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How Uncertainty Clouds Hotel Buy/Sell Decisions

Descriptions of due diligence, or the buy/sell decision, often get around to some balance between analysis and instinct. Neither can be relegated to second-class status and seldom if ever has either been more difficult to navigate. A quick review of the state of things illustrates that we’ve never been here before:

Norms are out the window and transactional rules of thumb don’t apply anymore. The latest trends might last a month. “The world has changed dramatically in the past month,” says Robert C. Hazard III, vice president-acquisitions and development for Hersha Hospitality Trust. “Opinions have changed in capital markets; not sure if that’s justified or not. Maybe the slowdown is a good thing; the buying frenzy was getting out of hand. At this point a better use of our cash is to recapture our own stock.”

The Hersha REIT is not alone. Trophy properties have been snapped up by REITs traded at historically low cap rates, but in the last month many REITs have shuttered their acquisition activities.

"Many REITs are down; they buy so they can raise capital; if they’re not raising capital, what then? Operating margins are very thin,” says Ken Wilson, president & CEO of Boston-based Capital Hotel Management. In spite of the fact the fundamentals are good—according to STR July 2011 had the highest occupancy in US history—there are now hotel deals being terminated and re-traded.

Special servicers comprise an imposing part of the landscape and, according to Steve Van, president & CEO of Prism Hotels & Resorts, they’re now lending on certain assets. “The most important thing to remember is that the special servicer’s mission is to maximize value of the asset,” he says. “If they can sell at $7 million by providing a loan, it’s better than an all-cash deal at $5 million.” The challenge presented is that assets may still be leveraged beyond real value. Where is the value and what becomes of it when inflation kicks in? The sheer volume of REIT activity, coupled with historically low interest rates over the recent past, has driven cap rates for well-placed assets to new lows.

Brokers are receivers and receivers are brokering. Buyers are using brokers but looking at electronic auctions as well. Lenders are selling assets—and notes. Does everyone know what their role is? What they are buying and selling?

“We’ve had people close [transactions] thinking they bought the asset to find they only acquired the paper,” notes Jeff Kolessar, senior vice president of development for GF Management. “They’re not getting the keys and now have to foreclose. That time and money wasn’t counted on.” The layers of uncertainty go beyond forecasting; what “is” in the here and now is not always known. We may be operating in a world of sophisticated servicers and sophisticated buyers, but both can and do make mistakes. Due to the times and the various stages of assets and loans, the path is seldom clear or direct. Is foreclosure the route; maybe a short sale? For the transaction, should auction be considered?

And what about value? Income-approach methodology and a reliable sales’ database for appraisals aren’t slam-dunks anymore. As Robert Wells, director of American Appraisal says, “Unless you’re valuing a hotel in northwest North Dakota in the midst of the shale oil reserves, the greatest phenomenon today is uncertainty. Right now, we’re looking at trailing 12 [month] performance.”

Sellers are touting upside, but can they count on it? Buyers hope it’s there as well, but given the past four years, can they pay for it now? “It’s a tough time to appraise; trophy assets are going at low cap rates and distressed assets that may need work at high ones,” says Mark Lukens, MAI, of Strategic Hospitality in Bellevue, WA “There’s not much activity in the middle. For income, right now we’re doing projections.”

“Nobody is happy but nobody knows what it means. We always do forecasts, but lenders look at both: forecasts and trailing 12-month performance,” says Anne R. Lloyd-Jones, CRE, managing director of HVS based in New York. And while the REITs and the few conventional lenders making loans use appraisals, with so many cash buyers, according to Lukens, more and more broker opinions of value (BOVs) are being relied upon.

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