The bull market in the US hospitality sector has years to run, aided by low-cost capital and light supply. Christopher O’Dea reports
It was not long ago that many readers of this magazine were comfortably ensconced beside a resort pool enjoying a summer holiday. But many holidaymakers may have overlooked the fact that resort property is leading the resurgence in transaction volumes and pricing in the US lodging and hospitality sector, with top-tier resorts fetching lofty prices on the back of a bookings rebound by business groups and leisure travellers.
The hospitality property sector is nearing the end of the fifth straight year of strong growth in revenue per available room, or RevPAR. Industry leaders say the bull market in hospitality has several years to run, aided by plentiful low-cost capital and light supply, attracting interest from a wide range of buyers.
“We have been pointing to the opportunity in resorts for some time,” says Arthur Adler, Americas CEO and Managing Director of JLL’s Hotels & Hospitality Group. “There is plenty of available capital chasing assets ranging from high-profile full-service hotels to select service portfolios to resorts in markets across the spectrum,” he adds.
Hospitality deal activity totalled $8.3bn (€6.4bn) in May and is on track to reach $25bn for 2014, up from $22bn in 2013. But this is not a bubble, Adler says. “What’s driving transaction volume in hospitality are industry fundamentals.”
In the last full cycle in the sector RevPAR increased for nine years, from 1991 to 2000, Adler says. Today’s slow, steady economic growth, coupled with low new supply and low-cost capital, means the current cycle could last several more years. Twenty-three of the top 25 US markets posted RevPAR increases over the 12 months leading up to May, with Houston’s energy-driven market up nearly 13% and San Francisco up more than 15%. Even US secondary markets such as Nashville, Minneapolis and St Louis recorded accelerating RevPAR.
While all hospitality sub-sectors are participating in the rebound, the effects are most notable in the resort segment, says Adler, which typically responds more slowly to economic revival than other segments. Because new properties are expensive, resort supply has been sharply constrained. “Resorts require a tremendous amount of infrastructure and recreational facilities,” he says. Early in the recovery, necessary business travel picks up, but “Corporate America has to be really confident to start paying for group meetings again”.
Resorts were hit hard by the downturn, but are proving worth the wait. Sales transactions for the asset class reached $2bn during the first five months of 2014. Recent high-profile resort transactions include The St Regis Bal Harbour Resort in Miami which sold for $213m in January 2014, the Ritz-Carlton Kapalua which sold for $142m in February, and the Parrot Key Resort in Key West which sold for $100m in May.
“Competition is high,” says Adler. “Resorts under construction make up a mere 1% of the supply of resort properties in the US, meaning the sector will experience strong gains in RevPAR as demand continues to grow.”
Transaction and pricing data from Real Capital Analytics illustrates the robust environment for selling hotels. Transaction volume was up 22% through May, with robust activity in both full-service, up 23%, and limited service, up 19%. In addition, RCA data shows that cap rates have stabilised, holding between 8% and 8.2% since the third quarter of 2012.
The buyer pools have also widened, notes Goldman Sachs, with cross-border and private buyers becoming more active acquirers – accounting for 55% of deal volume in 2013 from about 30% in 2010. “The current asset sale market remains robust and is favourable for companies like Starwood [Hotels & Resorts] which have a stated asset divestiture programme,” says Goldman. Starwood was the seller of the St Regis Bal Harbour; the company has announced that the $500m it realised in net cash from the hotel sale and a recently completed St Regis Bal Harbour residential project would be paid out to shareholders in the form of four quarterly special dividends.
Fuelling the pace of transactions is an abundance of equity capital, along with strong debt markets, including the re-emergence in 2014 of the floating-rate CMBS market. US lodging sector borrowers raised $2.3bn through CMBS in 2013, up from $1.2bn in 2012, according to JLL. That has provided relatively high leverage with attractive pricing. At the same time, balance sheet lenders have become more active in extending credit to hotel transactions.
Private equity funds have been the most active purchasers this year, says Adler, accounting for one-third of transactions. The availability of debt capital at low rates enables private equity firms to use higher leverage to structure deals at higher prices than less-levered competitors can pay. While private equity funds pursue deals across the lodging spectrum, their primary targets are large select-service portfolios, luxury resorts and big ticket full-service hotels. Premium select-service hotels, such as Hilton Garden Inn and Courtyard by Marriott, do not have the labour and other costs of significant food, beverage and meeting operations offered by full-service hotels. As a result, they can produce operating margins before debt service of 25% to 45%, compared with just 15% to 25% for full-service properties, says Adler.
Some major private equity firms have been consolidating select-service hotels, and while public flotation as a REIT is a potential exit route, “that is still to come,” Adler says.
As their multiples expand early in a recovery, REITs usually see their cost of capital decline, giving them an edge in transaction pricing. JLL expects REIT purchasing volume to reach $5bn for 2014. However, because they focus on specific strategies, REITS usually target a more limited set of high-quality, well-branded assets in primary markets than private equity or debt funds. And in capital-raising, scale matters.
Host Hotels & Resorts, the largest hospitality REIT, cut its debt cost in July while extending its maturity – just before jitters about Fed tightening began to increase. Host amended and extended its existing $1bn revolver scheduled to mature in 2015 and its $500m term-loan scheduled to mature in 2017. The new terms extend the final maturity for both the revolver and term loan to 2019, and “reduce pricing to reflect current market conditions”, according to Host’s statement. “At the new pricing level based on our present credit rating, the all-in pricing was reduced 30 basis points on the revolver and 32.5 basis points on the term loan.” The net result was an enviable initial all-in rate of 1.35% and 1.28%, respectively, for the two credit facilities.
Host’s mid-year results and outlook illustrate the two themes of rising RevPAR and rising occupancy. For the second quarter of 2014, the growth in comparable hotel RevPAR of 5.1%, on a constant US dollar basis, was driven by an increase of 4.1% in average room rates at Host properties, while average occupancy slightly increased to 81%.
Outside the US, the news was even better, as Host’s comparable international hotels experienced a RevPAR increase of 16.2% for the quarter, helped by outstanding performance from its Latin American hotels.
Among the new offshore buyers entering the US market are Chinese investors who execute transactions through syndicates that bundle capital from high-net-worth clients in China, says Adler. These investors have been seeking yield, and have purchased assets in gateways like Los Angeles as well as secondary markets like Atlanta.
While some investors prefer yield, Goldman notes that the market for iconic properties is open. For asset owners, Goldman says, “a sustained sellers’ market as well as interest for trophy real estate like Starwood’s assets could prove to be fortuitous.”
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