As we keep abreast the continually changing impact of COVID-19 on the economy in general and hospitality sector in particular, the following HVS report details some of the unprecedented impact on hotel owners, operators, and investors.
Published by: Anne. R. Lloyd-Jones, Suzanne R. Mellen, and Tanya J. Pierson (HVS)
Published date: April 2020
The COVID-19 pandemic and the related restrictions on travel, business activity, and individual movement are having an unprecedented impact on our industry and economy. Hotel owners, operators, lenders, and investors are all facing greater challenges than ever anticipated, as they grapple with plummeting occupancy, average rate (ADR), and RevPAR and seek solutions to mitigate the impact on EBITDA. Owners and operators are dealing with the current crisis day-to-day, making hard decisions regarding staffing, continuing or suspending operations, and having difficult conversations with their management companies, franchisors, lenders, and investors. Management companies and franchisors are working to identify ways to support their hotels while maintaining a coherent business strategy, while lenders and investors are grappling with fundamental questions concerning risk, returns, and value.
We don’t know how long the pandemic will last, how long the related restrictions will be in place, or how much worse this could get for our industry. We also don’t know the final net impact on the economy, or the depth and duration of the downturn. We do know that these events will have, and have indeed already had, a significant impact on hotel values. While it is difficult to assess the full impact, an examination of value trends in prior cycles can provide some useful guidance. Those historical patterns, together with an understanding of the market’s current expectations for the ultimate recovery of the industry and its performance, provide guidance for the probable trajectory of decline and recovery for hotel values.
Hotel Values and Market Cycles
EBITDA is defined as earnings before interest, taxes, depreciation and amortization, and for hotels, it includes a deduction for management fees and a reserve for replacement.
The volume of hotel transactions and the price paid for individual assets are influenced by two principal factors: the availability of capital and the performance of the lodging sector as a whole. When the industry is performing well and financing is available on favorable terms, investors are attracted to the market, and both prices and the number of transactions increase. These market conditions often induce sellers to put their properties on the market, further fueling the pace of transaction activity. Conversely, when hotel performance declines significantly, generally due to a contraction in demand caused by an economic downturn or, in this case, the pandemic, owners refrain from selling their assets until the market improves. Additionally, many hotel lenders withdraw from the market, making hotel financing less available; the debt that is available is usually characterized by lower leverage and higher interest rates. As a result, transaction activity drops off significantly. The impact of these influences results in a cyclical investment market, recording peaks and valleys in response to changes in the capital markets and the economy.
Value Trends Evident Through the Great Recession and Recovery
To provide a basis for our analysis, we looked at hotel sales transaction trends from Q1 2007 through the end of 2019. As illustrated in the graph below, hotel sales transactions started to decline markedly in late 2007 as the market began to falter. The financial crisis in the fall of 2008 stalled out the transaction market, with few sales occurring in late 2008 and 2009. Once hotel performance bottomed out in late 2009, hotel investors jumped in, and the number of transactions began to accelerate mid-year 2010.
