NOW is the best time to buy or sell a hotel in many years

by Jeffer Mangels Butler & Mitchell LLP
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A version of this article was first published in the September 21, 2013 issue of Hotel Business.

The number of hotel transactions is up by more than 50% for the first 6 months of 2013 over the comparable period last year, and is expected to top $18 billion for 2013, according to Jones Lang LaSalle. And HVS reports that the sales transaction volume of hotels is now intersecting its 22-year moving average, and predicts that hotel values will continue to grow at an average of 12% for each of the next 3 years (substantially less than the past couple of years, but still a nice increase in value).

These numbers are only the tip of the economic iceberg that hotel owners and investors analyze in depth, to help make decisions as to the right time to buy and sell hotels. As they delve deeper, they are finding a confluence of economic and market conditions that spell "opportunity."

But how can it be a great time to buy and sell hotels? Why does the same environment indicate such different courses of investment strategy?

We will look at some of the factors that create this fertile ground, while keeping in mind that every owner and investor has a specific circumstance, investment horizon, capital situation and objective, and every hotel property has a specific condition, value, and potential for additional appreciation.

Why NOW is a good time to SELL a hotel

  1. Embattled owners can cash in their chips. With hotel values now reaching their 2006 peaks, many owners who were unable to refinance during the recession are discovering they can get out of underwater mortgages and sell their hotels at a profit. For many such owners, the investment horizon is past, and selling is more attractive than dealing with ongoing operating and financial challenges.
  2. There is an active market for hotels. The number of hotel transactions is up -- investors are looking for properties and the market is generally favorable to sellers right now.
  3. Robust, cheap financing is available. For existing assets with cash flow, financing is available -- as cheap as 4% fixed rate 10-year money for prime assets, and only a little more expensive for other products. Low interest rates make it easier for buyers to execute their purchase and to bid higher prices (due to the low financing cost).
  4. Interest rates have just begun to rise. And it is likely that interest rates will continue to rise. Higher interest rates take value away from a seller, as buyers calculate their IRRs with more expensive financing and fewer buyers can make a deal pencil out. The current environment for interest rates suggests that sellers should sell now so that buyers can take advantage of these record low rates.
  5. Values have increased. In part, this is due to record-low supply growth these past few years. That is about to end. New hotel developments in the pipeline will increase supply in the next couple of years, creating competition with older product, making it harder to continue RevPAR and profit increases in the future. Some cities have more than their proportionate share of new development, such as New York City, which presently has 11,534 rooms (or 10.9% of the existing supply) under construction.
  6. Improvement in hotel industry fundamentals is likely to moderate. Although occupancy growth is projected to be less than 1%, in 2014, ADR is projected to compensate somewhat to RevPAR, projected to grow at 5.8% for the next two years [something missing here - I don't get this]. Of course, conditions will vary by market. Some markets have recovered quickly and will likely moderate value increases for the next several years. Others may enjoy substantial growth at least for a couple years yet.
  7. Danger of eroding NOI. The erosion of NOI, as expenses and competition increase, is a concern at both the individual property level and industry-wide level. As cap rates are projected to remain stable for the next several years, any reduction in NOI will have a direct negative effect on hotel value. The list of challenges include competition from the new supply coming online, increased labor costs from unionization and rising wages, health care, energy costs, ADA compliance, government regulation and taxes, capital costs to maintain or improve properties, and the costs of amenity creep and brand management keep going up as more fees are charged to managed or franchised properties.

All of these factors indicate to many hotel owners that NOW is a good time to SELL a hotel.

Why NOW is a good time to BUY a hotel

  1. Hotel industry fundamentals will continue to improve. However, they are projected to improve at a slower rate in most urban markets, and at varying rates in other markets and market segments.
  2. There is room for substantial appreciation in value in many markets. This is due solely to improvement in market conditions and values in general. For example, HVS projects that hotel values will increase an average of 40% through 2016. In the top 10 markets for value appreciation, however, the projected value increase ranges from 44% to 73%. The top 10 list includes Richmond (73%), Tampa, Miami, Jacksonville, Phoenix, West Palm Beach-Boca Raton, West Palm Beach, Orlando, Cleveland, and Oahu (44%).

    On the other side of the coin, the 10 markets with the smallest value increase are projected to increase in value from 6% to 19%. The bottom 10 markets are Washington DC (6%), Rochester, Tucson, New Haven, Boston, Wilmington, Albuquerque, Dayton, Los Angeles and Denver (at 19%).

  3. "Value add" opportunities will increase the upside. Veteran investors are identifying capital-starved hotels that are poised for increased profitability. Experienced teams can analyze a property to determine what level of capital infusion is needed to meet market conditions and/or PIP requirements. They can also determine if new hotel management will increase profitability. By adding value in strategic areas, knowledgeable investors are turning languishing properties into a valuable assets.
  4. Interest rate increases will widen the "gap" in seller and buyer expectations. Rates appear to be on the rise and it doesn't look like we will see financing this cheap for another cycle, if ever. It will be easier to cut a deal when financing is cheap and plentiful. It can't get much better than it is now, so it is better to buy sooner than later!
  5. Experienced professionals can help close deals and protect your investment expectations. The good buying opportunities will go to those who can find opportunities, field an experienced due diligence team and are prepared to close in short order. Not all hotels for sale will be good opportunities. More than in less volatile times, values will depend on market dynamics, hotel condition, positioning, management, brand and adequate capital. Experienced professionals will advise buyers to pass on deals that don't make sense. Savvy investors will put together a team of professionals who provide great due diligence and analysis.

A good time to buy or sell

Depending on many factors unique to each owner or buyer, the market, the hotel property location, condition and potential, 2013 and 2014 will be a great time to buy or sell a hotel.

Don't be daunted by the prospect of challenges! The industry will always face challenges in driving increases in the top line revenues while controlling ever-increasing costs. Experienced management and ownership will find it is the same song, just a different verse. Experienced professionals can provide analysis and guidance to both buyers and sellers.

We believe that 2013 will be a turning point for hotel transactions as well as for new hotel development. It's a great time to be in the hospitality industry!

How to Buy a Hotel Handbook - a Global Hospitality Group® Resource

We invite you to register and download your free copy of our How to Buy a Hotel Handbook at the Resource Center on HotelLawyer.com. Published in March 2013, the How to Buy a Hotel Handbook is based on the experience our Global Hospitality Group® members have gained from more than $60 billion of hotel transactions involving more than 1,300 hotels all over the world. The Handbook provides a detailed overview of the hotel acquisition process, a thorough due diligence checklist, and informative articles that address some of the most important questions that arise when buying or selling a hotel.


 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Jeffer Mangels Butler & Mitchell LLP | Attorney Advertising

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