A look at factors such as industry growth and interest rates shows how they affect where buyers and sellers sit within real estate cycles.
As hotel owners, investors and operators, we are conditioned through experience to think and respond in terms of “textbook” markets and investment cycles.
After a period of marked slowdown, business activity rebounds, markets recover and occupancy and average daily rate improve. The resulting robust operating returns spawn new build plans and attract new investors, eventually leading to new construction and a resulting growth in supply. At some point, that supply begins to exceed demand, with some geographic and property class segments being affected more than others. Occupancies flatten or perhaps decline. At some point, supply and demand rebalance and, as the marketplace regains strength, the cycle begins anew.
Within these real estate cycles, there will always be buyers and there will always be sellers. On which side of the equation one sits depends on many factors. Those factors include interest rates, bank lending requirements, rate of new capital entering the market, investment resources, goals and strategies of specific entities, i.e. public vs. private capital and, to a certain extent, brand requirements.
Another contributing factor might be the need for a brand-mandated property refresh and capital improvements expenditure, or the conversion of a property from one flag to a new one, which often prompts a transaction.
In today’s environment, a new chapter is being added to the textbook.
CBRE notes that “2018 will mark the ninth-consecutive year of rising occupancy, something we have not seen since the 1990s. While the slow growth in occupancy does indicate we are at the top of the business cycle, all factors indicate that we are in the midst of a record breaking, sustained period of prosperity for U.S. hotels.”
If these projections hold, it will also mean “a ninth consecutive year of growth in (revenue per available room,) total operating revenue and GOP in 2018.”
Starting at the end
Where does this record-breaking run leave us with respect to the investment marketplace?
It relates back to investors and desired outcomes.
Some investors identify opportunities in value plays. Anticipated improvements in revenue management, cost efficiencies and other value engineering can lead to improved revenues and asset values, as can changing a flag and other market repositioning strategies. For these investors, the goal is to exit quickly upon achieving these ends.
For others, the plan is to build a portfolio by adding quality properties with the longer-term view.
Regardless, the strategy should be to start with the end in mind; to look at any new deal with a clear exit plan.
The new chapter mentioned earlier presents an interesting paradox. During this historically strong run for the industry, many hospitality investors have achieved their forecasted or intended value-add “ahead of schedule.” Whereas the initial plan may have been for a 36-month hold, the script might have been flipped in little more than a year. Yet for many private equity investors, the answer has been to stick with what was has been doing well, re-penciling the pro-forma and forecasting a longer hold, perhaps even a refinancing.
Whatever the market situation, capacity and new supply are always an important consideration. Right now, the construction pipeline remains active, fueled in part by the introduction of new brands and brand concepts into the marketplace. However, the recent severe natural disasters in Texas and Florida have only exacerbated what have been ongoing issues with construction capacity and costs, of both materials and labor. Overall, while these pressures are market specific, they should impose a braking action on construction.
Thus, slowing absorption in many markets bodes well for existing operators with strong fundamentals. These blocking and tackling fundamentals include excellent application of today’s best operational technologies and administrative efficiencies. Such strategies will help solve an operating challenge that we all face: the costs and availability of employees in an otherwise strong economy.
As we move into the New Year, we will watch for signs of a destabilizing hospitality marketplace, which might include stagnant or negative RevPAR and decreased operating profit.
Regardless, there will be good “deals” out there for everyone, depending on one’s appetite for risk, access to capital and investment philosophy. These will include opportunistic buys of properties, including those that have fallen behind in maintenance and capital improvements, to small private portfolios selling as part of family succession planning.
However, as we have discussed, some investors are now comfortable with longer holds on the “properties they know,” for all the right reasons—strong operating revenues and gross operating profits, along with even greater potential for asset appreciation.
Kerry Ranson, a 21-year veteran of the hospitality industry, is chief development officer at HP Hotels.
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