Hotel insurance is all about assessing risk – something that has become even trickier within a more volatile climate crisis. In fact, a 2020 study conducted by Deloitte showed that insurance-loss ratios in Canada grew faster than premiums due to catastrophic weather events. Throw in a global pandemic and estimating risk gets even more complicated.
But, as the hospitality industry continues its recovery to almost pre-COVID rates, insurers are anticipating continued growth and economic stability. “During the pandemic, hotel buyers and insurers would just look at how an operation was doing in 2019 to gauge its potential,” says Robert Webster, vice-chairman at Atlanta-based CBRE Hotels Institutional Group. “One of the pitfalls of COVID was that there was really no visibility on what the recovery would look like. It was the largest downturn in lodging industry history.”
During the pandemic, different sectors of the lodging industry were affected. “It really depended on the type of asset you had,” says Webster. “Hotels that you could just get in a car and drive to – such as a Great Wolf Lodge – saw increases, however, nobody was getting on airplanes.” A number of hotels were also purchased and re-purposed – whether that meant turning them into seniors’ residences, university residences, or even condo developments.
Webster reports that hotel acquisitions basically froze from April to November, 2020 due to the uncertainty of the pandemic. “By December, there were a number of trades because there was more visibility at end of year compared to how COVID was unfolding in March of that year,” he says. While Webster notes that the industry still has not fully recovered to pre-pandemic rates, the entire industry grew 29 per cent between 2021 and 2022. “We’re well on our way to a solid recovery at this point in time,” he notes.
Now, given the industry’s robust returns, companies are looking to 2022 RevPAR numbers when they consider how to underwrite hotel insurance. “Underwriting essentially relies on the RevPAR and the net operating income,” says Webster. “It’s really different than underwriting any other form of real estate because it’s not like an office or retail leases, for example. Our leases are daily – whereas an office might lease over a period of years.” However, this type of flexibility can also make the product more difficult to underwrite.
Webster says that examining a current “cadence of performance”, basically “revenue minus expenses” is the formula to figure out what kind of direction the market is growing. “While COVID did change the trajectory of the hospitality industry, the recipe for determining insurance rates remained the same,” he says. “It was all about performance.”
Now with skyrocketing inflation rates, hotel underwriting is feeling the impact. “There’s a dramatic factor with inflation because we are the only real-estate sector that re-prices our inventory on a daily basis,” says Webster. “Historically speaking, the correlation between inflation and industry growth has been 1:1. So for every point of inflation, you get a point of growth in your Average Daily Rate.” The risk for inflation meant that occupancy levels could quickly plummet.
But despite inflation rates, Webster says he is seeing a daily strengthening in demand – and that means a significant run up in net asset value coming into the next cycle. “Supply is contained,” he says. “What I mean by that is that it will be difficult to build a new hotel anytime soon due to the increase in costs of labour and construction post-pandemic.” In addition, Webster says the cost of borrowing is also significantly higher. There is also a segment of older hotels that might need significant repairs or renovations.
These increased costs translate into a challenging underwriting scenario. “Because the cost of a new build is significantly higher, it makes it that much more difficult to underwrite a return,” says Webster. “There’s just too much built-in risk if you are launching an entirely new product.”
With the compounded annual growth rate of about 1.9 per cent, Webster says that number will be cut in half to almost one per cent over the next five years. “Those figures just translate into a perfect situation for a growth in net average – you have less supply and a higher demand.”
“Things have changed because in 2022 there was a huge bounce-back in the industry,” says Robin McLuskie, managing director, Hotels at Colliers. “Cap rates for urban hotels in Canada are in the five to six per cent range.”
While she notes that inflation has had a big impact, the plus side is that hoteliers can take control of their product. “The beauty of hotels is that owners can price inflation into their daily rate,” says McLuskie. “That said, occupancy has not fully recovered or reached the same levels as before.”
For McLuskie, what’s missing is large sectors of business travel. “We still aren’t seeing the same [ number] of large conferences,” she says. “But we are optimistic that we will soon. One good thing that came out of COVID was that the majority of hoteliers held their rate and didn’t discount. However, a few people did choose to drop their rates to get occupancy up.”
In terms of underwriting, McLuskie says you mainly have to look at “market drive,” but also where the hotel is in its “life cycle.”
“Underwriting is a complex process and a lot of the time, it comes down to the product,” she says. “Does it need a renovation? What would be the cost to build and replace the product? Is there a re-positioning opportunity that could happen with a significant renovation?”
Underwriters also take into account the management company at the operation’s helm. But how management companies can differ, depending on the nature of their product. In many cases, this simply comes down to its asset class. “The owner/ operator model has done particularly well in Canada,” says McLuskie. “If you have a smaller asset or a boutique hotel, then having a local management team is important; but if you have a larger asset, the lender will probably require that a strong company manage it – especially when underwriting the deal.”
Even despite growing inflation rates, the recovery from COVID has been stellar – and that’s a good thing for underwriters.
BY JENNY FEBBRARO