Hotel Investing Remains Cheap as Sector’s Recovery Continues, per Analyst

For commercial real estate investors, purchasing hotels is cheap and borrowing rates are headed down, so the lodging sector investment climate should be propitious up ahead, according to Morgan Stanley’s top hotel industry analyst.

Pointing to a plethora of hotel financings lately, Michael Bluhm, Morgan Stanley’s global head of gaming and lodging investment banking, declared in a recent webinar that the sector was facing a “better environment.”

While CRE’s overall recovery from the pandemic has been spotty—offices still are in trouble—hotels have shown decent growth. Occupancy climbed back last year to 63.0%, not too far below pre-pandemic 2019’s 65.7%, per the National Association of Realtors. That marks a heartening boost from the 2020 low point of 49.1%.

In addition, there are signs that deal activity is picking up, said Chris Darling, head of U.S. lodging and gaming research at Green Street, the real estate research firm sponsoring the webinar. Green Street stats show that some 100 fund-raisings occurred in recent months, benefiting from a drop in rates aided by the Federal Reserve’s indication that its tightening campaign is over.

One catalyst is that hotel buy-outs and financing in general are “cheap,” Bluhm observed. He pointed to a recent financing by Caesars Entertainment Inc. for $3.5 billion, the yield on which is just 225 basis points over comparable Treasury bonds. “That’s the tightest spread for a B credit that I can recall,” he remarked. This is indeed a bargain, although spreads are narrowing in general: The average spread for a B-rated corporate is 333, down from 471 in October.

Lodging property prices are down 7% from peak, although that is a far better showing than offices’ 35% drop, per a report by commercial real estate firm CBRE Group Inc. Revenue per available room, or RevPAR, the standard hotel financial gauge, is expected to show  3.0% growth this year, a slightly lower pace than 2023’s estimated 4.6%, CBRE found.

One oddity, Bluhm said, is the gap between public capitalization rates, which track investment returns (income divided by property values), and private ones, as evidenced by real estate investment trusts. The private cap rate, 9.4%, is a full percentage point higher than the public one. The implication is that public investors are not as sanguine as the pros who do private deals. The FTSE Nareit index for hotels is down 1.6% this year after a strong 23.9% increase in 2023.

“A lot of capital is waiting on the sidelines,” Bluhm said. “So hotel values will improve” in the future. He pointed to the “durability of consumers,” the hotel guests who are returning after the pandemic break. Large chains have demonstrated that “scale is powerful,” he added, referencing the 2016 acquisition of Starwood Resorts by Marriott International Inc. Marriott’s stock has more than tripled since, as revenue and earnings have burgeoned.

Still, certain markets today, notably those of San Francisco and Portland, Oregon, have persistent problems, owing to underpopulated business districts. Bluhm said, “They will come back, but it is a five-year thing.”

Lodging makes up a significant, albeit far from commanding, chunk of the CRE market. Public pension funds have 10% in real estate, according to the Center for Retirement Research at Boston College. While no further breakdown is listed for pensions funds’ holdings, a Green Street index showed hotels making up 7.5% of the CRE space overall.

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Tags: Caesars Entertainment, cap rates, Chris Darling, commercial real estate, Green Street, hotels, lodging, Marriott, Michael Bluhm, Morgan Stanley, offices, real estate investment trusts

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