The hotel sector is sitting atop a cresting wave of growing loan delinquencies that may soon break and douse the market with distressed investment opportunities. Investors who have been lining up to capitalize on distress since the COVID-19 crisis began are now sizing up the extent of the coming buying opportunities, how soon deals will hit the market and how deeply prices will be discounted.
Hotel owners remain saddled with cashflows that have plummeted and face a prospect of a prolonged and painful recovery with both leisure and business travel unlikely to roar back until the virus is under control. Although hotel metrics show some signs of improvement along with phased reopening, occupancies remain at an anemic 39.3 percent, while RevPAR is still down some 65 percent at $33.43, according to the latest data from STR for the week ending June 6.
“Many hotel owners are currently reviewing their portfolios to evaluate the hotels they will continue to support while others may require too much capital to carry them through the duration of the downturn,” says Patrick Arangio, vice chairman of the national loan and portfolio sale advisory practice at CBRE.
The resulting cashflow shortages for hotel owners have fueled a surge in forbearance requests and spike in loan delinquencies. According to Trepp, the hotel delinquency rate jumped from 2.71 percent in April to an astonishing 19.13 percent in May. And there is likely more pain ahead. “Loan defaults are going to continue to increase significantly,” says Michael Cahill, CEO and founder of Denver-based Hospitality Real Estate Counselors (HREC) and co-founder and principal of HREC Investment Advisors. There are a lot of properties in technical default that may end up falling into hard default, he says.
Lenders provide a lifeline
The potential wave of distressed loans is sizable. The outstanding CMBS loan balance alone for the lodging sector spans $86.0 billion across 3,000 individual loans, and the percentage that have moved to special servicers jumped from 2.3 percent in March to 16.2 percent in May, according to Trepp.
“It’s very difficult to predict the exact timing of when these assets will hit the market and at what level of discount they will trade, as there is still a lot of work that is being done between the sponsor and lender to work through loan modifications, workouts and other strategies,” says Adam McGaughy, managing director, JLL hotels and hospitality group. The first buying opportunities have already started to hit the market in the form of hotels within special servicing before the COVID-19 crisis. “Those assets were already facing certain challenges, and the special servicers are selectively selling these to clear their inventory of hotels in REO as they continue to work through the flood of hotels that have been transferred to them,” he says.
Certainly, there are some early cases of hotel loans in default. However, it’s not that easy for owners to give properties back to lenders. “You don’t call up the lender and say you’re going to FedEx them the keys. It’s a process,” says Cahill. HREC currently has 10 hotels that it is brokering by taking them to auction platforms. Those hotels were all stressed prior to COVID-19, and the pandemic has just pushed ownership to sell at whatever price they can get. “That is the wave that you’re seeing right now,” he says.
Many hotel owners have been able to buy extra time by obtaining a paycheck protection program loan and/or negotiating some type of forbearance with their lenders. Even hotels that were showing signs of distress pre-COVID-19 with owners that do want to give the keys back to lenders may take several months to officially transition to servicers and then have servicers bring the properties to the market. So, those real estate owned properties that do emerge are likely going to start hitting the market at the end of 2020 and early 2021.
“I think we may see an increase in defaults later in the summer as some of the initial forbearance periods roll off, but others may receive additional relief or modifications that could extend the timeline a bit longer,” says Jack Howard, executive vice president, national loan and portfolio sale advisory practice at CBRE. “I do believe we could see some initial activity later in the summer, but it probably won’t start in earnest for three-to-six or even six-to-nine months,” he says.
Capital is ready to pounce
A common number being thrown out is that the average hotel is worth about 30 percent less today compared to what it was worth pre-COVID, notes Cahill. What that means is that owners are not necessarily upside down, but they have lost all of their equity. So, owners are motivated to hang on properties in order to regain that equity. That is not great news for the opportunistic capital chomping at the bit to acquire distressed hotels.
“We get calls every day from massive amounts of equity that want to invest in hotels,” says Cahill. The problem that people have is the bid-ask gap. Who are the sellers that are going to be distressed enough that they are going to put assets on the market and at the discounts that these buyers are looking for? “That is what is going to keep transaction volume low, because unless a seller has to, they are not going to put their hotel on the market,” he adds.
“We continue to marvel at the amount of capital available,” agrees Arangio. Arangio and his team took bids on a portfolio loan sale recently that did contain a significant hotel component, with mortgages secured by both limited and full-service properties included. They received more than 20 offers, and there seems to be no shortage of liquidity in the space. In addition, the team is observing the beginnings of a bifurcation in the timing of the market recovery. For example, there currently appears to be more capital targeting limited service properties, because investors believe that the sector can recover faster. “Ample liquidity typically creates a floor for pricing, even in times of distress. Maybe more importantly, it often creates a much faster recovery,” he says.
Some big convention hotels in gateway markets might be three years away from returning to pre-COVID-19 cash flows and values. Select-service and extended service in Middle America markets were not hit as hard and are already starting to recover both leisure and business travel. So, some of the small business hotels may not have been hit as hard as some of the larger institutional owned hotels, and they may be able to come back quicker.
In addition, there is still a chance that capital looking to pounce on bargain basement prices may be disappointed. Back in 2009 and 2010, there was supposed to be the greatest hotel buying opportunities of a lifetime with all of the distressed assets that were supposedly going to come on the market cheap, says Cahill. That never happened because of the willingness of lenders to “extend and pretend,” and lenders are again going to be willing to work with borrowers in the current environment, especially those bank lenders that have relationships with their borrowers, he adds.