CEO of Driftwood Capital, focuses on the investment, development and syndication of institutional-quality hotel assets.
Now is an ideal time for patient real estate investors to consider carefully chosen hotel assets. Many U.S. hotel properties are trading for deep discounts, as distressed owners struggle to cover their expenses with sharply diminished revenue streams.
While the U.S. hotel sector is slowly recovering from the devastating impact of the Covid-19 public health threat, it will likely take a couple of years or longer before occupancy rates return to pre-pandemic levels. For investors, that opens the door to attractive acquisition opportunities supported by private equity or debt capital with the potential for outsized returns in the long-term.
However, investors need to be patient. The recovery in the travel and hospitality market largely depends on the world’s ability to manage the pandemic and potential action from the U.S. government. Whether that takes the form of a second economic stimulus or something akin to the Troubled Asset Relief Program (TARP), Congress must do something to address the looming tidal wave of hotel loan defaults and business closures as millions of jobs and vital government services are at risk. The hotel sector is made up of mostly small operators and franchisees who in turn support an entire ecosystem of even smaller businesses — from restaurant owners to Uber drivers. Hotels also provide municipalities with a significant source of tax revenue.
With those considerations in mind, it’s important to note that the long-term fundamentals of the hotel industry remain sound. Unlike the retail real estate sector, there has been no structural disruption from online competitors. That is, hotels will continue to offer real-world business and leisure travel experiences that are valued by people of all ages and backgrounds.
In fact, it would not be surprising to see pent-up demand for travel skyrocket after an effective Covid-19 vaccine or treatment is available. After an extended stay-at-home period, Americans are going to want to travel again, visiting distant family members and friends or going on long-delayed vacations. In time, business conferences and trade shows will also rebound strongly, boosting revenue and occupancies for nearby properties.
Uneven Recovery Means Due Diligence Is Essential
Today, the U.S. hotel industry has nowhere to go but up. A recent report from STR found the third-quarter occupancy level was 48%, the lowest in the global analytic firm’s database. Room rates and revenue per available room (RevPAR) were also down significantly from 2019.
Despite the drop in demand and some hotel closures, hotel developers have been busy during the pandemic. From March 1 to October 1, there were 521 properties accounting for 55,395 rooms that opened in the U.S., according to STR. While many projects have been put on hold, you still have some previously planned hotel developments moving forward, which is a sign of confidence in the long-term health of this sector.
For hotel investors, these demand and supply numbers point to the need for a thorough market analysis before making a financial commitment. For instance:
• How many hotel rooms will be supported in a local market in 2025?
• What types of properties, such as luxury, economy or extended stay, will see the highest demand?
• Does the property cater to leisure or business travelers?
• What are the tourism drivers in the local market?
• What is the competitive picture, including recently completed hotels and those still in the pipeline?
• What are the barriers to entry for other competitors to come in?
Other important considerations include the track record of the ownership, the level of working capital needed to survive the current storm, and whether the property’s current debt burden is manageable or if restructuring would be needed. Even if the asset is in distress, in many cases, an injection of private equity can make a positive impact on cash flow projections.
From my perspective, the leisure travel market will recover more quickly than business travel. Pent-up demand will be stronger among consumers than business executives and professionals, who are increasingly comfortable with virtual conferences and meetings.
I also believe consumer demand will be strongest in the family, economy and extended-stay segments. Many affluent individuals, couples and families have been vacationing in luxury properties despite the pandemic’s challenges, unlike Americans from middle-income brackets.
Properties in drive-to destinations are likely to outperform assets in markets where air travel is the primary transportation mode. For example, during the pandemic, hotels in Florida’s Panhandle had much higher occupancy levels from travelers driving in from the Northeast and South than properties in Hawaii that were only accessible by air.
Based on those trends in demand, we can expect to see great acquisition opportunities in smaller, family-owned properties in popular vacation destinations and suburban market locations. An ownership facing financial challenges and a property that appeals to families or extended-stay travelers should be particularly attractive to investors.
With appropriate market research and financial due diligence, savvy investors are well-positioned to capitalize on acquisition opportunities in the U.S. hotel market.