The worldwide COVID-19 pandemic is an unprece-dented event in our lifetimes. Late this past March, the overall impact of the crisis was not yet known, but hotels have been among the worst casualties thus far, suffering a massive hit to their bottom line.
Undoubtedly, this is one of the most challenging times ever for hotels given that international and interstate travel effectively ended in March 2020. In Manhattan, several major hotel chains closed. Unused rooms were candidates to take on overflow hospital patients. No U.S. destination was spared. The coronavirus closed down Miami Beach, the Las Vegas Strip and Disneyland.
Preliminary data suggests that hotels of all types will be hurt badly everywhere. According to early projections by CBRE Hotels, room occupancy rates will drop industrywide by nearly 20 percentage points this year and room revenues will fall by nearly 40%. Larger hotels in major cities that rely on conventions and meetings are likely to see the steepest declines in revenue.
As of March 2020, the coronavirus crisis had only begun in the U.S. The federal government imposed social-distancing guidelines and travel restrictions through at least the end of April. Hotels were expected to be severely impacted for a minimum of two to four months.
Collateral damage
All of this will have an impact on hotel financing this year. With almost no demand for rooms, many hotels will have to close for an undetermined period and are expected to struggle to meet their loan obligations.
Commercial real estate data provider Trepp projected that lodging assets would have the highest loan default rates by far, rising from less than 1% this year to more than 10% by the end of 2021. The cumulative default rate would reach 35% over five years, according to Trepp.
Despite the strain on the industry, the situation is not hopeless. Hotels survived the Great Recession. In an analysis released this past March, CBRE Hotels said the industry was better positioned to get through this crisis than in 2009. During the last downturn, hotels also were the first commercial real estate assets to suffer. By the end of 2011, however, room rents and occupancy rates were growing, and the industry saw an unprecedented period of revenue growth that continued through the start of this year.
Prior to emergence of the coronavirus, hotel fundamentals remained exceptionally strong. CBRE Hotels reported that the national occupancy rate in 2019 matched its record high of 66.1% while hotel profit margins were 4.5% higher than their long-term average. The initial forecasts from CBRE Hotels and STR indicate that room demand and revenues for hotels and other hospitality-related businesses will recover once the virus is under control. By next year, the occupancy rate should rise again to above 60%. So, the outlook for hotels beyond this year remains positive.
Building relationships
Although it is not yet clear how long this crisis will last, we do know from past market shocks and downturns that hotels will eventually recover. So, how can commercial mortgage lenders and brokers approach this unusual time?
The hotel industry is cyclical, and its upswings and downswings tend to be more dramatic than other asset types. Initially, we can probably expect a significant slowdown in hotel loan volume. Property values will likely fall as revenues drop. This will throw off income and debt ratios, making it far more challenging to complete loan deals. What could naturally result is a prolonged pause in lending activity while lenders and investors wait out the crisis.
Commercial mortgage brokers can best use this slower time to reach out to lenders, keeping close tabs on credit availability and the lender’s loan criteria. When the industry reemerges, there could be significant lending activity brought on by asset sales and refinancing. Hotel owners will likely need to restructure their debt and may look to capitalize on exceptionally low interest rates to refinance their existing loans.
Brokers also may find opportunities in financing the sales of distressed hotels. This shock is likely to bring a new group of opportunistic investors into the hotel industry along with a fair number of asset sales.
Remaining flexible
As for lenders, the majority will likely remain flexible with their existing borrowers and keep an eye on the future of the industry. Banks, for one, are in better shape than they were in 2009, putting them in a better position to grant their borrowers leeway. The Federal Reserve has taken drastic measures to ensure that cash is available in the system and that banks continue to lend money to businesses at low rates.
Hotel lenders also understand that even well-run hotels are vulnerable to short-term downturns but are good business risks over the long run. It won’t be in the best interest of the typical lender to seize an asset. Lenders understand that the coronavirus is an exceptional event. This situation was not caused by a collapse of the financial system, overbuilding in the hotel industry or a natural recession. This is more like a tsunami or tornado, a true Black Swan event that could not be anticipated.
Hotels that were performing well prior to the crisis will likely return to health once the crisis passes. Once this health emergency passes, hotels also have one advantage: Unlike other asset managers, hotel operators have much more flexibility in adjusting room rates as needed to attract customers.
The recovery period will probably begin roughly six months after this past April. Hotels may not fully recover their revenues and occupancy rates, however, for at least a year. In the meantime, the borrowers will likely need a break. One would hope that lenders will choose to be compassionate and solidify their relationships with their long-term borrowers.
There’s no doubt that what is happening is unprecedented and will have lasting effects on the U.S. economy for some time. The economy will recover as it always does. The hotel industry will bounce back, too, and we can all be a part of the next positive investment cycle.
