Hotel Deals Plummet, but Industry Players See Opportunities
Deals in the hotel sector are still there to be done, but adapting will be key to a post-COVID recovery
Hotel Deals Plummet, but Industry Players See Opportunities
With the continued spread of the pandemic across the globe, tourism and hospitality industries continue to struggle. Global tourism has declined dramatically as countries – and even entire continents – have closed their borders to prevent a resurgence of the virus. As a result of a marked decrease in both domestic and international travel, hotel occupancy rates in the US for the week ending 21 November were 32.6% lower than the same week one year ago, according to data provider STR. What’s more, revenue per available room (RevPAR) across US hotels declined by 52.2% to $36.45.
Despite the effect of the pandemic thus far, institutional investors, fund managers, and developers still believe in the potential of hospitality investments. Apartment hotel start-up Sonder raised over $150mn at a valuation north of $1bn, despite laying off one-third of its staff earlier this year as bookings decreased. And Airbnb, the largest hotel alternative in the hospitality sector, expects to IPO later this month at a valuation close to $42bn. The venture capital- and private equity-backed company will attract significant interest from investors in public markets as well, especially given its outperformance relative to traditional hotels during the pandemic.
A Buyer’s Market
Some seasoned real estate investors that focus on the hospitality sector, however, feel that lower valuations will present opportunities in more traditional hotel types. MCR Hotels, the fifth-largest hotel owner-operator in the US, raised two funds that will acquire limited and full-service hotels, expecting steep discounts on previous valuations. Joe Delli Santi, the firm’s Senior Vice President of Acquisitions and Development, said that by the beginning of Q4 2020 some properties may be trading at 20-40% off 2019 prices. Delli Santi expects more buying opportunities and steeper discounts on hotels that rely on group and corporate travel, both of which will not likely return to pre-COVID levels until a vaccine is developed and widely administered.
Lower valuations that have cultivated a buyer’s market are the result of a combination of factors, both pre-existing and COVID related, according to Matt Rooney, Vice President at TriGate Capital. Rooney believes hotel fundamentals have changed materially, but that the dislocation has made hotel pricing more attractive than it was pre-pandemic, adding that his firm is "currently evaluating several opportunities to provide capital to distressed hospitality assets and companies in growth markets across the US."
Due to low unemployment, labor costs were high even prior to COVID, and some hotels ran with larger budgets than necessary due to expenses beyond their control, such as high taxes. The pandemic has forced a rise in other costs, too, such as workers’ wages, sanitizing and disinfecting rooms and public areas, purchasing and implementing infrastructure to enable contactless check-in and entry to rooms, and branding and marketing campaigns to attract safety-conscious travelers.
While operating expenses have increased, hotel valuations have been hurt by a bevy of other factors too. A decline in demand has had a knock-on effect for RevPAR: fewer rooms have been filled, and group and corporate business is almost non-existent, all of which has hurt hotels’ bottom lines. Above all, the uncertainty over how long the virus will go unchecked prior to widespread vaccination, influence reopening policies, and curtail travel makes investors wary of overpaying for an asset.
Down but Not out
The need to price uncertainty in the sector notwithstanding, MCR Hotels believes that more opportunities will be available as we enter 2021. Similarly, TriGate Capital’s Rooney believes that “the hotel sector will recover as therapeutic and preventative solutions to the coronavirus pandemic unfold.” Acquisitions and sales of hotels will likely rebound as a result of consumers and investors adapting, despite a steep decline in the number of US deals from 2019 to 2020 (Fig. 1).
Historical data from Preqin Pro suggests that, with their lower valuations, deals done during and soon after the COVID crisis may outperform. Indeed, private funds with exposure to hotel properties that were formed in the years following the Global Financial Crisis yielded higher net IRRs than previous vintage years due to lower valuations. Similarly, funds of more recent vintage years, which will deploy capital and invest in the hospitality sector before a return to pre-COVID valuations, could outperform previous vintage years, assuming a concurrent economic and public health recovery.
Amid changing consumer behavior, industry players may also look to acquire properties with depressed valuations and appreciation potential in their search for high returns. Sonder, for one, is betting on a new model of hospitality, one that blurs the lines between residential and hospitality properties and provides a more self-contained guest experience. COVID-induced safety-consciousness might compel travelers to avoid shared spaces even after a vaccine rollout, and lead to a market for safer alternatives to packed hotels in heavily populated areas.
In spite of the challenging environment, hotel owners will not rest on their laurels and will look for a path toward recovery. One Southern Californian hotel developer told us he believes new opportunities will present themselves as a result of the changes wrought by COVID. The more companies that decide to implement remote working permanently after the crisis abates, he says, the more demand there will be for meeting spaces and lodging for offsites as companies struggle to develop a culture and foster camaraderie between employees. Adaptation will be key to survival across the hotel sector.
