The latest interest-rate increase isn’t setting off any alarm bells about the cost of debt, but hoteliers believe this is the time to act on acquisitions or refinancing loans before rates go higher.
REPORT FROM THE U.S.—The Federal Reserve raised interest rates another 0.25% this month, but the amount of the increase is overshadowed by the apparent new pace of increases and the confidence in the economy to allow for it.
This increase comes only months after the Federal Reserve last raised interest rates by 0.25% in December 2016, one full year after it raised rates by that percentage for the first time in seven years.
Jim Butler, founding partner and chairman of the global hospitality group at law firm Jeffer Mangels Butler & Mitchell, said he doesn’t know of anyone concerned about interest rates, since those in the U.S. hotel industry have been anticipating this move for years. Interest rates have remained at historic lows for a protracted period of time, he said, and the only remarkable thing about the recent increase is how long and how low they have been before it.
“They inevitably had to go up,” Butler said. “There’s an improving job market and seemingly economic stability. I think people would have been more concerned if the Fed hadn’t raised rates.”
Now it’s time to see how much rates increase from now on and how quickly, Butler said. That means watching how lenders react and whether they’ll shift from 10-year, fixed-rate loans to only adjustable rates. The other question is whether borrowers will take that, he added.
Signs of the economy
While his company would prefer to see interest rates remain as low as they have, Michael Everett, chief investment officer at Sage Hospitality, said the move shows an increased level of confidence in the U.S. economy. The Federal Reserve sees growth coming, he said, and a higher interest rate implies additional inflation.
In the context of what a rate increase means, it’s not the worst news in the world, he said.
“If the Fed’s seen enough signs of growth starting to tick up above relatively low (gross domestic product) growth the past couple of years, that bodes well for us,” he said.
The economy in general is signaling it has not only turned a corner, but there’s a nice runway ahead for steady growth, said Andy Chopra, principal and chief investment officer at Banyan Investment Group. The headwinds of the past 10 years are dissipating, he said, and the economy is showing sustainable and stable trends in unemployment and GDP growth.
The U.S. hotel industry has seen several years of steady revenue-per-available-room growth, he said, though it has slowed a bit recently. Businesses are spending money and hiring new employees, and people are traveling.
“We’ve seen a tremendous uptick in business travel, which means leisure is not far behind,” Chopra said.
Making a move
With the Federal Reserve signaling more increases in the near future, the cost of debt will grow incrementally more expensive.
There might still be some time left to refinance before rates continue to increase, Butler said, but most owners either already have or at least should have by now. Those who have recently refinanced when rates were even lower should have several years before needing to take any further action, he said.
Sage Hospitality is interested in refinancing any property that’s a candidate within its portfolio, Everett said. Rates will move higher throughout the year, he said, and lenders have more dollars to put to work earlier in the year. Those two factors combined make his company a little more eager to consider refinancing now rather than in years past when hotel rates continued to rise consistently, he said.
“We’ve turned a corner where we’re getting to the point of where we want to do it sooner,” Everett said.
At this point, if they haven’t already, owners will try to get into fixed-rate scenarios while larger lenders would like to move to variable rates, said Nitin Shah, chairman of Embassy National Bank and president of Imperial Investments. Many of the larger lenders still aren’t lending, he said. Local banks generally loan with a flexible rate while bigger nonbank lenders can give fixed rates.
Properties can still likely qualify for fixed-rate loans of 5% or 5.5% for the next five to 10 years, Shah said, but owners will need to act quickly and the value has to be correct with a good sponsor. Down payments might need to increase as well, he added.
Banyan Investment Group is primarily about acquisitions, not development, Chopra said, and company executives look for predictable and relatively risk-adjusted yield. The last 12 months have created some challenges for asset purchases, he said.
Likening it to a blessing and a curse, Chopra said RevPAR is so high that it’s led to high values for hotels. Combined with higher RevPAR, this translates to high net operating income. The historically low yields of U.S. Treasury bonds mean debt is relatively inexpensive, he said. In the current environment, such assets won’t provide the type of consistent and safe yield in which investors are comfortable with.
“A rise in interest rates corresponding with rise in treasury bond yield means that cap rates have effectively risen,” Chopra said. “That should hopefully bring pricing down to level to make it comfortable to achieve the yield we need to. With rate hikes ahead of us, this will be an environment attractive to acquiring.”
Predicting where rates will go
The Federal Reserve has signaled another two increases this year, but Butler said he doesn’t expect anything drastic.
Barring some problem or other reason necessitating a change, there’s no reason to shock the system right now, Butler said, adding that he doesn’t expect the Federal Reserve to push rates too high or move too quickly. Businesses hate uncertainty, he said, and having a predictable and reliable schedule gives companies the opportunity to plan ahead.
“Members of the Fed aren’t typically people looking for radical changes to the system,” he said.
Any time rates start to go up, it’s happening for a reason, Chopra said. The Federal Reserve has its ears to the ground to make sure it’s not too aggressive in its strategy to raise rates, which could cause the economy to sputter out too soon.
The Federal Reserve will likely keep increasing interest rates as much as the economy can handle it, Shah said. At some point doing so will start to hurt, he said.
“Relatively, rates are still cheaper (than in years past),” he said. “Still, if you do it quarter after quarter, then we will see a certain impact on the bottom line.”