The past two years have been brutal for the hospitality sector. The COVID-19 pandemic also decimated the restaurant industry. The National Restaurant Association estimated that by the end of 2020, about 110,000 restaurants had been forced into a long-term or permanent closure. And even today, restaurants are still struggling to find their way.
Hotels have not fared much better. The year 2020 ranked as the worst on record for U.S. hotels
, with the industry experiencing all-time lows in occupancy rates and revenue per available room (RevPAR), according to hotel industry research company STR. That year, hotels experienced an aggregate of more than 1 billion unsold room nights.
Some facilities closed or drastically cut back their services, and hotel room revenue was cut in half to about $84.6 billion, the American Hotel and Lodging Association (AHLA) reported. More than 670,000 direct hotel-industry jobs and nearly 4 million jobs in the broader hospitality sector were lost due to the pandemic.
But as Maureen McGovern sang in the film, “The Poseidon Adventure,” there’s got to be a morning after. And sure enough, that is happening. The hotel sector is making a comeback, just not as quickly as everyone would like. Here is a roundup of the recent history of the U.S. hotel industry, which commercial mortgage brokers should keep in mind as they work with investors and lenders on these types of projects.
Downturn and recovery
Amid worries about the spread of the novel coronavirus, tourism across the globe slowed to a crawl in the spring of 2020. A series of restrictions were put in place for many foreign travelers visiting the U.S. On Jan. 14, 2020, Transportation Security Administration checkpoints nationwide counted more than 2.3 million daily passengers. By April 5, this number had fallen to 97,130.
The impact of the slowdown hit hotels hard. The situation was bleak until the government rolled out the $2 trillion-plus Coronavirus Aid, Relief and Economic Security Act. Even with hotels and restaurants receiving a slice of this capital, however, many businesses and properties in the hospitality sector failed.
By 2021, circumstances began to improve for the hotel sector. Some states began to ease their COVID restrictions as the pandemic seemed to be more under control. Tourism and leisure travel, which typically occurs from Thursday to Sunday, began to grow. Hotel room revenues came back strongly, jumping to $141.6 billion
, about $56 billion above 2020 levels. But business travel continued to trend below the levels seen prior to the pandemic.
This year, the AHLA expects room revenues to reach $168.4 billion, just slightly behind the $169.6 billion recorded in 2019. Hotel loan delinquencies continue to decline, even in the commercial mortgage-backed securities realm. And while business travel is still recovering, an analysis from hotel research firm Kalibri Labs projects that it will reach 80% of 2019 levels by the third quarter of this year.
Even with its recovery, the hospitality sector has changed. Since the beginning of the pandemic, hotels have been cutting back on services, a shift that may continue well into the future. One example is that many hotels won’t provide housekeeping unless it’s requested by a guest.
Looking forward, the hotel industry is going to experience some headwinds in the recovery process. The return of top-line revenue during the first half of 2022 is encouraging, but owners are seeing a decline in profit margins due to increased wages, inflation and other post-pandemic cost increases.
The erosion of these margins is concerning and will continue with the resumption of more services, such as housekeeping. Alternative lodging options, such as Airbnb and Vrbo, will continue to thrive. Major hotel brands have yet to acknowledge the ill effects of these additional competitors, but time will tell.
Increased operating costs, regardless of the growth in top-line revenue, will create stress on debt coverage. Declining profits will impact the capitalization rate, devalue the asset and place stress on bank balance sheets. Lending institutions may require hotel owners who lost value to add equity to their investment and lower the stress on existing debt.
Owners may not want to go this direction, and the industry could see a similar scenario to 2009 when RevPAR dropped by nearly 20% year over year. During the same period, profitability as measured by net operating income (NOI) fell by nearly 37%.
A hotel is real estate. It’s true that economic changes can create a sudden loss of value, as described above, but does the hotel actually lose value? No. The hard asset, or the brick and mortar of the building, doesn’t change. Its value may decrease due to reduced NOI, but the building is still the same.
Knowing this, a lender should consider the conditions that created a loss of value. The culprits usually include some combination of poor management and deteriorating property conditions. The hotel might be losing its guest base, or the market where the hotel is located collapsed or had an increase in supply. It’s also possible that a hotel lost its brand name due to certain conditions and that the related economic stress affected the property’s ownership.
If these reasons are not the cause of a sudden decline in value, and the only reason is tied to the pandemic, then a lender should take certain actions. They should review the asset’s best years prior to the drop-off, then consider that adverse conditions may dissipate, thereby allowing the property to regain its footing. In other words, concentrate on what could be rather than what is.
There is talk of many hotels being sold during the latter half of 2022 and into 2023. Such transactions may take place due to foreclosures, bankruptcies or the dissolution of equity partnerships. Lenders shouldn’t throw the baby out with the bathwater. They should look at a hotel’s financial history to understand its potential. The market is now in a bubble, due in large part to the pandemic, but this is going to dissipate. Mortgage financing should have an eye for the future. And that future could produce ramped-up profits, much like what occurred following the previous industry recession in 2009.
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No doubt, this is a difficult place to be as commercial mortgage lenders, brokers and borrowers will be looking at present results to forecast future financial performance. But it is more important to look at the past as a means to predict a hotel’s future.
The pandemic can be categorized as a one-time disaster. The world and the hospitality sector are recovering. Lenders and investors need to be cognizant of what is happening now as well as what could happen over the next two years. They can be part of putting capital into a future growth scenario. Bubbles happen, but so do recoveries. Brokers can get a piece of the action. ●