A Q & A; on the Economy, Hotel Financing and What’s in Store for OC
At the recent “Meet the Money” hotel conference in Los Angeles, major players agreed that debt and equity financing for hotels have become increasingly difficult. Changes in the market are likely to mean fewer deals this year. As a result, OC is likely to see fewer hotel starts in 2001 than in the past few years. That could affect OC’s tourist market, with meeting planners saying room blocks at hotels in the Anaheim area can be tough to get, despite an inventory of 19,000 or so rooms. And with the expanded Convention Center,the largest on the West Coast,back on line, some industry watchers believe more rooms are needed to grow the visitor industry in the county.
With that in mind, the Business Journal’s Sandi Cain asked some local and regional players how they see the hotel financial market shaping up for the balance of this year and what kinds of projects, if any, are likely to get funded.
BRUCE BALTIN
Senior Vice President
PKF Consulting, Los Angeles
Confusion reigns in the market. We’re seeing a strong reaction (in the capital markets) to what is so far a relatively mild downturn. The downturn is more corporate driven than consumer-driven. There has been a slight increase in troubled properties due to strict loan requirements.
STEVEN K. BONE
President
Robert Mayer Corp.,
Newport Beach
I think it’s going to get a lot more difficult because of the small “r” word (recession) clouding the future.
I think you’re going to have to have at least 50% equity in a project, with perhaps required personal guarantees. The loan to cost after personal guarantees might be just 35%.
From a regional perspective, I think that the difficulty of financing is in direct proportion to the cost of the project just because it’s so difficult to find those larger equity dollars. At the so-called motel level (one and two diamonds), even that market has gotten saturated over the last several years and we’re all waiting to see how local tourism performs over the next year before you’ll see anything significant announced.
If you haven’t been in the pipeline for a number of years, I don’t think there’s much chance of getting financing in this round. I think the financing market for hotels will be as tough now as it ever was in the early ’90s, not because we’re in so much of a recession, but because the projects that have gone out or are ready to go out are products of the late ’80s and early ’90s and have taken that long to get packaged together. If you’re starting from scratch, it would be unusual to be ready to build in the next two to three years. Those providing the financing are the same generation that suffered through the early ’90s and they’re not going to finance anything but low-leverage loans. Pools have brought discipline to the marketplace that requires more conservative financing.
MARK BURDEN
CEO
The Rim Corp., Stockton
Company manages Raffles Best Western,
Anaheim, 19 other hotels
The way I see it right now, there’s money available, but at reduced loan-to-values. Today it’s about 60% loan to value vs. 70% or so last year. Rates are still pretty good. The money is a little more expensive.
In the limited-service sector,excluding SBA loans for under $5 million,it’s a little bit tough. It’s always been tough for that segment and is probably going to tighten up more until we find out what’s going on in this economy. We don’t know how hard the hotel industry will be impacted.
Our hotels are a little ahead this year in occupancy and rates, but we’re disappointed that we’re a little behind in revenue per available room compared to our forecast. I thought the second half of the year would be better, but other experts seem to say the first half will be better.
There have been positive signs recently, which could turn things around. I see consumer confidence is impacting us,people are being conservative and putting things off. If some of that confidence comes back, both the leisure and business traveler will come back.
We’ve seen the biggest impact in the largest markets like San Francisco and Portland, whereas the secondary markets are holding their own. In Anaheim, we’re just now starting to see the see the jump I thought we’d see in February when California Adventure opened. Through March, we were flat in occupancy compared to last year, but the rate was up some. What you’re seeing is the Convention Center business kicking in.
We’re maintaining revenue pretty well, but expenses are going up,utility bills, labor, etc. The expense creep could impact the bottom line a little bit.
JEFF DALLAS
Hospitality Practice Leader, Western Region
E & Y; Hospitality Services, Los Angeles
There has certainly been a lot of discussion about supply, demand and balance or imbalance coupled with a perceived or real economic slowdown. Certainly the lodging industry in general has seen a slowdown in demand, but it isn’t being severely outpaced by supply.
Interestingly, when you look at the U.S. on a region-by-region basis, the Pacific region is doing all right. There’s been a slight increase in demand with occupancy up a percentage point over March last year and (the average daily rate) continues to increase. It’s even more interesting when you realize that the San Francisco/San Mateo market had about an 11% decrease at the same time.
San Diego is doing very well year-to-date and Anaheim is doing well, which we thought it would. Certainly with the infrastructure done and with the Convention Center expansion and Disney’s new hotel, theme park and Downtown Disney, that helps. The performance is great considering there is a perceived economic downturn.
We’ve always felt California and especially the Southern California market is a little better positioned for the current economic state. There continues to be development in Orange County, which speaks well for the market; Orange County has a lot to offer for residents from all parts of the U.S.
As for the state of the financing market,there’s a couple different ways to look at it. As for real estate in general, you can call it tight, though some types of real estate continue to do well.
Hotels continue to be considered an interesting asset. Is it a real estate investment or operating company? I think the answer is “yes.” Volatility occurs on a daily basis because rooms are a product, so that can be either positive or not positive. And that’s the thing lenders look at and is a factor in their lending criteria. More equity needs to be placed into the project today, which means fewer projects will get done.
That leads back to supply and demand and the balance is pretty close, whereas in the past supply exceeded demand.
The market does have challenges,some are in the paper every day from the power perspective. And that has an effect on the general market and real estate market. In general, as the lodging industry continues to grow and in certain markets we see labor shortages, that could impact the bottom line. We still see a positive outlook for the lodging industry as a whole but probably not the growth of the last couple of years.
MARK DAVID
President
Landmark Cos., Newport Beach
Building Embassy Suites and Marriott Suites in Garden Grove
It has definitely been very difficult to get construction financing for full-service hotels for some time and I don’t see that it’s gotten any better.
There is a perception in the lending industry that hotels are riskier to lend on than other entities, like apartments. That may be a result of the last recession when hotels took a pretty good hit, though there are fundamental differences this time around.
Last time, we had a terribly overbuilt market. This time, if we are going into a recession, lenders have been strict with financing, so we aren’t overbuilt. You could make the argument in some markets that we’re underbuilt. We’re more diversified than we were in the early ’90s, too.
On a micro level, we have new attractions in Southern California like the Convention Center and California Adventure that will still create business even in a downturn.
During the last several years, which have been really great for the hotel industry, if lenders weren’t going to be more liberal during those times, I can’t imagine them getting more liberal in a downturn. It’s not just availability of money, but the terms. If you’re forced to put more equity in, then you have to look at if that investment makes sense. If you have to put in more equity, it makes it more difficult to make the deal make sense.
SUZANNE R. MELLEN
Managing Director
HVS International,
San Francisco
Hospitality consulting and valuation services
The cost of capital is up. Through April 25 this year, there was an 80% decline in deals in the $150 million-to-$200 million range. We expect transaction activity to decline throughout the year. The smaller the deal, the easier the chance of getting it done.
ALAN REAY
President
Atlas Hospitality Group, Costa Mesa
New construction financing is still proving to be difficult. Larger ($5 million and above) existing hotels that want to sell are finding it difficult to find financing.
The typical loan-to-value ratio is 60% to 65% instead of the 80% from a few years ago. That will slow down the sale of larger hotels. Fewer hotels will get built. But smaller (under $5 million) hotels will still get built,and SBA is still a viable source of funding for the purchase of smaller hotels.
If we don’t get hit with a recession, travelers will see higher rates for rooms (including surcharges like the energy surcharges).
We’re very selective in taking on a hotel to make sure it’s one we think can get financing. That’s probably true across the board.
BRUCE G. WILES
President and Chief Investment Officer
MeriStar Hospitality Corp., Washington, D.C.
Owner and operator of Hilton Irvine
Hotels are priced like they’re going out of business. Wall St. doesn’t like hotels because of the cyclical nature of the business and because they operate with debt. On a risk-adjusted basis, lenders just don’t like our stuff, so they charge a premium. It’s going to be some time before the hotel industry sees favorable financing.
DON WISE
President and CEO
Wise Hotel Investments, Corona del Mar
With the breakdown of the dot-com complex, I thought Wall Street would focus back to non-virtual lending like real estate, but so far that hasn’t happened.
Equity continues to be problematic. Right now, the vast majority of savvy capital is taking a wait-and-see attitude, partly because of the market and partly because the direction of the Bush administration is still somewhat an unknown. There are a lot of issues that keep people from getting involved right now.
(Our clients) may see the cost of capital increase a bit because of high expectations for return on investment. Underwriting has gotten more conservative by as much as 10%.
Energy is another wild card. There are no easy solutions or quick fixes and that’s clearly problematic for all industries.
This brownout situation is frankly quite frightening. Who would have anticipated last year that these thorny issues would be in front of us without an apparent way out?
Bizarre things are happening here (in OC),who would have thought three major resort destination properties would be under construction right now? n
