Hospitality’s Outlook Promises More Hotel Buyers and Sellers
2024 Hunter Hotel Conference
Hotel owners, investors, and operators met in Atlanta last month for the 35th annual Hunter Hotel Investment Conference. Attendees from all groups walked away with feelings of optimism for increased hotel activity toward the end of the year, pending much-anticipated rate cuts this summer. Here are the main topics covered.
Property Improvement Plans
A property improvement plan (PIP) is a set of objectives designed to bring a hotel up to compliance with the latest brand standards. A PIP can involve upgrades to a property’s exterior or interior that improve customer experience and ADA compliance. Usually created by brand managers or franchisors, PIPs are a routine exercise for hotels and happen every six to 10 years or when ownership changes.
One of the event’s dominant topics was the need for hotel owners to invest in PIPs. Now that the deferral grace period is over, owners face a growing urgency to fund the improvements while managing nonideal operating margins, inflationary pressure, and insufficient renovation reserves. Lee Hunter, Chief Operating Officer for Hunter Hotel Advisors, noted that the cost of PIPs for a mid-market, select-service hotel is $35,000 to $40,000 per key.
Right now, hospitality is the only asset class in commercial real estate that requires owners to invest millions of dollars to maintain a property’s existing net operating income (NOI). Such a high sticker price on maintenance will prompt owners to bring more hotel properties to market this year compared to multifamily, retail, and industrial properties. Hospitality pricing is also expected to decline more substantially than alternate asset classes. Many hotel property owners will become sellers due to the unaffordable PIPs and increasing pressure from franchisors to complete them.
Owners considering the sale of a hospitality property to a 1031 exchange (for an alternate asset such as retail, multifamily, or industrial) are advised to list the property before hospitality market inventory increases due to increased sales activity.
Bid-Ask Spread
Another hot topic was the bid-ask spread between hotel buyers and sellers. During an executive panel, Dustin Fisher of Noble Investment and Mehul Patel of Newcrest Image shared that while the current minimum spread between a buyer’s bid and a seller’s ask is 10%, institutional buyers are offering up to 20% from pricing guidance for starting offers to gauge sellers’ motivation.
Several promising shifts are expected in the hospitality industry this year. First, franchisors will want PIPs completed since deferment has ended. Buyers face a unique opportunity to take over PIPs that have exceeded owners’ initial budgets by 30% to 40% since the pandemic. As a result, more owners will become sellers due to PIPs or loans coming due and a potential June rate cut incentivizing sales to a 1031 exchange. Second, the number of hotel properties for sale, or market inventory, is expected to increase alongside a decrease in hotel pricing, as historical evidence suggests that commercial real estate properties decline in value for the six months following the first rate cut. Lastly, hotel transactions will increase in Q3 and Q4 as buyers and sellers face a smaller bid-ask spread.
While hotel pricing declines, it will be another eight to nine months before increased transaction velocity and buyer demand outweigh the increase in market inventory.
Interest Rate & Property Values
At the time of the conference, there was an 86% chance of a Federal Funds Rate cut on the June 12th FOMC meeting. Today, April 23rd, there is just a 19% of a rate cut on the same June 12th meeting date.
Data suggests that property values typically decrease by 10% to 20% during the six months following the first interest rate cut.
Main Takeaways
It’s not possible to “time the market,” but historical evidence from previous rate cuts suggests that hospitality owners will likely list their hotels for sale in June or July 2024. Rate cuts motivate owners to list their hotel assets to avoid high PIP costs or maturing loans. Property improvement plans, or PIPs, dominated conversations at the 35th annual Hunter Hotel Investment Conference since their cost increased by 30% to 40% compared to pre-pandemic values, and franchisors no longer offer deferrals. Overall, increased supply will soften pricing for hospitality assets—a notable outlier from the declining prices for retail, industrial, and multifamily assets.
