A report back was written by Rachael Rothman, CFA, ILHA Northeast Chapter board member

The International Luxury Hotel Association (ILHA) hosted its second in a series of timely and topical webinars, hosted by the NorthEast Chapter, with Navigating Today’s Hotel Financing & Transaction Environment. The webinar was moderated by Chelsey Leffet, Senior Vice President, HVS, and featured panelists: Kathy Conroy, Managing Director, HVS, Deborah Friedland, Managing Director, EisnerAmper, Fernando Mulet, Chief Development Officer, Playa Hotels & Resorts, and Rudy Reudelhuber, Managing Director, Hodges Ward Elliott.

Recovery Outlook
Chelsey opened the discussion with each panelist giving an overview of their fundamental outlook on the potential for a recovery in lodging.

“This is my fourth downturn in the hotel industry and this time actually IS different,” stated Deborah, with Kathy reminding the group that this shock is both an economic downturn and a “national health emergency.”

In past downturns, occupancy levels have hovered around 50%.  This time, occupancies are in the 20%, with some properties experiencing mid-single-digit occupancy levels. Despite the uniqueness of this downturn, demand patterns are expected to return in their traditional order:

1) Low-density leisure – for example, master-planned luxury resorts,

2) High-density leisure – for example, Orlando,

3) Business transient customers,

4) Small group, and finally,

5) Large group.

“Your mix of business will influence if your recovery curve is sooner, or if it's later,” Rudy highlighted.

Fernando commented, “factors such as airlift and government regulations and/or stimulus will also influence the shape of the recovery, particularly for international assets, and perhaps most importantly, the industry needs to send a strong signal to potential guests that it is safe to travel and stay.”

Recovery Timeline
Among the panelists, the estimated time to return to 2019’s levels varied from potentially 2022 – if only considering demand – to 2024, if talking about operating profits.

Between 60% and 65% of Rudy’s clients believe that operating profits will return to 2019’s levels ‘around 2023.’ Both Rudy and Deborah were hopeful that just as the downturn came as a big surprise, fundamentals could surprise to the upside as, “We are already seeing green shoots at some of the luxury properties in Florida and on the west coast, where on the weekends, some of them are already full,” Rudy said.

Additionally, Deborah and Kathy suggested that the tighter credit markets will limit supply growth, supporting a recovery. “We do not have any new construction being financed, and people may walk away from projects that were just beginning. So, while this tightening is painful, it will ultimately help us,” Deborah concluded.

Kathy noted the tightening of the credit markets will, “ultimately increase pricing power once demand returns.”

“The drive to leisure markets always come back first and they are coming back as evidenced by what we are seeing in Florida. This should be followed by regional commerce.  Then once people are comfortable flying they will layer-in fly-to domestic markets, and traditionally last is always the meeting and group business,” Kathy continued.

Financing Environment
The panelists all agreed that so far, lenders have been working aggressively with the borrowers to avoid default.

“Right now, we are still in a bit of a honeymoon period with lenders in terms of forbearance.  They are offering forbearance.” Deborah said. “Be sure to proactively reach out to your lenders. Do not wait to default.  Call them.  Start a dialogue. Make a plan, and be conservative, you don’t want to have to do this again,” Deborah continued.

Kathy is seeing senior debt become more limited in its availability and lenders are lending less. “When times were good, lenders were offering 70% loan to value. Now they will drop back to 60% to 65% tops. Properties will need to put in some mezzanine debt and some equity capital, or just more equity capital. So, at least for the next few years, the capital stack will look different than in recent years,” Kathy summarized.

To the degree that some traditional sources of funds may not be available, some of the brands have mobilized to capitalize on the corporate bond market and monetized their loyalty points. “They are providing lifelines to some of their customers in terms of key money or loans,” Rudy highlighted.

In Fernando’s markets, “Many of the operators learned their lesson during the 2008/2009 downturn and they have spent the last several years deleveraging. They are coming into this recession stronger than ever from a balance sheet perspective and local and regional banks, as well as Spanish banks, which have been very active in the region, have strong relationships, and continue to work with the ownership groups.”

There is financing available. Yes, some of the traditional sources of capital may not be available but are a lot of PE funds and debt funds that are forming and are out there looking, waiting, especially with all of the CMBS coming due.

The Transaction Environment
Fernando’s Playa Hotels & Resorts was one of the only public companies to enter and close on a transaction during the COVID pandemic. “In some markets it is nearly impossible to transact.  How do you conduct property tours or due diligence when government agencies are closed?  There are no attorneys you can hire, paperwork is challenging.” Fernando said.

“Deep and longstanding relationships with potential buyers who understand your markets and your assets, and identifying those with dry powder or easy access to capital, are key to getting deals like ours done in this environment,” Fernando continued.

Although there are not many transactions taking place, there are assets for sale, and bids have been coming in, “which gives us a sense for valuations,” Rudy remarked.

To properly prepare for a sale or transaction Fernando suggested that, “All owners need to make best efforts to model what the recovery will look like in their specific circumstance, and evaluate that within the context of the capital requirements of those individual properties. Try to have your own realistic view of valuation.”

Rudy’s firm, Hodges Ward Elliott had a full book of business coming into COVID, with over 100 assignments. “There hasn’t been enough time with the forbearances or regulatory allowances.  There is real hope on the part of the sellers that they are going to be able to get through the worst of this,” Rudy stated.

There have not been forced sales yet, except for a few markets like New York City where there was already oversupply and some distress coming into this. In New York, it is hard to run a union hotel with union F&B profitably, so it is likely that some supply will not come back.  There may be conversions to multifamily or residential.

According to Rudy, “Unlike the last downturn where the financial markets were unhealthy, properties had 97% or 103% financing, and the banks themselves were stretched, we went into this with unprecedented liquidity. So, even though the markets for new mortgages and even for transactions are extremely limited, we are seeing these opportunity funds, private equity funds, and they are willing to write loans.”

“The phone has been ringing off the hook with family offices that are willing to participate in the mezzanine or in some cases even a first mortgage or provide some bridge financing, with the understanding that they will be financed right back out in the first or second quarter of next year as the traditional financing comes back into the market,” Rudy continued.

Valuation
Kathy highlighted that “Valuations are extremely challenging now for a few reasons. Value is the price at which a buyer will buy and a seller will sell. There is a gap between what the buyer wants to pay and what a seller is willing to accept.  So very few transactions are taking place, which makes the valuation difficult to assess. At best we are looking at a range of values at different scenarios.”

What is causing the gap between the buyer and the seller?

The buyer’s point of view: the buyer is being asked to assume all of the market and operational risk, much of which is outside of their control, and they are often buying an asset that is operating at a loss. “If the buyer is going to assume a large market risk and operating risk, then they want a large pricing discount, which can be anywhere from 20 - 35%,” Kathy remarked.

The seller’s point of view: I realize the asset is operating at a loss, but it is just temporary. Kathy continued, “The seller is not motivated to sell if they are going to wipe-out a quarter of their asset value.”

The availability of debt capital is influencing the transaction markets.  With the debt markets more accommodating than at any time the panelists can recall – including government intervention to change accounting rules for banks and changes for CMBS – there is less pressure on a seller who likely has four to six months to figure out how to recapitalize and generate some net income.

Rudy highlighted the impact the equity markets are also having on the transaction market. His firm has run a few processes where there was pressure at the corporate level.  At the time, the sellers indicated that they would be willing to accept a 20% discount to the pre-COVID value, but the most optimistic bids came in at 25% below.

“Keep in mind, those processes were started in the darkest days of the equity markets. Equities are now up 30% and hotel REIT prices are up 100% off the bottom. By the time the bid/ask reached an equilibrium, the seller was only at a 15% discount. So, there is still that bid/ask spread. The highest and best bidder remains the seller, and they are optimistic,” Rudy concluded.

In Kathy’s view, “The most bullish scenario could be that there is a lot of capital on the sidelines with just a few properties that are distressed.  We could see a situation where the valuations don’t decline as much as the drop in net income because there is significant capital chasing the same deal.”

Fernando summarized the debate with, “Once there is a better sense for what the recovery will look like, the gap between buyers and sellers will be bridged.”

Impact on the Luxury Segment

RevPARs have fallen the most in the luxury segment, as luxury guests ‘can afford not to travel’ but ‘when the market gets going again, those are the types of properties that will rebound strongly.’

In Rudy’s view, the supply picture in luxury lodging is better. “Luxury hotels will hold their value better. The barriers to entry in true luxury in terms of location, large upfront capital investments, and in some cases environmental regulations, just to name a few, which present challenges to new entrants.”

“From a capital perspective, “there is a lot of interest from buyers who are not necessarily concerned with the return. Personally, we have top bidders for what we call ‘Better than Treasury’ real estate,” Rudy continued.

Deborah cautioned the participants, “Luxury hotels are labor and capital intensive. The costs to operate are astronomical and they are difficult to operate.”

“It is worth doing significant due diligence before moving forward with that type of asset.  You really need to know what you are doing and what you are getting involved with, before you take on a luxury property,” Deborah continued.


The Role of Branding

From a guest standpoint, as the industry rebounds, Fernando stressed the importance of guest confidence and feeling of safety that comes with a globally recognized brand.

Fernando believes, “The luxury and upper-upscale all-inclusives will outperform the market because of the power of pricing certainty and transparency, and because customers are focused on safety, quality and trust. Guests want to know, who the operator is, what the brand is, and the protocols, and standards of operation behind them.  Premium, globally recognized brands, will be perceived as a safer hotel after we come out of this crisis.”

Deborah agreed, “My first instinct is that the brand would bring trust.  You know what you are going to get.  You know what to expect, and you know that the brands are putting the policies and procedures in place, which is very structured.”

“Right before this, we were in this communal/coworking/shared resources/get out there and explore exotic destinations. Now it is completely different. There is a flight toward safety and a brand that customers feel they have confidence in,” Deborah continued.

“On the other hand, a lot of clients are frustrated with some of the large brands in terms of getting out policies on cost control, furloughs, should the owner open/close/what the cost structure will look like. The brands need to remember, the ownership groups are their customer and the customer is always right in our industry.  The brands that put the owners first, and make sure that the policies and procedures are followed, are the ones that will be remembered,” Deborah emphasized.

This webinar was sponsored by Elavon, a subsidiary of U.S. Bank, a leading provider of payment solutions for the lodging industry. They help hotels and resorts accept and process all payment types in any environment - in-person, online or on-the-go. Their flexible, secure global platform offers a reliable and fast transaction and seamlessly integrates into most PMS and POS systems. Hoteliers can trust them to keep up with the latest trends, like touchless payments and device sanitation, so that they can deliver their guests the exceptional experience they expect.

Join the next webinar on Traveler Trends and Drivers of Behavior post-COVID-19 on Wednesday, June 3, at 4 pm ET, with Anna Domingo, Founder, PADZZLE, moderating and Jerry Henry, Chief Executive Officer, H2R Market Research, Dr. Brent Smith, Professor of Marketing / Chairperson, Department of Marketing Communication, Emerson College and Joni Newkirk, CEO, Integrated Insight, Inc.

The International Luxury Hotel Association is offering a Name Your Price Membership for May to support the hotel industry as well as access to their online training program Luxury Hospitality Standards, which teaches four comprehensive courses aimed at elevating guest experience.

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