March 20 2009
By Joel Ross
There have been various parties commenting recently that development is alive and well and that we just need to look at the construction pipeline numbers to see a strong outlook. In light of the worst downturn in the industry in possibly 80 years, why would anyone think that a lot of new rooms coming online is something to cheer about? It is a terrible piece of news. The last thing we need is more supply.
The suggestion that if you want to build a under $10-million hotel you can find the money simply is not reality. I have been trying to find anyone who can prove to me that there have been new construction loan closings and funding for hotels since 1 January, 2009. So far, nobody has come forward with this evidence. I assume there is some bank out there that does not read the news or does not understand the hotel industry and made a construction loan, but that would be the rare exception. I have heard of banks offering to do such loans, but they require compensating balances, personal guarantees, high rates, low leverage and other terms that make the loan very unattractive.
I suppose that if you are determined to lose your money you can go forward with new development at this time. But why would anyone do such a thing? If you really want to own a hotel, just be patient. There will be plenty of them coming back to lenders during the next two years. You will be able to buy at 50 percent or less of original value and far below replacement cost. We are already seeing major properties offered at large discounts off the senior loan balance, which means they are being offered at less than 50 percent of original cost.
Be aware that planning and announcements are not the same as closing a construction loan and actually commencing construction. Ask yourself why Marriott International laid off much of its development staff if there is going to be a major uptick in new projects. If there was a prospect of opening into an upswing in the near term, why is everyone laying off staff now? Just because brands announce projects does not mean any of them will start construction anytime soon. Just because franchise agreements are being signed does not mean anyone is going ahead and obtaining a construction loan. Discussions about what allegedly is happening in China or elsewhere overseas have no relevance to the typical U.S. real-estate owner. Besides, most of the economies of the rest of the world are in much worse shape than the U.S. economy, so it is hard to believe that there is any hotel development starting in most places.
While there is cash on the sidelines, it is staying there for now because everyone is waiting for the government to announce the toxic asset program so we all know what the new rules of the game are. Once that program is under way, there will be hundreds of billions of dollars worth of deeply discounted assets to buy from all sorts of sellers at banks, private equity firms and other lenders.
I represent several very large and highly liquid investors and funds. We are in the market buying notes with the intent to own. They all talk about their inability to borrow money to buy assets. If these investors can’t borrow, what makes you think you can? We are buying all equity in most cases. The lending market is worse now than it was in 2008. I am in New York and very deeply involved in what is happening in the capital markets at the most senior levels of lenders and investors, and with some of the advisors to the government programs. All the stories you hear about the lending being frozen are true. I do know that there are some local banks still making loans to very good borrowers at wide spreads, and with personal guarantees on good cash flowing hotels. There are not many of these loans getting done, but clearly some are. What nearly all lenders say is that they are loaning to good customers, but not to new borrowers. Most lenders prefer to extend past maturity in exchange for a 10 percent to 15 percent pay down and a personal guarantee. That usually is better for the borrower and for the lender.
I am well aware that a lot of people in the industry wish I would stop writing and speaking about the reality of the situation. But that is exactly why I do. I believe very strongly that owners and developers need to know the unvarnished facts so that they can make informed decisions. The industry is in a severe depression that is getting worse by the week. If the revenue-per-available-room trend continues, then industry losses in 2009 and 2010 will be terrible. Many owners will lose their properties and their accumulated personal wealth. I hate to see that.
My intent is to warn everyone that we are in the most pressing survival mode in 80 years—and you need to be prepared to accept that and to do whatever it takes to protect yourself. In many cases, it means just handing over the keys now instead of feeding the hotel thinking it is all going to get better late this year. It is going to get worse as we head into summer. Your first loss is your best loss in many cases. Do not fall in love with any piece of real-estate or a hotel. If you act on emotion, it will eat you up. There is no embarrassment in handing back a property in this market. You will look smart in many cases by saving your personal assets. Just make sure you get good and objective legal and financial advice before you do anything like this.
The latest STR numbers for trailing 28 days show RevPAR down more than 22 percent. Just do the math. If that becomes the number for the year--which it might--then just assume typical net operating income margin, on average, when the business is running well, is around 18 percent to 24 percent. If RevPAR is down 22 percent, then there is not enough cost savings possible to allow full coverage of debt service while still maintaining sufficient service and quality. In fact, in some properties, there will be a loss at the NOI line in 2009. The luxury and conference segments are even worse off. There is no magic to the numbers.
Interstate Hotels is a very well-run company with top quality, highly experienced management, yet its accountants just announced that there was a question about the ability of the company to continue as a going concern. Interstate owns hotels and manages for others, which seems to be a nice mix. This announcement, along with Interstate’s delisting from the New York Stock Exchange because of its low share price, should be the canary in the coal mine to everyone.
Most people who know me well think I am a Pollyanna and the ultimate can-do optimist. For me to be saying these things is neither my normal bent nor my wish. I just believe there has been far too much fluff and personal agendas pushing rose-colored glasses in the hotel industry. Everyone needs to wake up and smell the coffee before it is too late.
