The Hotel Developers’ Lost Year

As H&LA keeps abreast the continually changing impact of COVID-19 on the economy in general and hospitality sector in particular, we are sharing insights from industry experts and stakeholders with our clients and partners. This Hotel News Now article discusses how developers have been impacted from construction financing drying up and new projects halting for hoteliers. But some developers could be positioned to benefit.

Published by: CoStar News and Hotel News Now/Sean McCracken
Published date: December 2020

It’s been a memorable year for hotel developers, though most would rather forget it.

Bereft of financing and severely lacking in clarity over the industry’s trajectory, new hotel projects came to a sudden halt in the U.S. in March with the onset of the COVID-19 pandemic.

“When COVID hit, everybody just shut down and was paralyzed for a while,” said Rick Takach Jr., chairman and CEO of Vesta Hospitality. “Everybody was really afraid to spend money in the hospitality world.”

A common theme for developers is that projects already under construction continued, while projects in early stages stalled or were abandoned.

Data from STR, CoStar’s hotel research and data company, shows that as of the end of November, the number of hotel rooms under construction across the U.S remained flat year over year at 206,000, while rooms in final planning decreased 2% and hotels in planning fell 14%.

As the pandemic lingered, developer interest in some stalled projects seemed to wane, as more moved from the planning and final planning stages to deferred or abandoned in August and September.

Alan Reay, president of Atlas Hospitality Group, said properties in California have followed the national trend, with a significant jump in deferred or abandoned projects in the second half of 2020.

“A lot of those developers are trying to pivot to other uses, but unfortunately there aren’t a lot of choices,” he said. “It comes down to residential multifamily or for-sale condos, and in a lot of cases, zoning doesn’t allow” for those changes.

The top hurdle for new hotel construction is that financing has disappeared.

“For those developers without construction financing, you’re seeing a lot of those projects abandoned, or they’ll be mothballed for a few years,” Reay said. “In 2021, unless you’re already under construction, we do not see an increase in the number of [projects] moving from planning into construction. That’s for two main reasons: One is banks, especially on the hotel side, are reluctant to provide construction financings; and secondly, owners are waiting to see how the recovery goes in 2021 into 2022.”

Mike Jaynes, president of lender Hall Structured Finance, described the landscape as “very, very bleak.”

“We have put our construction financing program, which has been our bread and butter for years, on pause,” he said. “We’ll get back into construction financing, but given the pandemic and the situation specific to hotels, we’ve moved from construction to providing bridge financings for hotels.”

In another move that is perhaps telling for the industry, Jaynes said HSF, which has historically focused primarily on the hotel industry, is increasing its lending for multifamily projects.

He said a return to normal levels of hotel construction financing for his company will require a better understanding of where the industry is headed.

“There’s so much uncertainty now,” he said. “It depends on who you talk to if you want to know when the recovery will be back to pre-COVID levels. We’re not looking for that, but we want better clarity. At least there is light at the end of the tunnel with the vaccine.”

Even when some sense of normalcy returns, Jaynes said the firm could transition investment away from certain types of projects.

“We’re definitely going into [large full-service projects] with more caution,” he said. “There’s no question about that. There are easier deals for us.”

He said the company likely will be more selective about deploying capital in some markets and submarkets and will focus primarily, but not exclusively, on select-service and extended-stay hotels.

Insights From Developers

Takach said a project he thought was in good shape almost disintegrated due to lenders being skittish.

“Our biggest surprise was from the debt provider,” he said. “We’ve worked with these guys forever, then all of a sudden they start hedging on the price. It was a good deal for them, and I’m thinking I’m paying them a pretty good price, but then that overpricing to me was underpriced to them.”

At the same time, equity investors shifted their focus to hunting for distressed assets they could pick up at a discount — a market that’s yet to truly materialize, Takach said.

He said he hoped the silver lining in this environment would be a reduction in construction costs, but that never materialized as construction demand for other forms of real estate has remained high.

Ultimately, Takach’s project got off the ground with financing from a local group that had an interest in it being completed.

“I was pretty fortunate I was able to put (the project) back together,” Takach said. “By accident, I found a favorable piece of debt for the project.”

Mark Ricketts, president and chief operating officer of McNeill Hotel Company, agreed that working locally on projects has helped with financing.

“We’ve worked with some local banks that, while they were somewhat nervous, we’ve had a strong relationship with them,” he said. “We’ve been fortunate to have done pretty well during the pandemic.”

Ricketts said his company has benefited from strong performance across its portfolio and the leveraging of local relationships. It’s also helped to focus on projects that are more resilient during the downturn, such as select-service and extended-stay properties in college towns or others with multiple demand drivers. Those projects include a recently opened Tru by Hilton in Rockwall, Texas, outside of Dallas, and a Courtyard by Marriott in Manhattan, Kansas.

He said well-positioned developers have opportunities coming out of the demand crisis.

Those with projects underway now could be opening to the onset of a travel rebound, and successful developers are being offered better brands and locations than would have been available otherwise.

“Now with the downturn, sites have popped back up with premium brands,” he said. “It’s been interesting.”

Takach acknowledged the difficulty hoteliers have had contacting brand representatives, as many brands cut staff in response to the downturn, but said that was far from the biggest hurdle for hoteliers.

“It’s definitely not business as usual, but we haven’t found it challenging either,” he said. “Maybe that’s because of the stage [of development] we were in. We were always able to find somebody with support or answers.”

Expectations for 2021 and Beyond

Takach reiterated that developers who are building now might be poised for a strong rebound.

“You’re pretty fortunate if you’re in the middle of building something because there’s a good chance to open at the right time,” he said. “Coming out of the pandemic without a lot of new supply, you’ll be pretty lucky to get this right.”

Takach said he expects to open a property in 2022, for which he projected performance will still be lower than 2019 levels but significantly higher than today.

“People will have more confidence, especially hopefully with business and group travel,” he said.

Ricketts said he’s “intrigued” by the development possibilities in 2021. His company does some development but primarily exists as a third-party opportunity. The open landscape for development might shift that thinking somewhat, he said.

“I think we’re going to take a hard look and maybe look into more development than we had in the past,” he said, noting his company projects a rebound for the hotel industry in 2023.

Reay said his best guess right now is a return to 2019 performance levels and development appetite will come in late 2023 or into 2024.

“It will be three to four years, and a lot of that will depend on how healthy the economy is and where we’re at with interest rates,” he said.

In terms of whether the pandemic changes developers’ strategies long term, Takach said it definitely “gives you pause,” and lessons will be learned.

“Anytime you hit a downturn, you learn something new,” he said. “We’ve been through a number of them. The last downturn taught us not to be overlevered, and that paid off this downturn because I certainly wouldn’t want to be overlevered right now. But I don’t know what’s going to happen this time.”