The last five months have been unusual for the hotel transaction market. Some of the hotel real estate investment trust (REIT) stocks began to compress in late January, resulting in fewer REIT purchases than the first five months of the same time period in recent years. This market change began after the ALIS hotel investor conference in late January, which is somewhat countercyclical, given there is usually an uptick in stocks after investment conferences. Clearly, market analysts heard news at the conference that caused concern, which led to pull back on hotel REIT valuations.
I believe a considerable amount of top-tier product was priced late in 2017 for sale to public REITs. When REITs began to pull away from the transaction market, it caused a bid/ask spread to develop, resulting in fewer sales transactions to be consummated early this year, versus the same time period in recent years.
While recently, hotel REIT stocks have rebounded nicely, although many are still short of market pricing from six months ago. I do, however, expect the current pricing trend to bode well for hotel transactions in the second half of 2018.
Concern regarding public companies has caused debt to be more expensive today than six months ago, and spreads have widened due to multiple concerns with EBITDA. We believe the impact of these changes over a five-year internal rate of return (IRR) will be mitigated by continued RevPAR increases, provided those increases outpace the 2-3% annual cost creep to labor and taxes. Despite these factors, we are still in historically low debt cost territory relative to past market cycles.
Additionally, we are seeing heavy increases in hotels that are going into special servicing for a plethora of reasons, but it is still a concerning component given the public secondary debt market is vital to the overall financial health and function of the hotel transaction market. Should this trend continue, it may push the market more to on-balance sheet lending. We believe this could be the beginnings of the next down cycle.
Keith Thompson is principal-hospitaliy group at Avison Young, a commercial real estate service firm. Prior to Avison Young, Thompson was the founding principal of Hotel AG.
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