Interest rates in the U.S. have gone down (with signs they will continue to drop), so hoteliers should act now to take advantage of lower rates with new development, refinancing and transactions.
For years, I’ve been expecting interest rates to go up. They had to. They couldn’t stay this low for this long while the economy simultaneously grew. At least that’s what I thought.
I have been preaching this to my clients for years. And I felt vindicated when the Federal Reserve began raising short-term interest rates a few years ago. But that didn’t last. Now the Fed is cutting short term rates, and long-term rates have dropped too, occasionally below short-term rates, resulting in temporary yield curve inversion. What’s an adviser to do?
Following the pathway of Europe and their trillions of dollars of negative yielding debt is one potential outcome to plan for. In Denmark, some home mortgages are even negative yielding. The other pathway is a rising rate environment that comes unexpectedly. Political uncertainty and the length of the recent expansion are likely to keep rates low in the short term. But because many experts are predicting that, expect rates to increase dramatically, without warning.
If the previous two paragraphs tell you anything, it’s that nobody knows what will happen to rates, but we know that rates in the mid to high 3% range for hotels is exciting. The downside is new supply coming to market that probably shouldn’t, but the upside is far more powerful: high debt service coverage ratios. Most deals financed today, even at peak leverage, are operating at DSCR levels that provide powerful coverage. This is great for owners, bondholders, portfolio lenders and just about all industry participants. Ten-year fixed-rate mortgages have not been priced this low—ever.
And for those borrowers who are financing now, their risk of DSCR issues over the next 10 years is very low. Thus, default risk is extremely low. Despite the rating agencies’ attempts to enforce phantom rates on underwriting, real-life operators can breathe easily knowing that their cost of capital is going to make their lives painless over the next 10 years. This is going to result in industry stability just when it’s needed, given the threat posed by short-term rental sites.
With that, all borrowers should consider long-term fixed-rate debt. Even if interest rates on government bonds go negative, hotel mortgage rates in the U.S. are unlikely to follow. And the risk that rates rise is probably higher than we all think, since almost nobody is expecting it to happen, a typical harbinger. For those owners in the midst of a property-improvement plan, building a new hotel, refinancing an existing property or buying a hotel with upside, now is the time to reduce risk by locking in low rates. Even if we face an economic downturn, coverage ratios will be the barrier that ensures default risk stays low.
Even though most would argue that we are late cycle economically, with rates this low, it’s time to be aggressive in terms of leverage and financing. With rates starting with a 3 handle, we all might look back at this era and wonder why we didn’t finance every single hotel and item in sight.
Zak Selbert is the founder and CEO at Vista Capital Company. Vista is a real estate investment banking firm that specializes in arranging financing for hotels. Selbert can be contacted at 310-285-3803 or firstname.lastname@example.org.
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