In today’s operating environment, lower interest rates and availability of debt are catalysts for hotel deals. According to Drew Coles, president and CEO at InnVest REIT, this is an unprecedented time for lending capital availability and interest rates for Canada’s lodging sector.
“Lending requirements seem to be a little less stringent than in the past,” he says. “Overall, Canadian hoteliers have been very prudent in their leverage ratios and lenders seem to be attracted to the hotel space at the moment. Requirements will still be tighter than other real-estate classes, but lenders are seeing hotel portfolios perform.”
Robin McLuskie, VP, Hotels at Colliers International Hotels, says the 2015 hotel finance environment was very strong — one of the strongest, in fact. “From a hotel transaction point of view, volume grew 70 per cent year-over-year, so we saw almost 150 hotel trades across Canada [totalling] $2.47 billion. That’s the third highest since the late ’80s and the highest we’ve seen in the current [performance] cycle.”
McLuskie gives credit for this trend to Canada’s finance environment, which she says boasts a strong and competitive landscape for vendors.
Notable trades in 2015, says Marc-Aurele Mailloux-Gagnon, director, Hotels at CBRE Limitée, included Vancouver’s Royal York Westin Bayshore, and the Fairmont Hotel Vancouver.
An increase in U.S. interest — thanks to both the low dollar and cycle of performance — attracted more lenders and better financing interest, explains Mailloux-Gagnon. “For the hotel financing market, generally speaking, financial conditions were very fair in 2015, with the exception of Alberta and Saskatchewan, which were impacted by declines in the oil and gas sector. Most other regions — especially B.C., Ontario and Quebec — have ample sources of financing.”
But, Coles says the bigger impact remains on the fundamentals side, whereby the U.S. dollar’s strength can help direct consumer demand into Canada, while keeping domestic customers at home. “This dynamic has the attention of more domestic hotel investors than U.S.,” he says. “We’re seeing more participation in the market from U.S.-based lenders than we are from equity investors.”
So, where are foreign investors looking to park their money? “Vancouver is number 1 followed by Toronto,” says McLuskie, adding that investors will sometimes look outside of those two major cities if land size and product type meet their requirements.
In Quebec, Montreal has emerged as a strong market as European interest there builds. “There were some hotel closures in that market recently, but I think the overall market fundamentals are strong in Montreal and Quebec City,” says McLuskie.
Other parts of the country have also seen positive gains, notes Mailloux-Gagnon. “The markets in B.C. and Ontario have been performing well and will remain positive thanks to strong tourism sectors in Vancouver and Toronto.”
A Matter of Interest
“Interest rates are difficult to predict right now,” says Coles, noting the U.S. Federal Reserve has been slow in its movement of rates, despite job creation and GDP growth. “The Canadian economic outlook appears slightly more buoyant than at the end of 2015, which could trigger rate lifts, but likely not significantly. Inflation seems relatively in check as well, so small interest rate movements will have a small or insignificant impact on the industry and deal flow.”
McLuskie doesn’t see interest rates changing this year, but says they are asset- and market-specific. “It depends on the property that’s trading. If it’s in a prime urban market, you’re going to see more competitive interest rates because there’s more competition to lend.”
Cap rates are also expected to remain steady in 2016, although there may be some slight compression if the overall performance of the industry gains momentum by the end of fiscal year. “Certain city-core assets may experience some compression and Alberta Cap rates may relax slightly,” predicts Coles. “But overall, across the country, I wouldn’t expect much movement. Northern Alberta has likely experienced softening in Cap rates.”
Debt financing is also expected to remain competitive throughout 2016 and into 2017, as hotel loan portfolios continue to perform. “Operators are more sophisticated today and the macro underlying fundamentals in Canada seem to have volatility in check (except for northern Alberta),” says Coles. “There seems to be an abundance of debt capital looking for a home and U.S.-based lenders are interested in Canada, which should keep the landscape in competitive mode.”
Who to watch
McLuskie recommends keeping an eye on domestic product capital in coming months. “There’s a lot of wealth out there, groups that are aggressively looking for properties,” she says. “There’s a lot of buzz around whether we’ll see more foreign interest this year, and I think we will, but I also think you can’t underestimate the wealth in our country.”
She says players to watch are mainly Ontario or B.C.-based private groups looking to expand their portfolios. She thinks both private and public will be competitive this year. “On the lender side, it really is still a relatively small market, so it will be the usual cast of characters in terms of the credit unions in the smaller markets and, if it’s bigger properties, insurance companies and foreign banks.”
Looking forward
In terms of trading volume, Coles say 2015 was “off the peak in the 2006/2007 range by over $1 billion. However, it was a significant jump over 2014 and the volume only had one significant portfolio trade.” In other words, the volume of trades was primarily driven by individual asset transactions, which is a very different profile from the peak volume years. “Activity in trades for the right strategic reasons is good for the industry and I suspect that will continue into 2016 and 2017.”
McLuskie agrees that 2015 was a banner year for transaction volume “and 2016 will be another strong year, but it really depends on the pipeline and what’s out there in terms of [available trades]. It’s a little too early in the year to say whether we’ll be able to surpass [2015 numbers], but it’s going to be healthy market.”
With increased interest from foreign groups, Colliers has been involved in a number of sales involving Asian buyers. According to McLuskie, there hasn’t been a lot of U.S. interest in the Canadian hotel market. “However, the real-estate market in general has been increasing significantly. The low loonie has offered a real cost advantage for foreign buyers and we’ll likely see more of that. The real message is it’s a reflection of what product is out there — U.S. [investors] generally want prime cities and urban markets; they aren’t interested in our secondary or tertiary markets.”
Moving forward, McLuskie identifies some of the main financing challenges for the hotel sector. “Lenders are really focused on TTM (trailing 12 months), so to get them to look at performer numbers is a bit tougher and that can be a challenge depending on how the asset is performing.”
Overall, underwriting remains stringent. “Compared to other economies, Canada has a very low, more conservative leverage and debt. That hasn’t really changed, and won’t change, so investors can’t expect to see high leverage — it’s going to be in the 55 to 65 per cent LTV (loan-to-value) range.”
Although there’s still a lot of capital out there, Alberta and some other parts of the country continue to suffer from low-trade volume. “People are currently holding in those markets and you aren’t going to see a lot of trades,” says McLuskie. “[We] just have to ride it out.”
Volume 28, Number 3
