A Virginia hotel real estate investment trust that watched its revenue deteriorate as guests stayed away from the hospitality industry during the pandemic is finding a way to buy more hotels while preserving cash. In the process, it's showing how the coronavirus is changing hotel financing.
Apple Hospitality REIT, based in Richmond, said it paid a total of $111.6 million for newly built properties in two separate deals, one in Arizona two weeks ago and the other in Florida in mid-April.
The firm completed its deals by supplementing existing cash with the sale of shares, having unsecured debt lines, securing seller financing and eliminating monthly distributions to investors to ensure it had the funds to operate, according to filings with the Securities and Exchange Commission. The filings show the REIT also negotiated amendments to loan agreements with unsecured debt lenders to “suspend its financial covenants until June 30, 2021.”
How the REIT closed the deals in tough times illustrates that buyers are cobbling together transactions with debt significantly more difficult to obtain because of the financial fallout from the coronavirus.
More than 5,200 U.S. hotels closed temporarily and occupancy for the industry declined dramatically as empty rooms reduced revenue and profit, and in many cases, led to losses for those staying open.
High-end hotels took the brunt of the losses from closings because of the vanishing of business travel and corporate group meetings, the mainstay of their revenue. A decline in property values followed, giving investors opportunities to snap up distressed assets if they can pull together the funding.
“Everyone is shying away from” lending on hotels, said Pat Jackson, founder and CEO of Irvine, California-based Sabal Capital Partners, who arranges and securitizes loans for small-balance and middle-market firms. Hotel lending "has dropped off the Earth" during the past five months, Jackson said.
In the first quarter of this year, there was a little more than $3 billion in financed hotel acquisitions in the United States, according to CoStar data. Since then, there has been just $564 million in financed deals posted.
Fitch Ratings said recently it probably won’t rate commercial mortgage-backed securities for single-asset, single-borrower hotel deals because of volatility in the hospitality industry. The firm said it won’t start rating “hotel transactions until performance data evidences the beginning of a sustainable recovery in the lodging sector.”
That could take a while. Fitch Ratings said in its report that “hotel performance is expected to lag the economic recovery and will depend on the return” of leisure and business travel as well as group meetings and conferences. Leisure travel has picked up in the United States but business and group meetings aren’t expected to begin gaining steam in earnest until next year when a coronavirus vaccine or better treatment therapies arrive.
Jackson said Sabal Capital is still lending on hotel deals but with the caveat that “it's going to have to be a pretty remarkable asset for us to get excited about it.”
Smaller Banks Fund Deals
For now, major banks all but disappeared from the lending scene after the first quarter.
JPMorgan Chase Bank, the largest U.S. bank by assets and deposits, according to the Federal Reserve, financed more than $144 million in purchases in the first quarter but none since, according to CoStar data. US Bank, the fifth-largest U.S. bank, was listed as the lender on $110 million in deals for the quarter but none since, CoStar data shows. Wells Fargo Bank, the third-largest U.S. bank, financed $104 million in the first quarter and less than $1 million since April, according to CoStar data.
Instead, hotel buyers in the second quarter turned to smaller regional and community banks and credit unions for loans. The average loan size has been $2.75 million, according to CoStar data. Regional banks did much bigger deals, though they were few.
In early July, Little Rock, Arkansas-based Bank OZK loaned $32.5 million to Buccini/Polling Group, a real estate investor based in the Washington, D.C., area, to buy the Renaissance Harborplace in downtown Baltimore for $80 million, according to property records.
Brannon Hamblen, Bank OZK’s chief operating officer, gave a peek into the bank’s hotel lending philosophy in the current climate during a late July earnings call with investment analysts.
“We try very hard to go into every deal we do with the best sponsorship out there and in the best markets,” Hamblen said on the call.
According to management notes in its earnings presentation, the bank had just 13 hotel loans as of June 30. Those had an average of 48.4% loan-to-value ratio, two-percentage points higher than the previous quarter.
Buccini/Polling Group also secured a $29.5 million mezzanine loan through New York-based Ramsfield Hospitality Finance, the lender disclosed on its website, to close the deal for the Baltimore hotel, and raised an undisclosed amount through investors on the online commercial real estate investing platform CrowdStreet.
Buccini/Polling Group said it had originally put the offering on CrowdStreet in February with the price at $100 million. It then relaunched the offering in May at $80 million. The hotel, like others around the country, have been temporarily closed, pushing revenue and profit to zero.
It closed on the Baltimore hotel, which it described as a distressed and opportunistic property on CrowdStreet, at a significant discount in July. The seller, Irvine, California-based Sunstone Hotel Investors, paid $157 million for the 622-room hotel in 2005 and invested another $64 million in the property, including a recent renovation, according to Buccini/Polling Group.
Buccini/Polling Group's goal is to sell the hotel in five years for $144.6 million, according to the offering.
In a different deal, Laredo, Texas-based IBC Bank loaned Southwest Value Partners $30.3 million to buy Union Station Hotel in Nashville, Tennessee, for $56 million in late July, records show. IBC Bank and San Diego-based Southwest Value Partners did not respond to requests for comment about the deal.
The Nashville hotel had closed during the coronavirus pandemic and was still closed at the time of the sale. It has since reopened under the new ownership.
Union Station Hotel is across the street from a Grand Hyatt that Southwest Value Partners built as part of a massive mixed-used project called Nashville Yards that the company is developing in downtown Nashville. Online retailer Amazon has an office lease in the development and expects to employ at least 5,000 workers for an operations center.
The Grand Hyatt is scheduled to open sometime this fall.
Cash and Seller Financing
With buyers having few lending options, sellers have also stepped up to finance deals. They have, in fact, financed the largest portion of deals in the second quarter, according to CoStar data.
One of the biggest deals involved Apple Hospitality. It paid $47 million in April for a newly built dual-branded hotel in Cape Canaveral, Florida, that has both a Hampton Inn & Suites and a Home2 Suites. The company used $25 million in cash with the rest being financed by the seller with a one-year note, according to filings with the Securities and Exchange Commission.
In August, Apple Hospitality spent $64.6 million on a 259-room dual-branded hotel property next to Arizona State University in Tempe. It contains the mid-tier hotel brand Hyatt Place next to a Hyatt House, which is an extended-stay brand, and construction just wrapped up on both of them.
The REIT had previously contracted to buy the hotels in 2018 prior to the start of construction directly from the university. Neither sold for less than the contract price.
Apple Hospitality didn’t respond to email or phone call requests for comment on how it financed the Arizona deal. In Securities and Exchange Commission filings, the REIT said it planned to use cash on hand or draw on its unsecured credit lines.
On Aug. 11, just days before announcing the Tempe deal, Apple Hospitality, which owns 235 hotels around the country, filed a stock offering to sell up to $300 million in shares.
Like the rest of hotel industry operators, Apple Hospitality's business took a big hit during the pandemic. In the second quarter, the REIT reported a net loss of $78 million compared to a profit of $62 million for the quarter last year. The company reported $1.6 billion in total debt and that it had drawn on credit lines early in the pandemic to ensure it had cash.
Now, however, it’s poised to recover more quickly than high-end hotel owners. Apple Hospitality’s business focuses on mostly leisure travel with extended-stay and suites hotels making up more than 50% of its portfolio.
Extended-stay hotels, which are like one-bedroom apartments and have kitchens, have been performing especially strong during the hotel industry's slow recovery, showing higher occupancy than other types of hotels.
Most of Apple Hospitality’s hotels are outside urban areas in cities travelers can drive to rather than fly.
Liz Perkins, Apple Hospitality’s chief financial officer, said on the company’s Aug. 7 earnings call that more than 50% of its hotels were operating at 15% occupancy in April. Occupancy hit 28.2% for the second quarter, far off from its 81.4% occupancy last year.
But by the end of July, “almost half of our portfolio was running at or above 50% occupancy and only 6% of our hotels had occupancy below 15%,” she said on the call. “We estimate we achieved positive cash flow in July with approximately 45% occupancy.”