Maybe I spoke to a different group of CEOs, CFOs and CIOs at the NYU investment conference and after, but I believe the grown-ups are more cautious than the impression I have gotten from some of the follow-on articles. While we all are thrilled that revenue per available room has bottomed and is trending up, we are all cautious that two months does not a trend make. While I did not hear it, I was told by multiple people that there was a projection that values would increase 150 percent over five years. And Santa Claus is real and he will fill your stocking with goodies this year.
Unemployment is the underlying driver of total demand. While companies are once again starting to travel, and that will build, the leisure market will take time to recover high levels of average daily rate. Luxury will recover faster than other segments because the higher income population is over its stock market losses and is starting to spend again, although nothing like in 2007. There is a real question as to whether overall demand is driven partly by low rates and people concluding that they can now take trips at far lower cost, so why not go while the rates are so low. Low hotel ADR is likely very akin to the housing tax credit. Once that went away, home sales tanked dramatically. Raise ADR too much, and revpar may tank as well, as occupancy could drop off materially.
The rest of the economy is suffering near deflation in pricing. Nobody has any pricing power. The Fed is going to continue holding rates low because it fears deflation. With unemployment remaining high, foreclosures still rising, fear of a second downturn and widespread lack of confidence in the government, it is hard to understand where pricing power in the hotel industry is going to come from when no other segment of the economy has it. Yes, ADR will go up some from here, but it is easy to have what appears to be nice percentage increases when the base is nil. Hotel industry pricing tracks the overall economy, so if there is slow growth and no pricing power, there will not be large real dollar increases in ADR.
There are still thousands of hotels in delinquency or default. The servicers have hundreds of hotels in foreclosure or serious default. All of these will be dumped back into the market by loan sales or real-estate owned sales over the next two years. While funding is available for refinancing or acquisitions in major markets, there is a distinct difference in the capital market willingness to finance secondary and tertiary market deals versus primary markets. Most major capital markets sources will not yet go to secondary markets no matter how good the sponsor or the deal.
This will change and improve, but for the next two years there will not be a major infusion of debt into these markets. It will only happen when the commercial mortgage-backed securities market is once again robust, and that is some time away. There is a strong belief that cap rates will actually increase over the next two years as a lot of these deals are dumped into the market by lenders and as interest rates rise, which they will do later next year. Do not be fooled about cap rates by looking at them now. At the moment they are low because they are being applied to very low net operating incomes and the bet is on terminal cap rates. Those will be higher than they are now.
The summary point is, listen to what is said in private by the grown-ups, and not the spin at conferences like NYU where many speakers have an agenda they need to push. Speakers pay US$15,000 to US$20,000 for sponsorships to be allowed to speak at the big conferences, and that is considered advertising dollars. That is why you don’t see me speaking at the two major conferences. I have no agenda to push. Things are better, but keep your attention on the world around you and not the spin at conferences, where most speakers want you to feel good.
Joel Ross is principal of Citadel Realty Advisors, successor to Ross Properties, the investment banking and real-estate financing firm he launched in 1981. A pioneer in commercial mortgage-backed securities, Ross, along with Lexington Mortgage and in conjunction with Nomura, effectively reopened Wall Street to the hotel industry. A member of Urban Land Institute, Ross conceived and co-authored with PricewaterhouseCoopers The Hotel Mortgage Performance Report. Ross is also the author of Ross Rant, a commentary on the economy, financial markets and politics that’s available through his website, www.citadelrealty.com.
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