I spend a considerable amount of time talking with hotel owners and investors, and they are a cheery group these days. For most, their hotels are performing very well, and cash flow is flush. Things are going so well, they aren’t feeling motivated to sell (and many are actively looking for new acquisitions). I hear it all the time, fundamentals are strong, yield is great and tax implications of selling are daunting. Still, I find myself wondering: are we/they missing something? While I appreciate the appeal of riding the wave, there are some factors that merit consideration — not to be contrarian, just thoughtful.
10. Brand Dilution
Marriott now has 30 brands. Hilton, Choice, IHG, Wyndham and Hyatt all have a dozen or more. I was at a hotel investment conference recently and the brand execs were asked the obvious questions – when is enough, enough? To no surprise, their answer was – never! Now, I am a believer in the brands, don’t get me wrong. And, on some level, they are correct. With international growth as a priority, on a macro level they are far from saturating the market. However, if you talk to the owners I know, they’re concerned. Not about the macro level power of the brand, so-to-speak, but about their local markets.
On a micro level, these brands are dropping in on top of each other and there’s no denying it. While there is replacement of old product and some inducement of new demand, I believe it foolish to subscribe to the train of thought that it’s okay to continue adding new inventory on the same brand reservation systems and expect that everyone wins. Time will tell — but in the meantime, I suspect there will be some losers.
9. Added Competition in a "Shared Economy"
Hoteliers aren’t really afraid of Airbnb per se, but they sure don’t love it. Inventory is inventory, and when property owners can add to it on a whim, the aggregate incremental impact is real. Don’t believe me? Log on and check your local market. Ask yourself, if you took those rooms out of circulation, would it help hoteliers? I’m not a rocket scientist, but you get the idea. Recently valued at $31 billion, this competitor has staying power (not to mention the other platforms and yet-to-be conceived disruptors that will come with new technologies).
8. Inflation is Real
Hoteliers see it first hand: Labor and OS&E costs are on the rise, and brand expectations continue to be enhanced. Many markets are seriously talking about (or have instituted) an alternative minimum wage. Threat of trade war is in the news every day. Every owner I talk to, without exception, says their managers cost more and it’s hard to find/retain the good ones. Barring some type of economic slowdown that will loosen the labor markets and bring a wave of new competition for OS&E goods, I don’t see this changing anytime soon. I won’t even mention technology costs, franchise and commission fees, or construction costs, other than to say, they are high and climbing.
7. Interest Rates are Inching Up
Yep, that’s what happens after a decade or so of favorable rate environments. What’s that saying? “All good things must come to an end?” While there is some evidence to show that interest rate increases do not necessarily cause values to drop, I suggest to you that, if true, it’s probably a short-term reality. Fundamentally, if interest rates go up and capitalization rates stay flat or go down, Wall Street makes less money. Do you really think that’s sustainable? Me neither.
6. Cash on the Sideline
In spite of all nine of the other reasons I note, there are plenty of buyers in the market. And, while I may pen a compelling case to be a seller, I could (and do) make a strong argument to be a buyer also. There is tremendous wealth in this country, thanks, in part, to a more favorable tax environment. I’m also not an economist, but there are billions of dollars in equity looking for a place to park and earn yield. Hotels, generally, provide better than average returns (for those who have the necessary risk tolerance). For sellers, this is good news – there is an active buyer market.
Just ask any Hampton Inn owner in the country about PIP costs and you will get an earful. It’s no secret that the costs of brand-required reinvestments can be huge. The most challenging issue is they’re somewhat unpredictable. Sure, owners know generally when the next one will be due, but the standards are constantly changing and, as such, the costs are too.
4. History Repeats Itself
I don’t recall much from college, but if memory serves, there were some charts in economics courses that pretty clearly showed markets to be cyclical. Hoteliers who have been in the business for a while remember the late ‘80s (not the music, think S&L) and the early ‘00s (the dot com boom/bust) and the late ‘00s (not the iPhone introduction, the great recession). I won’t break out the charts, but I do believe each of those eras had some pretty dramatic highs and lows. And, I suspect most would agree that the lows were more painful than the highs were enjoyable. Surfers love riding a good wave, but most would prefer to avoid the close out when the wave crashes overhead and slams you into the reef.
3. 1031 Exchanges
Most hoteliers I know who are hesitant to sell in the current environment convey a sense of uncertainty about what to do with their proceeds and a strong desire to avoid Uncle Sam on capital gains and depreciation recapture. Well, that’s why some folks a long time ago thought up this great idea of deferring certain taxes to incentivize reinvestment in real estate. If you can’t find a property suitable for reinvestment because the pricing is too rich for your blood, well, that’s probably when you should start feeling great that you were a seller. Uncle Sam will get his share one way or another – sometimes it’s okay to take your lumps and be thankful for the net proceeds.
2. Low Inventory, Aggressive Pricing
I spend virtually every day trying to find assets for clients to purchase, and I can tell you first-hand that the market is tight — the inventory of quality assets for sale is low. Serious buyers who have capital to deploy are ready, willing, and able to pay a premium because they need to generate yield. This drives up pricing, whether based on capitalization rate, revenue multiplier or per unit — we are regularly seeing trades at valuations that make your head spin.
Having said that, buyers are still selective and quick to pass over investment opportunities which don’t check all their boxes. It’s the well-located, well-maintained, Marriott and Hilton flagged properties which are hardest to find and most competitive to acquire when they do come available. With strong macro fundamentals in lodging, even lower tier properties are achieving much higher pricing today than during a stagnant or declining market. It’s a good time to be a seller.
1. Buy Low, Sell High
Sound familiar? Perhaps the most fundamental principal in economics seems to be overlooked by many owners in the current markets. The market is high. Don’t trust me? Read up on it yourself. Pick any credible source and I suspect you will find that most lodging forecasters think we’re either at or approaching the top of the cycle. Need I say more?
To clarify, I’m not saying it’s definitively time to sell your hotel; nor am I saying it’s a bad time to buy. There are plenty of good reasons to buy/hold. I’m merely suggesting it might be a good time to take a strategic look at your portfolio and the various factors that drive exit strategy… you may find some enthusiasm about selling after all.
Originally published on socialtables.com on May 17, 2018
By: Edward C. Denton