As so many aspects of the hospitality industry have been affected by the COVID-19 pandemic, many questions surround the business of buying and selling hotels.
“It has essentially brought the transactions market to a halt,” said Dennis Hopper, managing principal of hotel brokerage and advisory firm DSH Hotel Advisors. “Any transaction that was already in the works pre-COVID-19 may have continued to still get closed, some of them fell apart, and others continued to move to the closing table, oftentimes with re-trade or renegotiation of price. But a lot of them fell apart due to lending becoming unavailable. Any new transactions since COVID-19 has started have been very limited; there aren’t a lot of transactions taking place so far, so it really has brought things to a standstill.”
According to data from Real Capital Analytics, globally, hotels have been the asset class most impacted by the pandemic. Sales of hotels were down 50% in the first five months of 2020 compared with 2019 and just 113 hotels sold worldwide from April to the end of June. By comparison, more than 850 sold in the second quarter of 2019.
The company also reports that in the U.S., 48 hotels were sold from April 1 to June 28, for a total transaction volume of $678 million. On average, the market has traded $2.8 billion a month in the last five years. Moreover, few large assets are selling, and the average lot size of the traded assets has fallen by a third in comparison with the five-year average.
Like many other companies, hotel advisors Mumford Company started out 2020 with high expectations. “We had the best year we have ever had in 2019,” said Ed James, managing principal, Mumford Company. “We started 2020 with a wonderfully deep pipeline of hotels under contract or agreement of some fashion. Property-level operating metrics were strong and getting stronger. In mid-March everything came to a crashing halt. In terms of the transactions market, we had deals that were too far along to stop. For example, all of the funding had been committed. All of those deals went ahead and closed. We got five or six of them done regardless of what lay ahead; they were not cancellable.”
He said this happened all around the industry. “The ones who could terminate for whatever reason, whether it was still in due diligence or even leaving some hard money on the table, they did over the course of that six- to eight-week period; everyone who could cancel then did,” he said. “We came to a grinding halt. The capital markets were frozen initially, and to a certain degree they still are. But we do have people looking at things very selectively.”
Michael Sonnabend, managing member of PMZ Realty Capital, said that all but one of the company’s deals went on pause after the pandemic hit. “At the end of February/beginning of March, we had $300 million of financing transactions in process,” he said. “Only one of those deals closed and the others are on the back burner. I think that a lot of them will happen. But the question is are they going to happen in three months, six months or later? It is very dependent on the market and the type of asset.”
Sonnabend advises against owners selling their properties unless they need to. “If a seller doesn’t need to sell as we sit here in the middle of 2020, they should sit tight,” he said. “If buyers can find sellers who want to sell properties, it’s a distressed [asset]because there has to be a reason they need to sell now. Buyers can find that, but I think you are in a situation where there is a lot more capital than there are transactions. There is a lot of money raised and I think there are a lot fewer distressed assets available than there is capital.”
Kevin Mallory, global head, CBRE Hotels, said that there was a lot of equity wanting to invest in the sector early on in the pandemic. “There was a big ask spread between sellers and investors in that point in time,” he said. “As we started to talk to prospective investors…what investors really wanted was a 35-40% discount early on to 2019 values and the sellers just weren’t willing to go there. If I were to describe the ask from sellers, they were probably willing to trade at that point somewhere between a 15% and a 20% set discount to 2019 values.”
That disparity kept deals from happening.
Some experts believe that capital is hard to find. “We are starting to see it loosen up a little bit, but it is still very limited,” said Hopper. “A lot of SBA lenders are not really active right now. They are waiting for the dust to settle and to see how everything shakes out. There are a lot of SBA lenders who are active, but the properties have to fall within SBA parameters—so more of the smaller hotel deals basically. Some of the smaller transactions can still happen, and we are seeing that pick up this month. We are moving deals up to agreement and up to contract, but a lot of them are under $10 million.”
Bruce Kinseth, EVP, Kinseth Hospitality, believes that many lenders are taking a wait-and-see approach before they will make capital available. “A lot of lenders have taken a pause and said, ‘Well, we are going to wait out the next few months just to see what happens,’”he said. “I haven’t heard anyone say that they won’t be back into it in a year or six months, but we need to see how this recovery takes place if occupancies were mid-teens nationwide in April. May popped up to 30% and, setting aside the dense corporate markets or big group hotels, it popped up a little bit more. In the reflection, lenders are saying, ‘We need to see our current portfolios rebound to some level of debt service coverage, so we see the improvements happening; if the industry stays down at even 40%, that is way below where we hit in the recession 10 years ago.’”
If there is capital out there, it comes at a price. “The short answer is yes, there is some expensive acquisition capital out there for people who need to borrow today,” said James. “That is always out there, but the key to getting competitive acquisition financing is the ability to give some projections that are based in some sort of solid data. The problem is today we are not yet in a position where we can safely say we are on the way out of this, or that there is a reasonable expectation that a year from now we will be at x level of occupancy. There are simply too many uncertainties with the virus today to be able to do that on a regular basis.”
Mallory agreed. “The financing markets for hotels have not returned,” he said. “If you are able to locate an investment opportunity, assume that there are going to be costs incurred in carrying that investment opportunity before it can reopen and start to get positive cashflow. They are not going to be able to obtain financing at reasonable rates or at reasonable leverage levels relative to what they could do in the past. That is going to impact pricing as well. Then there is uncertainty around time. How long will it take for the markets to recover?”
Many lenders worked with property owners in the early days of the pandemic to help them survive the difficult situation. That was the case with Access Point Financial. “The immediate focus was what do we have to do with respect to the existing portfolio that we have?” said Dilip Petigara, CEO of the company. “What are the needs of our borrowers? We focused on a 90-day window at a time. The initial April, May and June with the initial modifications and forbearance if you will, whether it was a payment deferment or whether it was some sort of partial payment or interest-only, or whatever the case may be—whatever the borrower was able to handle, we went through and accommodated that and made those modifications.”
While many hotel owners have been buoyed by their loan forbearance and—if they were able to get them—PPP loans, those funds won’t last, and lenders cannot continue to allow for loans to go unpaid. “Over the next few months, those forbearance periods will burn off, those covenant reliefs may revert back to the original covenants and any subsidies that may have been put in place by the government that owners may have taken advantage of may be burned through, as well,” said Mallory. “Unless we have additional relief from government or from lenders, these properties will start to go back to the lenders. Banks, special servicers, insurance companies—these are all lenders that will be seeing hotel properties come back to them.”
Sonnabend thinks that lenders will continue to work with property owners to prevent takebacks—to a point. “The majority of the lenders are not interested in taking over the properties, and they will work with borrowers who are reasonable and have requests to restructure deals in a manner that works for the lender and the borrower,” he said. “You can’t just have a one-way street. If the lender proposes something that leaves nothing for the borrower, or the borrower proposes something that puts all of the onus on the lender, that is a difficult situation.”
He continued, “Part of the problem also is the amount of deals that all went into trouble at the same time. The lenders or the special servicers were not staffed up to be able to handle such an onslaught because the markets were pretty good. They went from a default ratio of maybe 1-2% to 15-20% in 30 days, which is a tremendous amount of transactions.”
Those takebacks will lead to sales by the lenders. “The next wave of transactions will be forced liquidity transactions where an owner has given up the property and ownership has reverted back to the lender or another financial investor,” said Mallory. “Many of those folks do not want or cannot be owners of hotel real estate. A lender isn’t going to want to be in that position either to have to pay real estate taxes and other costs. They are going to have outflows as well.”
He continued, “They are going to look really hard as to whether they want to own that property, to sell it at a future date—and feed it over that period of time—or whether they want to sell it immediately. Lenders may not be capitalized at a level to hold on to any number of hotel properties as well. Where are they going to get the cash to maintain these hotel properties?”
With the potential for buybacks and distressed sales, buyers will be looking for bargains like those described by Mallory early on.
“There is a huge segment of opportunistic buyers who are essentially waiting for any potential discounted properties to hit the market for sale: lender-owned properties or distressed properties offered at discount,” said Hopper. “That is the bulk of buyers right now. Everyone is waiting for an opportunistic deal to hit the market. They want as big of a discount as they can possibly get.”
James saw these opportunistic buyers almost immediately after the pandemic struck. “The phone began to ring almost immediately with people looking for distressed sales, but they haven’t really come to market yet because of those issues of forbearance and relief,” he said. “The pressure is really not yet on the sellers. It will be eventually, and hotels that were not necessarily under water, but buyers who are heavily leveraged, a lot of those properties are going to have to come back to market and they will be sold at pretty significant discounts the way they were before. The bargain hunters will no doubt be looking for that.”
Sonnabend believes that, because times were good before the pandemic hit, the transactions market will rebound. “I am optimistic,” he said. “There is a lot of capital out there and in previous downturns—after 9/11, after the great financial crisis—things started to come back when capital was ready to invest because if there is capital to invest, there are always hotel buyers and sellers who want to do deals. The main thing that holds back transactions is the ability to finance them. There was a lot of capital a few months ago, and while it may be sitting on the sidelines now, it didn’t all disappear. I think that as we get into the latter part of the summer and the end of the third quarter, we will see a lot more transactions and capital coming back into the market.”
He continued, “The fact that things were going well will help people bounce back and help transactions happen quicker, because if it was on a long downward trend, you would have economic issues beforehand, plus the pandemic issues. Here, we didn’t really have a lot of economic issues causing problems; it was just the pandemic, which was no fault of lenders, no fault of borrowers. It was no one’s fault, so they are not looking and saying the properties are overleveraged by the borrowers or overleveraged by the lenders. It was just an event that no one had any control over.” HB