate Steps
Hotel owners and operators facing these severe market headwinds should take a proactive approach to stabilizing their financial positions, including the following immediate steps:
• Minimize cash outflows as much as possible.
• Restructure your contracts, beginning with the largest agreements and moving to the smaller ones.
• Reduce labor costs, but keep the key personnel required to maintain the property and understand the client base.
• If open for business, find creative ways to increase occupancy, such as providing shelter for out-of-town healthcare providers.
• Apply for all government assistance programs, including the new CARES Act.
• Talk with your lender about extending or adjusting your current loans if necessary.
• Communicate with your investors, and keep them informed of what you are doing.
• Explore new sources of debt capital, if necessary, to keep the business afloat.
• Be ready able to ramp up quickly when this crisis is over.
Investment Considerations
While commercial real estate traditionally is less volatile than the financial markets, investors should weigh the potential for asset appreciation, as well as long-term income, before making allocations to the hospitality sector. Here are several questions to consider:
• Is the debt in place manageable with terms that can be easily covered?
• What is the current cash flow, and is revenue likely to increase in the near term?
• What is the current condition of the property? Will it need extensive maintenance or renovation in the coming months?
• How much capital will be needed to carry the asset for 12-18 months?
• Is a bridge or mezzanine loan the most appropriate financing approach?
• If you prefer an equity investment, do you want to be a majority owner with all the responsibilities or a limited partner without an active role in management?
• How would a post-crisis rebound affect the property? Will a luxury boutique hotel in a prime location, for instance, see a faster increase in occupancy than a 300-room economy lodge off an interstate highway?
For investors seeking to diversify their portfolios, commercial real estate can be a stabilizing asset class with the potential for income and added value in the future. Nowhere are those opportunities greater today than in the U.S. hotel sector.