Expert’s Voice: Are we facing a distressed opportunity for hotel investors?

Marc Sontag, CEO of Aedartis, considers to what extent hotel investors will pick up properties for bargain prices as the market adjusts to the realities of trading during a pandemic.

It is now virtually impossible for hotels to generate a meaningful return, let alone cover debt service or refinance loans. In consequence, investors are gearing up for a resurgence of distressed hotel acquisitions similar to those that resulted from the 2008 financial crisis. 

However, contrary to the previous economic crisis, it is not to be expected that many banks will now take over long-term ownership of hotel assets. The ownership will cost banks money during periods of low occupancy and instead they’d rather support asset owners until there is a vaccine and travel can pick up again.

Properties in technical default may end up falling into hard default, but it is difficult to predict the exact timing of when these assets will hit the market and at what level of discount they will trade, as in the current environment lenders are more willing to work with borrowers on loan modifications, workouts and other strategies. 

In this context, common opinion seems to be though that:

1. the emerging distress of assets leads to opportunities by early 2021 due to the fact that forbearance agreements will expire, and
2. the average hotel value for fair-market-value buyers who were already searching for well-positioned hotels dropped by as much as 15%, whilst opportunistic buyers seek a 30% discount compared to pre-Covid

Owners are not necessarily upside down, but have lost their equity and are motivated to hang on to properties to regain that equity, resulting in a classic wait-and-watch game, which might keep transaction volumes low, unless sellers are going to be distressed enough that they are going to put assets on the market and at the discounts that these buyers are looking for. Moreover, with more opportunistic buyers in the market for bank-owned properties, an increased demand will create less of a discount than investors are anticipating.

Cash is king in situations where debt capital is going to be hard to come by for hotel acquisitions and we might thus see predominantly equity-backed deals. For those who have money, timing is critical and some investors will wait closer to market recovery to put less capital at risk. In this circumstance it will be even more critical to: 

1. move with care around market selection and asset quality
2. focus on hotels which can be acquired at sizable discounts and where pre-Covid operations produced a long-term yield or provide the opportunity to add value through hybrid concepting, conversion and repositioning, and
3. partner with operators and/or asset managers with a track record of managing distressed assets

Future success will be based on correctly modelling various scenarios and, for example, answering if big is still beautiful. Scale is crucial for larger private-equity investors and they want to see an investment scenario where multiple assets over a period of time build a case that eventually gives them a profitable exit.

For others, the game-plan will remain acquiring strategic hotel assets and adding value through leveraging opportunities for hybrid concepting to mitigate pandemic risks, conversion, repositioning and/or rebranding. 

Or, is it on the other hand a sustainable model more about individualism, a sense of belonging, private space and as such conceptually met by boutique, leisure/resort-style hotels – with their inherent limitations of seasonality and predominantly management agreements instead of leases – or apartments with limited service rather than corporate hotels? 

Inevitably this crisis is bound to push all hotel owners, management companies, franchisors and operators to go back to the drawing board to create value and solidify their partnership. It may be argued that the hospitality sector, often criticised for its high fixed costs and low ROCE [return on capital employed], was overdue a major correction and we will see consolidation, a clean-up of portfolios and an increased activity in mergers and acquisitions by both hotel-owning groups and private-equity investors as a result.

This is an edited version of an article that appeared on LinkedIn Pulse.

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