How swiftly things can change. When it comes to the state of the economy, the much- talked-about credit crunch and the immediate outlook for the lodging industry in uncertain economic conditions, the news and prognostications seem to change day by day. During the last nine months, as the news has played out, hotel industry executives have seen their reactions go from a shrug of the shoulders to a stressed wipe of the brow, and from optimism to worry and back to somewhere in between.
“It seems to change by the hour,” quips Joe Long, executive vice president of acquisitions and development for Kimpton Hotels & Restaurants. In fact, the outlook for lodging not only changes with each passing news story about the latest banking institution to find itself in sea of difficulties, but also
with each person you ask.
Long, like his peers, knows that the situation is no laughing matter. There’s no doubt that the nation’s lending conditions are having an effect on lodging franchising and development. Just how much, and for how long, it will impact the industry is a matter that proves a little more difficult to ascertain.
Some hoteliers are preparing for a recession-fueled downturn, while others are still anticipating a year of increasing profits and more opportunities for development down the road. It really depends on what you’re looking to accomplish and what you examine.
While it’s difficult to make definitive predictions, there are a few notable facts when it comes to lending: mortgage money has become less available than it was six to 12 months ago and hotel interest rates, especially for refinancing existing hotels, have generally risen. In addition, loans that are granted come with much different terms than in the past.
“I think whether it’s for an existing hotel, and certainly for new construction, the terms of those loans—if you can get a loan—are substantially different than they were, certainly nine months ago, but even a month ago,” Long says.
But that doesn’t necessarily mean the sky is falling and that all deals have stopped. Many mid-market and limited-service chains are still reporting steady franchising numbers through the beginning of 2008. La Quinta reported 140 franchises sold in 2007. In published reports, America’s Best Franchising estimates it will open 50 new Country Hearth Inns & Suites this year.
Financing is still available depending on the type of transaction hoteliers are seeking. “You’ve got to distinguish between construction financing and regular purchase and sales financing,” says Phil Gordon, a partner in the Leisure Practice Group at Perkins Coie LLP, who has supervised the acquisitions, financing and management agreement negotiations for more than 50 hotels in North America and Europe.
Many experts in the industry say that you also have to take into account the size of the transaction. “Clearly, we’ve seen a significant slowdown in transaction volume. The mega deals—the big corporate mergers—are pretty much shut down, because that level of financing is just simply not out there,” Long says. However, individual asset deals can still be done, even if they are a little tougher.
State of the Crisis
Recently, news of trouble at banking institutions such as Bear Stearns has gained the attention of hotel industry executives. Has it changed their outlook for development in their own industry? Has it suppressed the cautious optimism that was prevalent at the Americas Lodging Investment Summit in January?
“What’s interesting as I talk to people, not just hotel real estate people, but general real estate people, is there is a general feeling is that the underlying real estate fundamentals are not nearly in as much chaos as just the liquidity crisis that currently exists,” Long says. “I think people are feeling pretty good about the fundamentals. Certainly with facing or possibly in a recession, we in the hotel business are usually in a little bit of a lag, but we’re going to start to see the effects. And I think everyone is already. You see that the big public companies have all guided down in terms of revPAR growth.”
But that’s not to say there won’t be any growth. “Clearly, the growth isn’t going to be what it’s been,” Long continues. “But I do think we still will see revPAR growth in 2008. What happens in 2009, at this point, really remains to be seen.”
Others in the industry are keenly aware that it is inevitable that the industry will feel the effects of the nation’s credit crunch. While not giving into any type of doom-and-gloom prophecy, most hotel executives are preparing for a tougher go during, at least, the next year or two.
“We knew from even the end of last year that it’s going to be a problem for us,” says David Kong, president and CEO of Best Western International. “What we’re seeing right now is more and more bad news coming out, which we anticipated. This is not to say we’re not optimistic about the future, we just have to be look at how we adjust the way that we operate, how we prepare for the crisis.”
Prove Your Worth
One of the aspects of the development market that has changed in light of the crunch is that developers are competing for less available money. That’s because, after years of granting interest-only and other favorable loans, lenders are tightening their belts and handing out funds more selectively.
Many commercial mortgage-backed securities (CMBS) lenders, the basis for financing during the last few years, are moving to the sidelines. They typically earmark 10 to 15 percent of their funds for hotel real estate. Unfortunately, many of these lenders are maxed out and no longer funding deals. “The CMBS market provided a tremendous amount of liquidity that drove down pricing on debt,” Long says. However, other lenders, such as portfolio lenders, are starting to fill the void.
One requirement for getting a development loan that has become vital now is equity. These days, equity requirements have moved from the 15 percent range, as they have been for the last few years, to 30 percent or more.
“What we’re seeing in the development market is that there is a definite slowdown,” Kong says. “We’re seeing that the credit market is increasing the equity stake.”
Many industry insiders say that in order to get funds for new construction, you’ll probably need to be able to demonstrate your liquidityl. “It’s unclear whether there is any significant amount of financing for construction available,” Gordon says. “To the extent it exists in the United States, the word we get it is that while there is construction financing avail-able, it’s of limited amounts and available only to bor-rowers who have enough liquidity so their construction guarantees are meaningful.”
According to Gordon, in these uncertain financial times, lenders are looking for hotel developers that provide them with not only guarantees, but also familiarity. “[Funds] exist for pre-liquid-qualified sponsors who traditionally have a relationship with the lender,” he says.
“The individuals who tend to build [hotels] will have to find an established, pretty good brand, that the lenders are comfortable with, but I think just as much, they’re going to have to have a lot of equity up,” Gordon continues, “and a lot of liquidity backing up the construction guarantees.”
Kong agrees, “This is when a well-established brand, a well-recognized brand, is going to fare much better. If you’re independent, you’re going to have a tough time, unless you’re a boutique in New York or something of that nature.”
Where does that leave the independent hotelier? Steve Belmonte, CEO of Vantage Hospitality Group’s Lexington Collection, believes lenders are gaining attraction to independent membership models, such as the one at his company. The reason: they want to know they will be paid back.
According to Belmonte, independent membership fees are only 4 percent, compared to steeper fees for a brand franchise. He says that hoteliers must pay their franchise fees first, before they pay back the lender. Knowing that the hotel owner is reaping more return-on-investment after paying smaller fees better ensures that the bank gets paid.
Conversion Versus Construction
With development loans getting harder to come by, will the industry see an increase in conversion rather than construction? Quite possibly, according to some.
“We’ve seen more conversion and less construction projects,” Kong says. “People are looking at reducing the size of projects.”
As Belmonte points out, “When you have a downturn in the economy and things start getting tight, hotels start becoming competitive. One of the things is that people start looking for alternatives, better ways to strengthen their return-on-investment.”
That may mean owners will start to look at other brands, other models or other management. “As economic times get tougher, owners get more anxious,” Long says. “When they get more anxious, or if their properties aren’t performing, often, they look to make changes.”
For a company such as Kimpton, which does not franchise, but manages its own and others’ hotels in upscale space, the economic environment may present opportunities to shift some growth from new development to conversions. “I think for people like us in the four-star sector, we may start to see opportunities for change of management in existing hotels,” Long says.
Looking Forward
As previously mentioned, the crisis looms larger for some than others. So which sectors and markets figure to fare better?
“I do think that the hotels in the major urban markets will feel less of an effect with respect to the economic downturn that we’re in right now,” Long says, “just because those markets have seen less new supply.”
Looking back at the trough in the late 1980s and early 1990s, hoteliers can see a similarity. At that time, the economy went south about the same time there was unprecedented supply growth just about everywhere. “We don’t have that level of supply growth today,” Long says. “There are isolated markets where there is probably more supply coming in than is necessary. The markets that are most vulnerable are the suburban markets that had fairly low barriers to entry.”
As the economy changes, some industry insiders say that because credit and money may grow tight for consumers, there could end up being a drop in occupancy, even if hotels are able to keep building. “If you look at the historical patterns of hotel occupancy in downturns, you have to be sort of dubious of both rate and occupancy,” Gordon says.
“Traditionally, in downturns, excess supply comes into the market at the very time business and leisure travel tend to go down, which puts a lot pressure on revPAR and occupancy. It has a negative effect on net income. I’m not sure that we’re going to see any dramatically different pattern today, overall.” One of the reasons the industry can withstand the crisis for a while is that 2008 got off to a good start. “We’re very fortunate, because we started the year with a big bang,” Kong says. But as we move into the middle of the year, the change is being noticed. “All of a sudden you start to see the tightening [from the lenders],” Kong continues.
That type of up and down movement illustrates the uncertainty of the moment. No one can really know exactly what will happen next.
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Surviving the Downturn
Hoteliers should stay lean and efficient in uncertain times.
In these tough financial times, hotel owners must look at their business plans more closely. A good plan can help maneuver rocky times and even increase occupancy and
revenue. The trick is to stay lean and efficient, says Seth Siegel, an assurance partner for the hospitality industry group at Grant Thornton LLP, a tax and financial advisory firm. Siegel discussed what hoteliers can do to the
expected downturn.
n Lodging Magazine: What are the main general business planning issues for hotels during this downturn?
n Seth Siegel: Developing a plan to enhance occupancy and revenues while evaluating opportunities to reduce non-critical expenditures has to be the top priority. Managing revPAR and ADR is a balancing act. Most operators will have the knee-jerk reaction of wanting to lower rates to spur demand. This is a dangerous strategy that may impact the ability to restore rates when the economy rebounds. One way to drive revenue without sacrificing rates is to create new incentives and packages surrounding amenities and services, rather than focusing on rate alone.
n LM: What can they do to keep themselves in good shape?
n SS: To best position your properties for the rebound, do not sacrifice your brand in order to achieve temporary results. Customers make lodging decisions based upon previous experiences with a brand. A full service customer expects a full-service experience.
n LM: What are some ways to stay lean and efficient?
n SS: Review discretionary spending and identify items that can be deferred or reduced. Again, there is a fine line between managing costs and impairing the guest experience. Consider reducing the hours that certain services are offered, rather than stopping the services altogether. Consider the pros and cons of outsourcing appropriate functions. Restructure your workforce and hours to minimize benefit expenses while remaining competitive.
n LM: What tax strategies should hoteliers be aware of during a downturn?
n SS: Hotels as we all know are capital intensive. We are advising our clients to evaluate the timing of capital expenditures to take advantage of economic stimulus legislation that includes bonus depreciation for many types of capital investment. Also, property taxes are one area that offers some low-hanging fruit for savings. Whether it is conducting a cost segregation study to ensure that property and equipment are being depreciated at the fastest possible rate or challenging the property tax valuations of your assets, this area is one many companies mistakenly overlook.
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