The pending recovery from the COVID-19 pandemic poses a number of financial challenges and opportunities for hotel investors.

During “The Money Talks: Navigating Cash and the Capital Stack in These Times” webinar for the NYU School of Professional Studies Jonathan M. Tisch Center International Hospitality Conference, industry and financial experts spoke about the availability of capital within the hotel industry, the lending environment and what’s happening with hotel real estate investment trusts.

There's a great deal of pent-up capital waiting for the chance to invest in hotel deals, and it has to go somewhere, said Tyler Morse, chairman and CEO of hotel owner-operator MCR.

“It’s just the pie has gotten so big, and you can’t put that genie back in the bottle,” he said. “So this wall of capital is here with us for a very long time, which is going to just drive down yield expectations.”

The thing to pay attention to going forward is the loans that originated in 2017, 2018 and 2019, which amount to roughly $230 billion in lodging loans at essentially peak earnings before interest, taxes, depreciation and amortization, Noble Investment Group CEO Mit Shah said. Many of those loans were leveraged at three-to-one, perhaps even more.

That means there are two walls of capital: the one that is ready to come in, and the one that is already existing, Shah said. It’s going to be interesting how that plays out over the next year as banks look to their own balance sheets and see a loan outsized to the present-day value.

The assets Noble is looking to buy look different from what it’s looking to sell in terms of metrics, structure, strategy and yield values, Shah said. He didn’t expect to be as active selling certain assets this year based on values, but it’s a testament to the amount of capital in this business that wants to build scale and do it significantly.

“If you truly believe that you’re going to hold these for a very long time, and there’s not going to be significant supply growth, you are going to get cap rate compression,” he said. “The first three years’ cash flow isn’t really a big deal.”

There’s a different world that exists with sophisticated investors who are saying they are going to be long on this business because there is growth, Shah said.

Interest rates will start to climb slowly and will continue to do so over the next couple of years, Access Point Financial CEO Michael Lipson said. There shouldn’t be a spike in rates for the next 24 to 36 months.

The Federal Reserve will have to raise rates to slow down inflation, but on the other side, spreads will tighten because of this wall of capital coming to the U.S., he said.

“The overall rate that borrowers will pay may not dramatically change,” he said.

The rate may go up 25 basis points or 50 basis points at the most, Lipson said. Borrowers won’t care, though, about the spread and rate as what they care about is the total cost of capital, and that will continue to moderate.

MCR has 30 different banking relationships, and they have capital, Morse said. The community banks are looking to lend money, but they want trusted borrowers. A would-be borrower who doesn’t have much experience in the hotel space is going to have trouble getting financed.

“It’s not about spread,” he said. “If they know you and they like you, they’ll lend you money to help. If you haven’t borrowed from them before, they’re just not going to lend you money at all.”

There was capital lined up last summer waiting for distressed deals, but nothing happened because lenders were generally forgiving, Morse said. That period has ended. His company recently bought a $16 million loan, and the lender said it doesn’t want to take the asset back. In California, the company made a deal on a courthouse’s steps to buy a hotel in a foreclosure option, but they had to move in within two weeks.

“This is the distress that is starting to come,” he said. “It’s coming a year later than people thought it would. I think the lenders are saying, ‘Hey, either stand up for your loan like you said, or you’re out.’”

The lenders feel they’ve given borrowers plenty of leeway, and some borrowers are still asking for more, Morse said. Those running a five-day yield are getting turned down because lenders feel they gave enough and now they have regulators breathing down their necks.

“You’re going to see a lot of action in the next 12 months,” he said. “It’s past where people thought it would be, but I think it’s coming.”

The hotel ownership sector generally is in OK shape, said Michael Bluhm, managing director and global head of gaming and lodging investment banking at Morgan Stanley. Some companies came into this with tough leverage, and some companies came into this without. The equity markets heretofore haven’t picked winners and losers, and some hotel real estate lodging trusts are trading like GameStop today with companies selling equity into them.

“I say that because no one’s forced to do anything,” he said. “The boards and management teams are being very thoughtful about the strategic direction of the business.”

Everyone generally wants to believe nothing is going to change, but as business, group and leisure travelers return, he asked whether hotel executives are going to consider repositioning their business.

There are a number of REITs that basically do the same thing, Shah said. Looking at EBITDA multiples that the various REITs are trading at, there’s going to be a combination of how they grow through various means and what they do to actually get a premium multiple.

“I believe that public investors have made this bet to say it will take a while for these REITs to get back to [2019] EBITDA, but we’re ascribing a higher multiple because of the liquidity in the marketplace because there’s got to be growth,” he said.

Most REIT CEOs and management teams are looking at the next five years as being the culmination of every opportunity that could have been over their careers, Shah said. Everyone has said for years there are too many hotel REITs, they all do the same thing and little gets done, but given the magnitude of this crisis and the current environment, there are some forces to do something differently this time around.

There are 63,000 hotels in the U.S., and only about 2,500 of those are owned by the public hotel REITs, Morse said.

“I mean, it’s nothing,” he said. “It’s a rounding error.”

Look at the other types of real estate, Morse said. In self-storage, there’s three or four companies. In student housing, there are two big companies. With malls, there’s three. There’s only a handful companies that own large office properties.

“The concentration of every other food group in real estate is 100x what it is in hotels,” he said. “It’s this extraordinarily diversified landscape that has never been consolidated.”

Some hotel REITs own only 30 or 40 hotels, Morse said, later adding that “there aren’t a lot of strategic macro visions when you own 30 hotels.”

They’re all valued the same, so investors aren’t incentivizing them to do anything, Bluhm said. However, this is a sector with a different volatility profile of its stock price. During a 10-year cycle, hotel REIT stocks have about two years in which they experience outperformance on valuation allowing them to capitalize on what’s happening in the private markets to get this arbitrage.

“That’s when you can really lean in and put real capital to work and really grow your business,” he said.

The biggest, most respected REITs by sector put capital to work in scalable way, year over year generally between 5% to 10% of their asset base, Bluhm said. That’s difficult to do for hotel REITs when their stock price bounces around so much over a 10-year period with an arbitrage period of about two to three years.

Scale is a key differentiator, whether it’s access to capital, cost of capital, ability to outperform, acquisitions or informational advantage, he said.

The hotel REITs in some respects “are stuck with one arm tied behind their back because they are subject to this volatility in stock price and the ability to buy and sell in only very small windows,” he said.