By Kristina Paider
Investors continue to have a more favorable outlook for West Coast properties versus the national average. This is due primarily to the high barriers to entry on the West Coast, where coastal property is at a premium — Hawaii at the extreme with very restricted development. The West Coast is poised with strong economies such as Portland, Seattle, Los Angeles, San Diego and all Hawaiian cities, each generating strong demand for leisure and business travelers, including group demand.
Western U.S. Hotel Sales Volume On Par with U.S. Trend
The United States’ year-end hotel transaction volume in 2007 reached $45 billion, the fourth consecutive year of record hotel sales. This marks a 38 percent increase over the 2006 total. Portfolio deals dominated the investment landscape in 2007, accounting for 71 percent of the volume, with hotel mega-deals — deals valued at $600 million or more — as the main driver. Often private company buyouts, these mega-deals alone contributed to $23 billion in transaction volume. In addition, Hilton Hotels Corporation was taken private by The Blackstone Group, representing a $26 billion global deal.
Single-asset sales topped $12.8 billion, $3.9 billion of which were hotel sales in the western U.S. states: California, Hawaii, Arizona, Colorado, Idaho, New Mexico, Nevada, Oregon, Utah and Washington.
For U.S. hotel investors, 2007 was characterized by two distinct periods. In the first 8 months of the year, debt was both plentiful and favorably priced, and investors benefited from strong liquidity and high leverage. The upheld cap rate compression enabled investors a broad approach to investment, covering multiple segments. Competition for quality assets was high with vast amounts of capital pursuing hotel investments. Pricing remained aggressive; however the 2007 average price per key decreased 9 percent to $145,691.
The credit crunch that erupted in August 2007 took its toll on the last quarter. For the first time in 3 years, the number and size of transactions began to slow, much due to the constriction in available debt financing available for acquisitions. Lending parameters quickly responded, increasing equity requirements. Lenders also raised requirements of cash flows servicing debt, making it more difficult to acquire value-add properties. That being said, hotel loans were still being originated, particularly for assets with a strong brand, good location and superior cash flows. Lodging fundamentals remained strong throughout the year.
Values may have come down a bit, and there are now fewer buyers competing for assets on the market. While there was still a lot of liquidity in the equity markets, the syndication market weakened. Since many of the larger deals already had their financing in place at this time, most deal closings proceeded as normal, so this slowdown will be more notable in 2008.
Two Hawaii Hotels Demand Top Pricing in 2007
The high competition for assets in the first 8 months of the year ensured top sales prices throughout the country, with Hawaii earning the top two positions for the year’s single-asset sales.
At $575 million, the Maui Prince Makena Resort in Maui represented the largest single-asset hotel sale in 2007 around the world. This asset, held as the second most expensive non-casino hotel sale in history, includes two 18-hole golf courses and 1,317 acres of developable land. Another Hawaiian resort, the Hyatt Regency Waikiki, consummated the second position. In the past several years, Hawaii has commanded the highest premium asset prices, exceeding the value of those sold in New York and other key gateway cities.
Credit Crunch Changes Market Dynamics in U.S.
The credit crunch has caused lenders to become more circumspect with the wider interest-rate spreads and decreased loan-to-value ratios. The environment will shift once securitized and conduit lenders clear loan inventories off their balance sheets and start originating fresh debt that reflects the changed market environment. Superior sponsorship is of central importance in this period of more conservative underwriting. Deals involving established properties and those with strong cash flows will still attract financing in 2008, while assets that require renovation or repositioning may find it somewhat harder to raise debt. The greater market volatility in 2008 will also create opportunities for buyers keen to exploit a market where yields are rising and fewer buyers are queuing up.
The weak U.S. dollar, showing no signs of recovering, will make assets more attractive to overseas capital. For these buyers, U.S. assets will be priced favorably, both from a valuation and currency standpoint. Foreign buyers’ impact on the U.S. investment landscape could be considerable in 2008 and strengthening beyond. A larger movement of capital from Asia to this country is expected, beginning in the first two quarters of 2008.
Capital flows from the Middle East to the U.S. are increasing as well. This money will come primarily from sovereign wealth funds, which are largely unaffected by the credit crunch. Capital flows from Middle Eastern oil-rich countries are more driven by supply of money than difference in currency. The U.S. hotel investment market is also seeing growing activity from British and Irish buyer groups.
While GDP growth is expected to ease in 2008, U.S. monetary policy is geared to pump liquidity into the economy, amply demonstrated by several Fed rate cuts starting in September 2007. And with core inflation moderating — year-on-year inflation growth to October 2007 is below the Fed’s upper ceiling of 2.5 percent — the central bank will have room to move when another rate cut is warranted.
The weak dollar has two positive influences on U.S. demand: it encourages visits from overseas travelers, especially to major gateway cities, and it makes overseas travel more expensive for Americans so they tend to take their vacations at home. Demand and spending power from overseas is expected to grow — for example, through the new U.S.A.– China tourism agreement, which is expected to increase by hundreds of thousands the number of Chinese who visit this country each year.
Outlook for 2008
“Hold” is the overriding investment strategy for 2008, with some 33 percent of investors intending to hold their assets in the short term. Savvy hotel owners will hold until they get the pricing and returns they’re after. This marks a period for renovation and asset-management projects to boost cash flow. To improve their assets and performance, many investors are taking this opportunity to expand or upgrade.
Unlike last year, when lenders were willing to price the upside, lenders today are looking only at a trailing 12-month history — and cash flow is king. Investors are renovating now to improve their position for future trading and waiting it out during this period of illiquid debt and perception gaps in pricing.
There are two exceptions to the hold strategy. First, trophy assets with exceptional cash flow will continue to trade. These assets will continue to get financing and interested buyers, as those left buying will pursue top-quality hotels. Second, select-service properties, viewed more as commodities, will continue to attract an audience.
Kristina Paider is senior vice president, research and marketing, for Jones Lang LaSalle Hotels.