When To Hold or Sell a Pandemic-Affected Hotel Property

With daily average hotel occupancy rates declining to historically low levels during the pandemic, revenue and cash flow have fallen significantly for all types of hospitality properties, making it difficult for some — and nearly impossible for others — to cover essential expenses. During this period, the ability to hold on to a hotel asset has been about generating enough cash to cover fundamental financial obligations. In some instances, the decision whether to hold or sell has been clear, but many investors have been unsure about how to proceed, with conditions improving one day and faltering the next.

LoopNet spoke with two investment sales brokers specializing in the hospitality industry to understand how financial, operational and market conditions are affecting decisions relating to buying, holding, recapitalizing and selling hospitality properties.

“It is very dependent on the situation and the needs of the owner,” said Melvin Chu, senior vice president of JLL’s Hotels & Hospitality Group in the Pacific Northwest, when asked about the medium-term outlook for the market and conditions that would favor buying, holding or selling an asset.

“When we look into a buy, sell, hold, [recapitalization] scenario, there's a lot of different factors that come into play,” Chu said. They depend on the “debt maturity, remaining term on [the hotel] brand, the PIP cycle, and overall capital needs for the ownership,” Chu said. In the hotel industry, a PIP, or property improvement plan, is a document that outlines the brand requirements with which an owner must comply. The brand holder usually mandates that owners make upgrades and improvements at certain intervals, increasing expenditures for the owner during those renovation periods.

“But high-level, what we're seeing is a tremendous supply and demand imbalance right now in the market where for the right product, with the right story,” properties can sell at a minimal discount relative to 2019 prices, Chu noted.

Consider the recovery timeframe. “You need to look at the recovery timeframe by hotel asset class,” said Thierry Roch, a senior hospitality broker with Avison Young, focusing on hospitality sales in the Mid-Atlantic and Southeast regions. The key factor, Roch added, is determining “how long it will take to get the asset back to profitability.”

If an owner can’t get close to turning a profit, “why would [they] want to continue to hold [an] asset and continue to feed [their] debt and operating expenses, if [they] could get out with a small profit [by selling]? They may be in a situation where the property is taken back in a few months and at that point they would have nothing,” said Roch. “So, you're playing a risky game by continuing to operate an asset at a loss.”

Debt maturity is the number one factor. Concerning conditions that would force an owner to sell all or a portion of an asset, Chu said “I think the number one factor is upcoming debt maturity where, refinancing is coming back, but still can be limited or much more expensive relative to pre-COVID levels.” He noted that he and his team have seen instances where obtaining refinancing for some assets has been challenging, noting that the terms are not quite what ownership wants, resulting in pressure to sell the asset.

Chu cited commercial mortgage-backed securities (CMBS) loans as the type of debt owners are having the most trouble with. Because of how they are structured, CMBS loans have less flexibility with special servicers. He noted, however, “if you're working with a balance sheet lender — a local, regional or national bank or insurance company — [and] you have been a good borrower, have kept the loan current and [the lender] is open to refilling your reserves, there's been a lot more willingness to extend.”

Two to three months of recovery. “I would recommend an owner consider selling an asset with just two to three months of strong RevPar (revenue per available room) recovery approaching the peak level seen in 2019. It doesn't need to be a full year of recovery, just two to three months will do. What we're seeing is [that] the investor community is able to use that to underwrite a pretty quick recovery,” Chu said about conditions that will attract buyers.

“We recently sold an asset in central California where, on a trailing three-month period, the RevPar was basically flat,” compared to 2019, said Chu. “Demand rebounded quickly and ultimately that traded at a minimal discount relative to 2019 value.” Chu specified, “We're seeing [this type of rebound mostly] in select service, extended stay and economy-type product.”

The asset doesn’t need to have completely rebounded to 2019 RevPar figures, Chu said. “But if there's material improvement in occupancy and ADR, that gives investors quite a bit of comfort that there's a much quicker recovery, or it's much easier to underwrite to a full recovery within the next 12 months.”

Slightly more bullish underwriting. “I think what we're observing in the last couple of weeks is that investors are being a little more bullish on their underwriting for a couple of reasons,” Chu said. “I think one, the vaccine rollout has been positive. With a big push from the government to have it be readily accessible to all adults by May, that is a huge momentum swing. Two, we're seeing schools across the country reopening. I think those two factors will really help drive leisure demand during the summer. And then, I think once kids are back in school, the corporate demand will also be able to rebound quickly.”

If holding on to a property with existing debt and equity partners is untenable, bringing on different or additional equity partners may enable ownership to retain an asset. “There has been a ton of equity raised for new joint ventures, rescue capital or runway capital. Generally it's not cheap to tap into these funds,” Chu said. “But I think there are instances where ownership may want to consider partnering with a new group, especially if it's an asset that's owned by a smaller private investor that is facing some pressure on debt or to simply cover shortfalls.”

Private equity partners typically provide more than just capital. “Private equity or family offices are highly sophisticated [and] well connected,” Chu said. “I think they can provide not just capital, but additional resources to help create value as a partner, such as asset management expertise and deep relationships with brands and lenders, enabling them to negotiate on behalf of the partnership.”

But obtaining equity can be expensive. Chu described some of the terms he is seeing. “On the deals that have been out for equity or runway capital, generally what we're seeing is high single-digit, low double-digit preferred returns, and additional profit-sharing up to a certain threshold.”

Chu added that with an infusion of private equity, “the ownership may have to give up some control, that may relate to major decisions about capital investments, renovation, sale, financing, rebranding or change of operator.”

Good debt, no recovery yet, but event on horizon. Chu noted that a scenario that lends itself to holding a hotel property is one where the owner has favorable debt conditions; there has not been material recovery at the property level; but the asset is in a location that will benefit from some future event that could potentially create value.

Chu provided examples of what he means by “event.” It could be an upcoming change “at the property level where maybe the franchise terms are coming up and there's a potential repositioning or conversion to another brand.” Another possible property-level scenario might be that ownership is going through the process of securing entitlements for additional expansion that will add value to the property down the road.

Other future value-generating events could be market-related, such as a large demand-generator coming in. “Maybe a tech company is expanding into that particular submarket; [they] haven’t quite moved in yet, but it's coming,” said Chu. Analyzing the likelihood, timing and degree to which these events may affect the property will help owners assess if they should hold or sell.

Provisional help. Operating expenses, which are largely variable, have been scaled back through staff layoffs and supported through government assistance programs such as loans from the Small Business Administration's Paycheck Protection Program. Also, according to Roch, “lenders are allowing for additional time [to meet debt obligations] based on regulators, enabling them to not worry about the covenants on their loans because of this shock to the industry.”

Generally, Roch said that the debt markets for the hotel industry have yet to return. Accordingly, people are either securing private financing or buying properties outright with equity. There are starting to be some more entities that are lending, albeit at higher interest rates and lower leverage.

So, “unless you're really distressed or don't have access to any additional capital,” most investors are foregoing selling their property outright, he said.

“In regard to a return to profitability, there are two completely separate spaces,” Roch said. “Extended stay [properties] and beach areas are already at — and in many cases above — 2019 performance.” But he cautioned that this does not mean the entire hotel industry is back. “The vast majority of hotels in the U.S. are [driven by demand from] corporate travel, meetings, conventions, conferences, sports and entertainment. The smart people believe these types of hotels will not see a return to 2019 performance levels until 2024 and, in some cases, 2025.”

Business and leisure travel slowly returning. With underwriters optimistic because of inoculations being administered and schools reopening, Roch too, is optimistic about the return of business travel, “because the people who are in business travel sales and marketing roles are typically extroverted and need to be in-person, face-to-face with others to not just talk and meet, but to create new relationships.” He noted that on platforms like Zoom, you can meet new people, but only if it is scheduled. “If you bump into people waiting at the buffet line at a conference or at a cocktail reception, you may come away with 10 new business cards.”

“I think those road warrior hotels, the select service hotels along major interstates and airports in urban markets, are going to continue to do well. I foresee by the fall that you're going to have a good amount of ‘unmanaged’ business travelers out again.” Unmanaged travel is carried out by small businesses or sole proprietors that don't have overly restrictive travel policies, so they are free to book wherever they want.

Asked about the sources of demand for extended stay properties, Chu said it was coming from several users, including leisure travelers such as families that want extra space when they travel. “Demand also comes from [long term work-related] projects from government and corporate sectors. That demand has held up fairly well,” Chu said. In terms of occupancy, “I've seen, as we’re underwriting deals across the West Coast, there has been some extended stay product where they're running at 60, 70, and even 80 plus percent occupancy. And I can say there was an initial drop-off in March, April and parts of May but, by June, some of these have just shot back up.”

Conference center hotels will need time. In person meetings and conventions have plummeted throughout the pandemic and Chu noted, “If we look at just statistics and numbers for the last 12 months, [conference center hotels have been] hit the hardest. These assets have higher fixed costs and at times in some urban markets, you may also have union pressure or just higher wages and related costs.

“I think group demand will come back and there is a lot of pent-up demand,” said Chu. I think there's just going to be a little bit of a lag on that full recovery, partly because it takes lead time to book a large convention or group events.”

Roch agrees that citywide conventions, conferences and annual meetings are going to take some time to get back to where they were before COVID-19. He surmises that the companies and nonprofits that have supported those venues may not send as many people to conferences as they did before the pandemic. “Zoom and other platforms can accommodate audiences just fine,” he said. Organizations that used to send 30 people “may only send their top 10 people and everyone else [will listen] in.”

Conference center hotels in urban markets are likely to sell for the deepest discounts, making them very attractive to investors. “Sophisticated urban hotel buyers can continue to own these hotels, but maybe pare off the parts they no longer need within them,” Roch said. “Let's say you have an 800-room hotel in center city somewhere, and you have a 40,000-square-foot ballroom. You [can] keep [about] 200 rooms under your elite level brand and then sell the rest to a residential” or office developer.

“And also, there are [hotels] in urban markets, like New York in particular, where you have deep discounts on these large hotels, in really nice parts of town that are going the condo route.” He cautioned that, “at some point, you may have an oversupply of multifamily in those markets,” but the hotels that remain will be better positioned because the supply of rooms will be reduced, helping to drive up room rates in the post pandemic recovery.

Additional Resources Relating to Hotel Investment and Operations:

• JLL: Hotel Investment Outlook 2021
• STR Data Insights