Throughout the two years of disruption in the hospitality industry, hotel operators and lenders have been working in tandem to find creative ways to manage ongoing debt and build their operating leverage. So far, their efforts have proven successful in staying afloat. As restrictions lift, experts say this year could see a steady increase in investment opportunities, but recovery to 2019 levels could be two to three years away.
“Operators have generally fared very well throughout this, considering hospitality was one of the hardest-hit industries,” says Robin McLuskie, managing director, Colliers Hotels Canada in Toronto. “A large majority are managing to service their debt despite low occupancy rates. This is in part due to government support, as well as lenders working with operators to support them through the pandemic.”
“Both lenders and borrowers are really trying to resolve issues together. You didn’t see that in past crises,” says Emil Iskandar, senior vice-president, Capital Markets, HVS in Los Angeles.
Lenders are making as much accommodation for their borrowers as possible, in the form of loan modifications, such as forbearance agreements or deferment of certain payables, he notes. Some are also allowing borrowers to use funds put into reserves for renovations or property improvements to supplement their cash flow or inject additional equity to keep their assets afloat.
Where additional capital is needed, borrowers are seeking additional financing rather than selling, says Iskandar. “Overall, there is not a lot of pressure to sell. We’re not seeing as high a volume of distress or lender-mandated sales this time, unlike the last global financial crisis where the pressure was much stronger for borrowers to resolve issues right away.”
While receiverships typically go up during a financial crisis, that hasn’t been the case in 2021, confirms McLuskie. In fact, she says receivership is at an historic low: two per cent in 2021. “Total volume of hotel trades was $1.9 billion, which is up 10 per cent for 2019 numbers. During the last crisis, receiverships peaked at 12 per cent.”
One factor that has played a key role is re-visiting operating models, she adds. “Owners have taken the opportunity to go line by line to re-negotiate contracts, re-do staffing models and streamline cleaning services. These have helped ensure they have cash flow.”
Operators have also explored alternative uses of assets — for example, long-term rental agreements with municipalities for frontline workers or quarantine hotels, says Ed Khediguian, senior vice-president, Franchise Finance, CWB Franchise. “Some have been waiving capex requirements during the pandemic so owners can spend that money on operating cash flow.”
On the geographic front, Khediguian notes Alberta has been harder hit as assets were already having problems before the pandemic that led to an oversupply in markets that were too small and/or dependent on the resource sector. “The pandemic pushed a few over the edge, but overall, we will see some stabilization with oil prices expanding quite strongly over the next couple of years.”
The larger Tier-1 and -2 markets in suburban locations will fare better in the coming months, he says. “Select or limited service will do better in the short term versus large high fixed-cost assets in city-centre locations until corporate demand comes back. Overall, the stronger owner/operators that have effectively managed their way through the pandemic will have access to more funds, while weaker ones will have a harder time accessing capital.”
Even those on solid footing should not expect a sudden rebound however, says McLuskie. “It’s not like a light switch goes on and everything goes back to normal. Returning to 2019 levels will be gradual. Most properties are not over-leveraged so they should still be okay. They just may not be as profitable for a few years.”
The suspension of government supports and rising interest rates could change the picture moving forward. Hopefully, that will be countered by a busy spring and summer season, says McLuskie. “There will be a lot of pent-up demand so business should increase in correlation with programs phasing out.”
As for new projects that have been on hold over the pandemic, that will gain momentum, albeit slowly. “A lot of new projects have been on hold because lenders and owners are having a hard time making projections,” says Iskandar. “When the picture becomes clearer, we will start seeing light at the end of the tunnel. So far, there are positive signs in the market, and we are starting to see construction loans coming back into the picture. However, new builds will be reduced in the months to come.”
Most projects that could be postponed were stopped and new supply was reduced to a low trickle, confirms Khediguian. “More importantly, the cost of construction and development expanded by 30 to 40 per cent, while performance metrics did not improve, which undermines the viability of new projects.”
Financing on new builds is not as available as existing cash-flowing hotels, says McLuskie, adding that interest rates could also impact decisions. “We will have to watch that closely. That could definitely be a contributing factor.”
Iskandar points out that while rates may be going up, inflation is a friend for hospitality. “Unlike other commercial properties, hotels are one of the very few asset types that can adjust their rates on a daily basis. Increases in borrowing rates won’t be a major disrupting factor because they can always adapt their ADR to support the higher interest rate debt.”
He also expects to see sales of existing properties increasing in the coming year. “We’re seeing a lot of motivation to sell as a lot of capital was raised during the pandemic that wasn’t able to be deployed. Right now, demand is much higher than supply.”
Khediguian projects three or four years of very low supply of additions to the market. “That’s a positive thing for existing assets. It means there will be lower supply levels when demand returns, so existing properties will be able to drive pretty significant rate increases.”
While there are no guarantees, Khediguian believes investment appetite for the hotel sector is strong across the board. “As owners bring capital to renovate or re-position, lenders will be in lock step with that. Industry expertise is key in navigating that.”
By Denise Deveau