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It is no secret that hospitality has suffered a fair deal in the wake of the COVID-19 pandemic. Plagued by capacity restrictions, annual traffic at TSA checkpoints plummeting by close to 60% from 2019 levels, along with significant curbing of business travel, the industry as a whole has fallen victim to low occupancy rates and a reduction in attention from the investment community.
As investors and lenders evaluate their portfolios and risks in the wake of the pandemic, uncertainty persists, casting particular attention to the importance of cash management surrounding hospitality assets. In response, many recent loan modifications require that borrowers establish a debt service reserve, along with substantial principal paydowns, to cover for unanticipated shortfalls in cash flow. Similar risk mitigation tactics are also present with new loan originations, further signaling uncertainty.
The degree of severity and likelihood of a recovery for this asset class is surprisingly inconsistent. According to data published by Reonomy in their recent report “Big Money: Portfolio Insights from Institutional Managers,” which takes a look at 35 major institutional real estate owners and their recent investment activities, the factors most heavily influencing the divergent nature of this asset type are both geography and classification (i.e. luxury vs. economy).
What large investors tell us about appetite for hospitality and valuations
On average, major investors, comprising real estate focused managers, alternative investment managers, bank affiliates, insurer affiliates and residential specialists, with significant portfolios of at least $1 billion of US commercial property owned at year end 2020, invested only $3.82 out of every $100 into hospitality—down from $8.59 invested in this property type in 2019.
Put into perspective, large investors allocated approximately $26.70 out of every $100 into multifamily and a whopping $42.60 out of every $100 into office at a time when corporate America saw unprecedented office closures.
When sliced another way, a different narrative emerges. The average price paid by large investors toward hospitality was $85 per square foot, down 59% from the previous year, suggesting a shift in preferences from full-service to more budget and economy opportunities in the space.
Recent analysis from a CBRE report provides additional color to the state of luxury hospitality assets, highlighting that closures for luxury hotels at the end of Q1 2021 landed at 16%, while the “closure rate of all hotel properties stood at just 4.6% during the same time period.”
The relative uncertainty of the effects of COVID on Hospitality, specifically in luxury hospitality assets, has made it difficult to assign property valuations to properties. This is a challenge experienced by both investors and lenders.
An urban exodus, albeit temporary
In addition to the massive hit to luxury lodging in 2020, hospitality in urban centers has experienced a devastating blow. CBRE’s recent report on “The Future for the Lodging industry” cited unprecedented decline in “revenue per available room (RevPAR) in markets like New York City, San Francisco, Chicago or Washington, D.C. [as figures]… remain[ed]over 80% below 2019 levels.”
Those same markets recorded only 15% occupancy, as cited in the same report. These primary markets, which typically depend on business and group travel, have suffered a sharper decline in occupancy rates, which recorded a 54.45% decline, compared to a 42.4% decline for the rest of the country. As a result of these vacancies, building conversions are materializing, particularly in New York, where the volume rivals records seen in the 1980’s. In these cases, hospitality properties across the spectrum of location and classification are being flagged as conversion opportunities into both housing and offices.
With the economy continuing to recover post-pandemic, demand for urban hotels is expected to increase due to pent-up demand for business travel as a more remote workforce seeks opportunities to connect in-person with colleagues, clients, and others in their network at conferences and conventions.
The widespread rollout of vaccines will accelerate the desire for face-to-face interactions and large investors will continue to look to TSA throughputs as a leading indicator for hotel demand after annual traffic at TSA checkpoints fell drastically in 2020.
Lending policies and the recovery of hospitality
In investigating the impact of the pandemic on hospitality in 2020 through the lens of major investors and other industry leading reports, it is reasonable to conclude that economy assets and those outside of urban centers will be the quickest to recover. Luxury properties and those within urban areas were hit hardest and will therefore see a prolonged return to normal.
As the vaccine continues to roll out, business and group travel will inevitably return to stronger levels. Difficult to ignore is the value attributed to in-person business travel. Oxford Economics, for example, found that “eliminations of business travel reduces profits by 17% in the first year.” ROI-motivated decisions, paired with a desire to connect and network in-person will push occupancy rates and investment attention in the direction of recovery.
Even with an optimistic view of the recovery and the future of hospitality, lenders are maintaining their COVID-era policies of requiring substantial principal paydowns in order to address the instability of inflation fears during the recovery. In April of 2021, inflation for hotels and restaurants registered at 3.9%, representing a 387.5% increase from the same time last year and well above the long term average of 2.51%. With inflation comes concern with consumer spending, however, occupancy rates are telling a more promising story. For example, recent figures confirm that rates have climbed to approximately 60%, showing an appetite to engage, despite inflated costs.
There are questions as to whether or not inflation will stunt the recovery of the hospitality sector and whether or not lenders will maintain tight restrictions and continue to require debt service reserve. With that said, occupancy rates show positive momentum as we continue into COVID recovery.
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