Following two years of near-peak investment levels, Canadian transaction volume dropped by 60 per cent in 2018, falling to $1.4 billion — 22-per-cent lower than the 10-year average. Missing from 2018 were the entity-level deals that bolstered volume levels in 2016 to a record $4.1 billion and in 2017 to $3.4 billion. However, even when M&A and portfolio sales are excluded, 2018 volume fell short of 2017 levels by 40 per cent — or nearly $1 billion. Conversely, the 10-year Government of Canada Bond yields remained stable in 2018 following two years of modest growth at 0.3 percentage points annually in 2016 and 2017.
Although investor interest remains at an all-time high and liquidity is abundant, many owners are taking a wait-and-see-approach to dispositions. Along with exceptionally strong fundamentals, low interest rates and increasing income levels — particularly in major cities — owners are choosing to hold for now, as they are finding it difficult to replace current returns. Also contributing to the slowdown in transaction activity in major gateway cities, such as Toronto and Vancouver, is the buyer profile. As an example, between 2013 and 2016, almost every major full-service asset in downtown Toronto transacted — in many cases to large private-equity owners considering hold periods measured in decades not years — raising the barrier to entry even higher in these markets. As a result, there’s been considerable downward pressure on cap rates, compressing to sub-five-per-cent levels, for full-service downtown hotels and driving investors to look at other markets for acquisition opportunities.
Among the most notable transactions from last year was InnVest Hotels’ portfolio sale of 12 assets across Canada, which was acquired by a domestic group of buyers (pricing confidential). After the acquisition, a number of theses assets were sold individually, both to first-time hotel buyers eager to enter the hotel industry and seasoned hotel owners focused on expanding their portfolios.
The largest single-asset transaction (by volume) was the sale of the 825-room Le Centre Sheraton Montreal by Marriott International for $92 million ($111,500 per room) to a private investor. Other significant transactions included the two-asset portfolio sale of the Courtyard by Marriott Edmonton West and Hampton Inn & Suites by Hilton Edmonton West, which was acquired for $36 million by Manitoba-based Genesis Hospitality. There was also the Gateway Casinos & Entertainment Metro Vancouver portfolio that included the Coast Hotel & Convention Centre Langley City and Delta Hotels Burnaby Conference Centre, which transacted in a sale-leaseback valued at $500 million (hotel value allocations not available). For the first quarter of 2019, reported transaction volume was $129 million, tracking 60-per-cent below the same period last year. However, there are several hotels and portfolios in the market at varying stages of the sales process and trade volume is expected to exceed both last year and the 10-year average of approximately $1.8 billion.
With a notable dip in available urban assets, it’s no surprise nearly three quarters of transactions occurred in secondary and tertiary markets. These trades comprise nearly half of total transaction volume — up from about one-third historically — as investors turned their attention to markets showing room for growth. As a result, hotel price-per-room for single-asset deals was 28-per-cent lower in 2018, falling to $117,200 from $162,100 in 2017 — a decline of 12 per cent compared to $133,500 in 2016.
Domestic Private Equity Dominated
In 2018, domestic private investors and private equity dominated the hotel-investment market, representing 97 per cent of total volume — up from 88 per cent in 2017. While there was interest from off-shore capital, the size of many of the deals, as well as the clamp-down on Chinese foreign investment, reduced the level of foreign hotel investment in Canada last year. However, there continues to be isolated examples of sales to Chinese buyers, such as the sale of the 197-room Metropolitan Hotel Vancouver to China-based Jinling Hotel Ltd. As significant assets come to market, we anticipate capital originating from countries such as India, Hong Kong, Mainland China and Korea will renew their pursuit of opportunities here.
National Fundamentals Showing Moderation
Between 2010 and 2018, national RevPAR grew by more than 40 per cent, approximately four per cent per year on a compounded annual basis. Expectations for 2019 are that national RevPAR will advance by an additional four per cent. These positive trends flow through to the bottom line, where profitably continues to climb. In 2018 Adjusted Net Operating Income Per Available Room climbed 9.4 per cent to $15.6 million and CBRE projects bottom lines will increase by another 6.5 per cent in 2019. Although RevPAR and profitability are expected to show growth in 2019, the pace of growth will moderate in light of shifting supply-and-demand fundamentals.
If you Can’t Buy It, Build It
From 2010 to 2018, national annual supply growth hovered in the range of 0.5 per cent to one per cent per year. As operating fundamentals improved over this same period and acquisitions became more competitive, investors pursued new-build development opportunities.
CBRE Hotels’ outlook for 2019 projects new supply will increase by two per cent this year — the highest single-year supply growth since 2008. Much of the new supply is being built in suburban areas of the country’s major markets, where demand fundamentals are improving, thanks in part to a surge in commercial and residential development. However, there are distinct pockets across the country where demand-conditions may not be able to absorb the new supply quickly, which is expected to have a negative impact on occupancy. Markets such as St. John’s should expect further declines in top-line results, as the 600-plus rooms that have come online since 2016 are absorbed and it braces for an additional 230 to open by 2020.
In Canada’s largests markets, where record-low office, residential and industrial vacancy rates are driving land prices up, the hotel product being developed has adapted.The high land costs and greater density potential for an office or residential build make the economics of developing a standalone hotel difficult. In response, many properties under development are smaller (i.e. 200 keys or less), at the higher end of the market (luxury, upper-upscale or boutique) and are often included as part of a mixed-use development. In suburban markets, where land costs have not escalated to the same extent, there are greater opportunities to acquire land and additional new-build hotels in suburban and secondary markets are expected.
As recently as five or six years ago, the financing environment involved a narrow base of domestic lenders with a specific mandate to provide financing options to the hotel industry under well-defined metrics and with an emphasis on working with pre-existing, established and proven clients. In more recent years, as the operating performance of the sector has strengthened, there’s been a notable increase in the willingness to provide financing at favourable terms to a wider pool of buyers and from a variety of lenders, such as locally focused credit unions, Schedule-A banks and international lending institutions.
Trends to Watch in 2019
Growth in top and bottom line is anticipated to be moderate in markets that have experienced significant growth in top-line performance for an extended period, such as Vancouver and Toronto, where compound annual RevPAR growth from 2013 to 2018 was 16 per cent and 11 per cent, respectively. In distressed environments where economic turmoil coupled with an abundance of new supply has negatively impacted top-line performance, such as Calgary and Edmonton, top-line metrics are forecast to remain flat or see slight gains — a hopeful sign the worst is behind us.
Hotel companies, flush with capital, will continue to closely study their hotel portfolios and weigh options relative to recapitalization, renovation, repositioning or disposition. With growing investor sentiment the market is nearing the top of the cycle, and some owners may feel enticed to sell. On the other hand, expectations are that strong operating fundamentals will likely support owners who prefer to hold their assets through the near term or who may be priced ahead of the market. Before any M&A or portfolio transactions are reflected, transaction volume could increase by as much as 50 per cent in 2019 over the prior year, to more than $2 billion.
Cap rates are expected to hold steady in most major markets, although some downward pressure may be reported in places where buyers are willing to take a lower yield in exchange for potential upside, such as Halifax, where strong population growth and an active commercial-development environment is drawing strong investor interest, or Winnipeg, where an uptick in the level of interest from hotel players focused on expanding their geographic parameters has brought about a competitive investment market.
Canada continues to be an appealing destination for tourists, thanks to new direct flights from Europe, South America and Asia; growing cruise-ship business that saw more ship berth expansion in P.E.I., Nova Scotia and Quebec; and favourable exchange rates for countries such as the U.S. Looking ahead, the Conference Board of Canada forecasts overnight visitation for the country to grow in the range of 1.7 per cent to 1.8 per cent per year through 2022.
While many owners may choose to hold the pause button a little longer, moderating top-line performance and increasing new supply may be the catalysts to increasing activity.
Written by Nicole Nguyen and Sylvia Occhiuzzi, CBRE Hotels