As the U.S. government prepares to seek a correction of the country's financial institutions, the effect it will have on the hotel industry remains unknown.
Editor’s note: This article was originally posted on 22 September 2008. The article was chosen as part of Hotel News Now’s look back at 10 years of the hotel industry.
GLOBAL REPORT—How deep of an effect the U.S. government’s proposed $700-billion bailout of the country’s financial industry will have on the hotel industry remains to be seen, but one thing is certain: Hotel owners and developers expect a rocky road ahead.
“I wouldn’t be unbuckling my seat belt any time soon,” said Neil H. Shah, CEO of Philadelphia-based Hersha Group, which has 78 hotels with more than 11,000 guestrooms in its portfolio. “We are going to keep doing what we’ve been doing albeit with more caution.”
“I would hate to be trying to enter the hotel development business in the next 18 months,” said Scott Tarwater, executive VP of development for John Q. Hammons Hotels and Resorts, a Springfield, Missouri-based company with 76 hotels and nearly 17,000 guestrooms in its portfolio. “It does (scare me for the industry). So many of the younger folks in management positions today have never faced a crisis like this. Those of us with a little snow on the mountain know these cycles come around, and you have to screw your expenses down, cut staff and the like. It’s going to be quite an education for the young people in our industry.”
Steve Van, CEO of Dallas-based Prism Hotels, also has been through several cycles, including the fallout from the savings-and-loan crisis in the late 1980s. He said there’s no telling where this current road will take the hotel industry, but that because the proposed bailout package includes commercial mortgage-backed security loans made on hotels, it will be a softer landing.
“Including CMBS in the package makes it better for the hotel industry,” Van said.
Hotel loans that were made in 2006 and 2007 could be problematic as the economic slowdown continues because some were made with such high leverage, Van said. Many of the loans were short-term loans, some of which had short extensions.
“I think a lot of them could go into default, especially if business drops,” Van said. “Special servicers are telling us to get ready. They think a lot of hotels could be in that situation.”
Special servicers are companies that focus on taking bad loans and making them current, rather than simply collecting and distributing payments.
Van said the government’s Federal Deposit Insurance Corporation hired 150 people in its Dallas office to run the national restructuring program in the banking business. Many regional banks with substantial exposure to hotel loans could be at the front of the line being taken over by the government.
“If someone didn’t borrow too much money and can make the debt service, they will be all right,” Van said. “Those that borrowed 85 or 90 percent (of a property’s value) in a market that has declining (revenue per available room) should be losing sleep at night.”
The savings-and-loan crisis of the late 1980s was followed by a couple of years of recession. Whether this scenario turns into that situation is debatable, but it will have an effect on the hotel industry.
A rocky relationship
Gross domestic product grew 3.3 percent during the second quarter, according to the Commerce Department. Randy Smith, CEO of STR, said the industry experienced an interesting phenomenon this year.
He explained that for the past 20 years, the change in demand for rooms has been closely related to the change in gross domestic product. However, that changed in the second quarter with the strong GDP showing and a flat demand for hotel rooms.
That declining demand spells trouble, particularly for hotels in cities that have traditionally had strong demand from the financial industry, Tarwater said.
“We’re pretty concerned,” he said. “Even though we don’t have properties in Manhattan, we’re keeping a close eye out. New York is going to be impacted tremendously in the next 18 months. You’re going to see big effects, and that affects the fortunes of the some of the major brands because they have a big presence in Manhattan.”
Van said a slowdown of business travelers is one effect that will directly impact the hotel industry.
“To some extent, we’re seeing the discretionary business travel cut back,” he said. “If a firm that generates a lot of business travel lays off 20,000 people, it is going to felt in the hotel industry.”
Appetite for capital
John Q. Hammons Hotels and Resorts has nine projects valued at $800 million in development—all of which have financing in place. That includes three hotels that will open during the next 30 days. However, it has about $1.5 billion in development for which it needs to find financing.
“We have an insatiable appetite for capital,” Tarwater said. “We’re meeting with our sources on how to request capital going forward. Ninety days ago we had our routine down and could do it blindfolded. It is entirely different today. There are all kinds of hoops that you have to jump through.”
Tarwater said developers should expect to be able to back up their projections as lenders will be more scrutinizing than ever.
“Our funding sources now, rather than taking it at face value, are spending a lot of time conducting more due diligence and spending time with our friends at Smith Travel Research,” he said. “If your business model cannot be substantiated by what the data comes up with, it is a difficult row to hoe.”
JQH uses Chatham Financial of Philadelphia to secure funding. JQH typically contributes 30-percent to 35-percent equity to each project.
“It’s not going to surprise me that they will require more equity, particularly if you are a newcomer to hotel development business,” Tarwater said.
Tarwater said this latest cycle isn’t a surprise to 89-year-old John Q. Hammons, the company’s founder who remains active in the day-to-day operations of the company.
“He actually predicted this two years ago. He notified all of us in the field to get ready for the financial crisis that will happen in 2008,” Tarwater said. “We all read that memo two years ago as we were flying high and thought maybe he didn’t hit the nail on the head this time. We positioned our portfolio debt-wise and secured our financing. We were as prepared for this as we could be.”
Tarwater said Hammons projects the downturn to be 18 months.
Shah said he expects the fallout similar to what happened in the late 1980s. He said the financial industry’s far-reaching tentacles into other industries is most worrisome.
“The shakeup we’re seeing is so pervasive,” Shah said. “It’s the entire financial industry. That’s what’s giving me more pause than my usual optimistic self would think.
“The intensity of it is going to exacerbate the already decelerating growth,” he added.
Shah stressed that because there will be a shift in the way business is conducted from the investment and development standpoints, it won’t change anything from the guest-service delivery perspective.
“There was clearly a bubble, and everybody knew it,” Shah said. “A lot of people turned a blind eye toward it and didn’t know what to do because it was unprecedented. Over the last year, people started realizing there were issues.”
Shah said some of the problems stem from the financial institution leaders’ belief that they could fix the problem because they had fixed similar problems in the past, but this time they underestimated the growth they needed to cover the high-risk practices in which they were participating.
Values in question
Hersha is putting several development projects on the backburner, Shah said.
With companies like Hersha and JQH forced to slow or shelve projects entirely, the focus will turn to the value of existing hotels. Those values will be greatly influenced on the condition of the debt market, according to Van.
“If this $700-billion fix applies to hotel mortgages, and it helps the liquidity of the lender, then we’ll see hotel transactions go up,” he said. “If it doesn’t, then values will be hurt.”
Van’s company has an affiliate company called REMIC Hotels, which specializes in taking over distressed hotels that default on loans. It works for lenders, and has assumed the management of more than 115 of these types of hotels over the years.
The entity’s name comes from real estate mortgage investment conduit, which is an investment-grade mortgage bond that separates mortgage pools into different maturity and risk classes. Clearly, hotels in default are a big risk.
“I don’t know if it’s going to be like ’91, ’92 or if it’s going be like 2001 and 2002,” Van said. “A lot is going to be determined by if these loans can be refinanced. (Commercial-mortgage backed securities) have dried up. Until it gets straightened out, there won’t be loans made. It could start happening in ’09, but it’s going to be a challenging year for everybody in the business.