The long-battered hotel industry is turning the corner as occupancy and revenue in the U.S. finally start to rebound.
But hotel owners can't start partying just yet. Hotel properties remain deeply indebted, with billions of dollars of mortgages coming due in the coming years amid forecasts the industry won't regain its full strength until 2013.
For now, however, hotel owners and operators are focusing on the first good news they have had in two years, which in some cases is coming earlier than industry analysts expected.
Revenue per available room, or revpar, in this year's first five months rose 1% to $52.99, according to Smith Travel. In comparison, it averaged $64.57 in the first five months of 2008.
Earlier forecasts had the recovery starting in 2011.
"I did not expect it to get this positive this fast," said Monty Bennett, chief executive of Ashford Hospitality Trust Inc., which owns 102 U.S. hotels.
Many hotels are hoping for a quicker recovery. For example, two luxury hotels in Chicago owned by JMB Realty Co.—the Four Seasons Hotel Chicago and the Ritz-Carlton Chicago—are banking on regaining 10 percentage points of occupancy this year. Those hotels have a lot of ground to make up, though. The 343-room Four Seasons saw its occupancy fall to 59% last year from 71% in 2008, according to Realpoint LLC. The hotel's cash flow fell 91% to $931,180 last year from $10.2 million in 2008, putting it well short of covering its $4 million of annual interest payments on its $49.7 million mortgage.
At the 435-room Ritz, located in the Water Tower Place complex, occupancy declined to 59% last year from 69% in 2008, according to Realpoint. Its cash flow declined to a loss of $2.8 million last year from a gain of $2.3 million in 2008. JMB Realty has covered the shortfalls on both hotels' mortgages to keep them out of default.
Some of the hotels' struggles are because of renovation projects that took some of their rooms out of service at times last year, said Pat Meara, a senior vice president at JMB Realty. The company foresees occupancies at both hotels returning to nearly 70% this year now that the upgrades are completed. "Starting in March of this year, we've seen a real uptick in demand," Mr. Meara said, adding later that the hotels are averaging 80% occupancy this month.
Still, the hotels aren't out of the woods. "You can have improving results but still have bad balance sheets," said Neil Shah, president and chief operating officer of Hersha Hospitality Trust, which owns 77 U.S. hotels.
Debt is the biggest problem facing hotel owners. There is about $5.6 billion in securitized mortgages tied to hotels coming due this year and next, and 27.8% cover properties now estimated to be worth less than their mortgage balances, according to research company Trepp LLC's Foresight Analytics. That makes refinancing those "underwater" loans challenging if not impossible without the owner chipping in more capital.
What's more, hotels carrying more than a quarter of that 2010-11 loan balance aren't generating enough cash to cover the interest costs on their loans, meaning their owners must dig into their own pockets to cover the difference, bring in partners to help them do so or default on the loan. Securitized mortgages, which are chopped up and sold to thousands of investors as bonds, represent about a third of all lending to hotels. The situation is more dire for hotel loans coming due in 2012, many of which were originated during the real-estate boom, when hotel values were much higher than now. Of the $5.1 billion in securitized mortgages coming due that year, 64.5% currently are underwater, according to Foresight Analytics. Those not generating enough cash to cover their interest payments represent 42.2% of that balance due in 2012.
An appraisal done in March valued the hotel at $160 million, amounting to 80% of its mortgage balance, according to Realpoint. A Rockwood representative didn't return calls seeking comment.
Write to Kris Hudson at kris.hudson@wsj.com
Delta Associates is a leader in commercial real estate market research and advisory services.
A critical ingredient for enlivening the commercial real estate market is the availability of credit at terms that are attractive to borrowers. Interest rates have been low, but credit has been hard to come by due to the two-year turmoil in the financial markets and the lingering effects of the recession. If mortgage interest rates remain low, they can facilitate a recovery in the commercial real estate market, and more broadly throughout the economy. What is likely to happen in the credit markets in 2010 and beyond?
Long-term mortgage rates are likely to rise due to government deficit spending, as the Federal government will have to offer higher interest rates to creditors to continue attracting capital. As shown in the accompanying graphs, the U.S. Treasury supply is increasing dramatically during the 2009-1 1 period to accommodate the deficit spending that is intended to spur an economic recovery.
At the same time, some buyers of debt, such as China, are easing back on their purchases of American treasuries for both financial and political reasons, which will drive the U.S. government to increase interest rates in order to make U.S. treasuries more attractive to foreign buyers. As interest rates for U.S. treasuries rise, mortgage rates for commercial properties will follow suit.
We believe that the availability of credit will increase in 2010, but that interest rates will increase 100 to 300 basis points in the next 12 to 36 months. While availability of debt will remain a problem during 2010, despite some improvement, real estate investors who have access to credit should be prepared to act quickly this year before rates become less attractive.With an increase in mortgage interest rates, we expect three significant effects for the commercial real estate market: 1. Cap rates that began to settle down at the end of 20091ikely will not decline much in 2010-11 even if good product is in short supply (as some brokers suggest). 2. Cash will remain king for at least another year. 3. It is possible that development lending will remain lean over the next 12-24 months, leading to a "hole in the market" for deliveries of new product, and creating rent spikes in 2012-15. If you are an investor in commercial real estate with cash or access to credit, consider deploying your resources soon, while prices and interest rates are low. While values may continue to edge down, the cost of leverage is likely to rise substantially in the near future, hampering returns. ...............................................................................................................................................................................
Understanding the Economy is a periodic publication of Delta Associates, and is distributed free of charge to friends of the firm. If this message was forwarded to you, and you would like to join our distribution list, please contact Alexander (Sandy) Paul, Delta's National Research Director, at Alexander.Paul@DeltaAssociates.com.