It looks like 2013 is the year to beat in Canada’s hotel investment sector since transaction volume approached $2.1 billion and represented the third-strongest year ever recorded. Transaction volume has only surpassed this threshold during the height of unprecedented merger and acquisition activity in 2006/2007 when annual volume averaged $3.8 billion. Activity this past year was fuelled by strengthening operating fundamentals, relatively stable cap rates in most markets, an abundance of equity capital, availability of diverse product and the relative ease of obtaining low cost debt financing. Solid domestic fundamentals mitigated global market concerns, including a rising U.S. dollar, volatility in European capital markets, hesitant growth projections in Asia-Pacific and the threat of escalating global conflicts such as the Ukraine crisis.
But, the hotel investment sector is cyclical, and moving into Q2 2014 there are signs Canada is past the peak of the cycle, with preliminary Q1 2014 volume at approximately $205 million, half of its total in Q1 2013. This shift is increasingly evident with limited product on the market, prolonged timelines for deals to close, increased seller/buyer pricing spreads and moderately constricting lending parameters. Investor risk tolerance has waned and will undoubtedly lead to widening yield spreads for trophy versus traditional hotel assets. And, The Real Property Association of Canada and FPL Advisory Group’s “Canadian Real Estate Sentiment Survey” — which measures executives’ current and future outlook for overall real-estate conditions, asset values and the availability of capital — shows numbers fell to their lowest level since 2009 in Q4 2013. The good news is there has been an uptick to the survey in Q1 2014, and longer term investor optimism remains. While Canada will no doubt experience lower levels of hotel investment activity in 2014 relative to last year, CBRE Hotels predicts investment will remain well within historical norms, averaging between $1.2 billion to $1.5 billion annually.
Canadian transaction volume increased 87 per cent in 2013, from approximately $1.1 billion in 2012 to $2.1 billion. While there was a wide spectrum of deals completed, the largest was the five-hotel Westin portfolio acquired by Starwood Capital and a Middle Eastern Fund in Q3 for $765 million. This represented 36 per cent of total transaction volume and helped push per-room pricing for the year to $129,000, an increase of 23 per cent over 2012. Even when this significant portfolio is removed from the analysis, volume of $1.3 billion still exceeded 2012 by 19 per cent. Preliminary Q1 2014 transaction volume is approximately half of what it was at this time last year, with per-room pricing at $75,000 compared to approximately $120,000 in Q1 2013.
Last year’s transaction activity was heavily skewed to Central Canada (Ontario and Quebec), accounting for 54 per cent of the total as volume topped $1.1 billion. This was partly due to an abundance of product that came to market — particularly within the Greater Toronto Area — that led to the year ending with 21 hotel sales, comprising almost 60 per cent of the aggregate volume reported within Central Canada.
Western Canada (British Columbia, Alberta, Saskatchewan, Manitoba and Yukon) continued to report robust investment activity in 2013. Transaction volume of $872 million represented an increase of 65 per cent over 2012 but was largely attributed to the Westin hotels located in Vancouver, Edmonton and Calgary, which totalled $429 million. Without these trades, volume in Western Canada slipped 16 per cent year-over-year; however, this is believed to be a direct result of limited inventory and not waning investor interest.
While Central and Eastern Canada have experienced tempered RevPAR growth, Western Canada’s RevPAR growth continues at a strong pace, particularly throughout the Prairies, northern Alberta and urban markets in British Columbia, comprising nine out of the top 10 Canadian RevPAR growth markets. The Western investment climate is built around cash-flow driven regional hotel investment companies, private investors and public companies looking to expand their position. British Columbia continues to see a steady flow of offshore capital predominantly through direct investment in the Vancouver and Vancouver Island regions.
Transaction activity grew immensely in Eastern Canada in 2013, due to Temple REIT’s strategic acquisition of the $87.5 million Centennial Portfolio; there were only two small deals in Eastern Canada in 2012.
Three significant portfolio sales in 2013 accounted for approximately $923 million, or almost half of total transaction volume, a significant change from the previous year when just one portfolio sale — representing only five per cent of total volume — occurred. Portfolios in 2013 included: the Westin portfolio (five hotels/$765 million); Concord Hospitality GTA select-service portfolio (five hotels/$70.5 million) and the Centennial Hotel portfolio (three hotels/$87.5 million).
Per-room pricing in 2013 of $129,000 was fuelled not only by the Westin portfolio but also other landmark deals, including the 600-room Hilton Toronto ($233,000 per room) and 549-room Centennial Hotel Portfolio ($159,000 per room). Western Canada led at $146,000 per room, reflecting a premium over the national average of approximately 13 per cent. Central Canada averaged $119,000, some eight per cent below the national average, while Eastern Canada achieved $141,000 per room, primarily from the Centennial hotel portfolio. The price gap between Western and Central Canada is primarily a function of a larger proportion of smaller deals occurring in Ontario and Quebec. As a point of reference, 34 per cent of the deals in the West exceeded $100,000 per room and just 14 per cent fell below $50,000 per room. This compares to Central Canada, which had only 23 per cent of its trades above the $100,000 threshold, with 41 per cent falling below $50,000.
Nine hotels were purchased for redevelopment to alternative uses in 2013, representing five per cent of transaction volume, compared to 14 trades in 2012, which accounted for 39 per cent of total volume. But, this trend is reversing, with sales pegged for alternative use in Q1 2014, including Hôtel des Seigneurs (Saint-Hyacinthe, Que.), Loews Hotel le Concorde (Quebec City), Holiday Inn & Conference Centre (Brampton, Ont.) and Holiday Inn Montreal Midtown (Montreal), accounting for just under half of total preliminary Q1 volume.
Buyers and Sellers
Institutions/equity funds dominated investment activity in 2013, followed by private investors at 44 per cent and 20 per cent, respectively. In total, non-Canadian buyers represented just under half of all transaction volume, largely skewed by the Westin portfolio. Similarly, institutions/pension and equity funds were the dominant seller group at 50 per cent of total volume, based on only eight transactions. Approximately 68 per cent of all trades were priced below $10 million, further demonstrating the impact of smaller, private investors. In contrast, private investors sold 75 assets (58 per cent of total assets sold) and comprised just 17 per cent of total volume.
Debt has remained readily available for most hotel asset types due to moderate increases in bond rates, stable to declining spreads and a mix of lenders. Interest rates for hotels range from 250 to 350 basis points over five-year Canada bonds (1.7 per cent at the end of Q1 2014), although slightly lower rates for relationship lending have been noted. Comparatively, urban assets in prime markets warrant interest rates at the low end of the spectrum, while assets in secondary/tertiary markets and those that are limited-service in nature would be at the upper threshold. Typically, loan-to-value ratios are 50 per cent to 65 per cent with an amortization period of 18 to 25 years, depending on the age and condition of the property.
The 2014 Outlook
CBRE’s 2014 outlook is based on trends that are expected to influence the motivations of sellers and buyers. Predictions include: limited hotel product actively on the market; stable cap rates, unless interest rates creep upwards or new supply threatens a market; an anticipated drop in the Canadian dollar to below the 90-cent threshold; tempered supply growth in most markets; abundant buyers, particularly private equity and private investors; low cap rate and turnaround deals may need a level of seller participation to facilitate the transaction; active debt financing in most markets; highly comprehensive buyer due diligence that could prolong timelines; and modest increase in the number of distressed sales.
Although hotel investment is unlikely to reach 2013 levels, all indications suggest activity will remain at very healthy levels in 2014. u CBRE Hotels is a commercial real-estate brokerage firm, specializing in hotel sales, consulting and advisory, with offices in Toronto, Calgary and Vancouver.