POSITIONED TO ACT: Hotel owners struggling to make debt service may resort to borrowing more money to stay afloat as the coronavirus pandemic continues to ravage the U.S. economy. Some private equity firms and financiers are prepared to offer rescue funding. But it’s borrower beware as some investors might turn out to be sharks eager to capitalize on an owner’s distress.
“The seeds for broad distress have been planted.” That’s a recent observation from Daniel Lesser, president and CEO of LW Hospitality Advisors, which tracks lodging transactions in the U.S.
On Aug. 3, Lesser released a report on sales of select-service hotels in the second quarter of 2020. He noted that over the past 40 years the U.S. has experienced some significant economic downturns. And each recession “has presented wonderful investment opportunities.”
“It appears that this downturn may very well produce a period that rivals the very best in both returns and depth of opportunity,” Lesser wrote.
The longer the coronavirus pandemic impedes business, corporate and group travel, the greater the level of distress in the hotel industry. “Like prior downturns, many anticipate deep distress will produce increasing levels of loan defaults, which will likely continue for some time,” he said.
Some financial firms are stepping up to help owners ward off default and foreclosures. But it’s buyer beware as private equity also is seeking some opportunistic deals if owners cannot generate the income required for long-term survival.
LISTEN: RESCUE CAPITAL: Episode 281 of Lodging Leaders podcast explores how some investment funds are positioning themselves to help hotel owners emerge from the storm with their businesses and investments intact.
Currently, traditional buying and selling has stalled.
In the second quarter of this year, LW Hospitality Advisors reported an 83 percent decline in the number of select-service hotel transactions compared to the same quarter a year ago.
LW Hospitality Advisors counted six single-asset transactions of more than $10 million, totaling $246 million. The number of rooms sold totaled 1,459 with an average price of $169,000 per key.
In the second quarter of last year, LW Hospitality Advisors identified 35 transactions totaling $2.6 billion. The number of rooms sold totaled 9,100 with an average sales price of $286,000 per room.
Though select-service is struggling, especially hard hit are full-service properties. As evidence of what may lie ahead, Watermark Lodging Trust in June sold its Hutton Hotel in Nashville for $70 million. The price is $7 million less than what the REIT said it paid to acquire and upgrade the hotel seven years ago.
A month later, Watermark said it signed a deal in which it sold shares worth $200 million to a joint venture between Ascendant Capital Partners and Oaktree Capital Management.
The influx of cash will be used to keep Watermark in business and give Ascendant and Oaktree preferred equity positions. Watermark will pay the JV a 12 percent annual dividend rate.
The activity is a harbinger of what’s to come as hotel owners struggling to stay afloat amid the economic downturn caused by the coronavirus pandemic may soon be forced to sell their assets at a discount or borrow money to keep paying their mortgages.
WATCH: INSIDER PRESENTATION: Daniel Lesser, president and CEO of LW Hospitality Advisors on July 16 gave this presentation to Peachtree Hotel Group investors on the current state of the industry and what it might mean for hotel investment in the coming months.
‘All in the Same Boat’
Peachtree Hotel Group has a portfolio of 50 hotels. Waldman said the coronavirus crisis and the shelter-in-place mandates impacted its hotel business the same as the rest of the industry. “We had conversations with lenders when our hotels went empty,” he said. Conventional balance-sheet lenders granted mortgage payment deferments of 60 to 90 days. The borrowed time has allowed both lenders and debtors time to figure out where things stand.
Stonehill Strategic Capital was having similar conversations with its borrowers. “We’re all in the same boat,” Waldman said. “We want to make sure they’re in a position to make it to the other side as well.”
Now, Stonehill has shifted into strategic mode and is exploring what a coronavirus rescue fund would look like.
The company got its start by investing in distressed mortgages during the real estate bust of 2008 and the Great Recession that followed. The goal then and as well as now is not to capitalize off someone else’s bad fortune but to buoy businesses enough to stay afloat until they can make it safely to dry ground.
The returns will be in the form of interest payments and taking preferred equity positions.
Evens Charles, president and CEO of Frontier Development & Hospitality Group, came into the hotel investment arena before the trough of the Great Recession by specializing in acquiring hotels in need of renovation and repositioning.
Today, Charles is calling on the lessons he learned during that downturn to navigate his way through the current crisis.
“Real wealth is created in a downturn,” he said.
Charles frequently teams up with other developers, managers or financiers when taking on a project.
In this case, he’s partnered with Cronheim Hotel Capital to create a pool of rescue capital aimed at helping hotel businesses navigate through the choppy seas ahead.
Currently, many owners are managing to stay afloat thanks to the Small Business Administration’s coronavirus relief such as the Paycheck Protection Program and the Emergency Injury and Disaster Loan program.
In addition, like Peachtree and Frontier, owners have negotiated mortgage forbearances and deferments with lenders.
But the government relief as well as bankers’ patience are coming to an end.
The rescue funding Frontier and Cronheim plan to deploy will allow owners of limited- and select-service hotels pay their mortgage debts and operational shortfalls. The fund will earn a return as well as the interest rate ranging from 12 to 15 percent.
As the coronavirus outbreak is not showing any signs of abatement and the hope-for uptick in hotel occupancy is stagnating, Turley realized Cronheim needed to deploy its capital in a non-conventional way.
The creation of the rescue fund, he said, is not only to help hotel owners stay solvent – it is to save them from predatory investors who have no true interest in saving their businesses.
Pre-pandemic, Cronheim was doing a lot of CMBS financing. “Then we became very concerned,” Turley said, as CMBS special servicers – who get involved when a CMBS loan misses a payment – deal with problem situations.
As Long Live Lodging has reported, CMBS loans are complex financing structures that are viable solutions when business is good but can lead a debtor down a winding and expensive rabbit hole when faced with an inability to pay the debt service.
Turley said he was at first hopeful that CMBS special servicers would be understanding and eager to help hoteliers struggling with a drastic decline in revenue caused by the coronavirus pandemic. “But that’s not happening,” he said. Instead, he’s hearing that special servicers are becoming somewhat predatory in their responses to borrowers’ inability to pay.
“I think they are emboldened by the amount of capital they have access to,” Turley said. “They saw some successes of the last downturn when lenders were able to convert debt positions to ownership through foreclosure and in some cases make a lot of money by holding on to some of those assets until the market has improved.
“We’re increasingly concerned that they see this as an opportunity to profiteer.”
Both Turley and Charles say besides CMBS lenders, conventional banks that have granted forbearances will soon run out of patience and seek payback. Federal regulators may also “swoop in” and demand banks right size their loan portfolios.
“At some point, the bank that hasn’t been paid for nine months will have to clear up its books,” Turley said. When that happens, the problem will be so widespread the only buyers of distressed mortgages will be private equity bidders eager to absorb the loans and eventually foreclose.
Turley and Charles did not want to see that happen to owners struggling in a crisis that is not of their own making.
“We recognize that there is a growing need for liquidity within the hotel industry to continue to pay bills during this downturn,” Turley said. “The reason for the rescue fund is to sit beside owners, to help them pay bills and eventually help them move on with their investing lives.”
Though many experts typically turn to past economic crises for answers to current problems, the coronavirus pandemic has caused an unprecedented disaster for the lodging industry.
Turley sees one dramatic difference between the current crisis and the Great Recession. And that’s the availability of investment money.
“The last time around, the fundamentals of the hotel business were bad and there was very little capital. It was very difficult to find a place for debt financing; it was very difficult to find equity. There was a large capital market dislocation.
“This time around, the fundamentals are much worse, at least so far. But there’s an enormous amount of capital; there’s an ocean of capital out there. Not all of it is ready to step in to provide cheap debt; a lot of it is very, very greedy and scared. But there is so much more capital than the last time around, and a lot of this capital is being formed to take advantage of this enormous period of distress.”
Turley said Cronheim’s rescue fund is targeting situations where there is acute need but owners can see light at the end of tunnel. For example, hotels in downtown and airport markets are not expected to recover as quickly as properties in drive-to leisure markets. But that business will come back and that’s where Cronheim wants to invest.
“I think you’re going to see a lot of that capital be very strategic,” she said. “Private equity investors usually are very clear on what they’re looking for.”
Most are attracted to high-barrier-to-entry markets while others may want to scale in markets where they already have properties. They’ll also be more attracted to newer hotel assets that require little re-investment of capital.
As with Lesser, many market watchers believe opportunistic buying and investing will begin in a month or two and continue into next year. Investors who’ve been watching from the sidelines are about to make their move.
“For those who have money, timing is critical,” Chivers said. “Some buyers will wait to invest closer to market recovery. The closer you can time the acquisition to the true trough in the recovery, the better for the buyer because it’s not having to put as much capital at risk.”
Chivers believes the critical time will be the fourth quarter of this year as a resurgence of COVID-19 infections in several states has stalled recovery. “We’re looking easily at 12 to 18 months just to get back to a footing for some owners. And we’re already seeing a few assets go to market. We’re also seeing lenders and (CMBS) special servicers planning note sales for non-performing assets they already have on the books.”
As creative and intriguing the concept of rescuing a hotel business is, Chivers advises it’s not a panacea for every troubled asset.
“A lot of owners may not even have that option because they’re not in a position to take on additional debt due to the debt that they already have,” she said. And in some cases loan covenants prohibit additional debt on the asset.
For hotel owners thinking seriously of repositioning or selling their properties to take advantage of the shift in business, Chivers advises they take a hard look at what’s feasible now and in the immediate future.
“In this market, unfortunately, it doesn’t make sense to take your equity and spruce up your property. You won’t get a return. Keep your equity and try to work with your lender. You will need your equity to reach a loan modification and even forbearance.
“Try to find a source of capital. Do everything you can to avoid default because if you go into a nonperformance category it changes the negotiation with the lender.”
Charles also has advice for owners considering applying for some form of rescue capital.
“Start having conversations about what rescue capital would look like. Even if you’re not ready to go that route, at least should know what it would look like at the moment you’re ready to pull the trigger.”