Cheap Hotel Debt Capital and the Current Interest Rate Environment

By Gavin Davis Director, Neptune Hospitality Advisors, Inc. | October 28, 2008

The U.S. appears poised to be coming out of one of the best interest rate environments of our lifetime, where we saw the Federal Reserve cut the Federal Funds Rate by 500 basis points from 6.00% to 1.00% in a total of 13 rate cuts over 30 months between January 2000 and June 2003. This was done in an effort to stimulate an economy weakened from the crash, 9/11 and an economic recession (11 of these cuts accounted for 450 basis points of the move in approximately 11 months time), the continued improvement of overall hotel industry and secondary hotel mortgage market fundamentals are fueling high levels of capital into the market. In turn, interest rate spread levels are continuing to compress, which bodes well for borrowers.

Short-term Interest Rates Continuing To Rise

Against a back-drop of relatively benign inflation data (excluding energy and housing), positive signs of economic stability and growth have spurned the Federal Reserve to increase the Federal Funds Rate 175 basis points in the past year from 1.00% to 2.75%. Wall Street economists are predicting further rate increases in the foreseeable future and one of our most utilized interest rate predictors, the forward US Treasury yield curve, supports this generalization, having priced in interest rate increases over the next several quarters. Short-term Treasury and LIBOR rates in the open market have exhibited similar levels of increase as the Fed-controlled Federal Funds Rate. For example, 3-month LIBOR has increased from 1.11% twelve months ago to over 3.12% at press time.

Long-term Interest Rates Give-back on Heels of Rising Oil Prices

While longer-term yields, such as the 10-year Tbill have increased in the past several months, these rates have recently pulled-back as oil prices have reached all-time highs. A consensus of rising rates pervades the capital markets, but the pace and magnitude of such movements remain in question. Some economists have warned that such a rise in oil will prompt the Federal Reserve Board to take a more accommodative stance and perhaps stall interest rate increases by several months if overall inflation remains at bay. While the Fed will never comment as to the definitive length of such a "pause", it could last several months cite some economists. As long as some resumption of a Fed tightening at some point in the future remains on the agenda, which the interest rate markets still indicate, this is a medium- to long-term bullish economic indicator and harbinger of potential rate increases to come.

Precisely Predicting Interest Rate Movements is Futile

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