Today is another AMA episode (Ask Me Anything). Brad from Ottawa asked me to look at a prospectus for an international hotel fund. He is asking for my opinion on the offering.
Clearly the global environment for hospitality has changed dramatically. Nobody knows what the new normal will be for hospitality following the pandemic. We’re talking about hotels in warm weather getaway destinations. We don’t know what airline capacity will be in the coming months or years for those destinations. Without knowing the airline capacity on those routes we have no way of assessing the demand for hotel nights. There’s no basis for building a new hotel without that data.
The offering memorandum document is out of date with respect to the current market conditions. There’s no way that an investor should be even thinking about putting capital into a new construction hotel.
I want every listener to understand that I’m not preaching about someone elses’s project.
I say this even for myself. I have a development project in the core of the city in one of the hottest neighborhoods. My original plan was to build a 4-star hotel in that location. It would have been the perfect location and an ideal product in that location. I really wanted to build that 120 room hotel. And then the pandemic hit. I know that in an environment where hotel occupancies worldwide are below profitability for the existing hotels, there is no basis for engaging anyone in a discussion about building a new hotel.
The most knowledgeable investors for hotels are those who have invested in hotels in the past. Many of these investors have decades of experience having invested in the hotel sector. It makes sense to talk to those investors and ask them about their strategy for hotels going forward.
Understand that we have a set of market conditions where a large percentage of existing hotels are in default on their debt. The actual percentage depends on the location. On August 28 of this year, just a few weeks ago we dedicated an entire episode to what is happening in the CMBS market for hotels. In NYC, the default rate is 38%, in Houston 66%. While these hotels have not gone into foreclosure yet, I predict that some of them will. When they do, there will be high quality assets for sale in the market at a discount. In that environment, would an investor rather acquire an existing hotel for a deep discount or would they roll the dice on a new development project that won’t generate revenue for another 2-3 years?
I’ve been saying this for a while. Now is the time to be patient. I’ve had a number of conversations with investors in recent weeks where they’ve had funds available. It seems like the money is burning a hole in their pocket and they want to put the money to work. I totally get that money sitting in a bank account is earning essentially zero interest. I have the same situation and it’s tempting to put the money to work.
I know we’re in what appears to be a hot market. In the residential market prices are continuing to rise, largely fueled by low interest rates. But that doesn’t translate into higher prices in the investment market. As investors we value property based on its income potential. In my home city, sale prices for condo’s are up 24% this year over last. That means that at the entry level of the market, people are willing to pay more and they’re gobbling up inventory in order to avoid being priced out of the market. But that has nothing to do with the valuation of rental apartments. Unless rents have gone up 24%, and I can tell you that they have not, the valuations for rental properties has remained steady or perhaps gone down a little. The valuations for hotels have gone down a lot.
