Who Will Win When the Hospitality Industry Improves?
By William A. Brewer III Managing Partner, Brewer, Attorneys & Counselors | July 30, 2010
Monitoring the Forecast: the Economic Recession and its Effects on the Hospitality Industry
The economic recession has had a tremendous effect on every aspect of the hospitality industry. Hotel owners, operators, and investors alike are experiencing the negative effects of reduced consumer and business spending on the industry. Leisure travel has suffered as consumers cut spending in response to lost jobs and the 2008 credit crisis. Corporations have cut spending wherever they can, resulting in less business travel and less convention and conference business for hotels. Although the luxury and upper-scale segments have been most impacted, due to their higher rates and higher cost structures, the entire industry is experiencing occupancy rates that are hovering near 30-year lows.
Faced with declining occupancy and reduced cash flows, many hotel owners are struggling to meet debt service. Owners have responded to the crisis in various ways. Some have put up additional equity capital to pay down debt. Many owners, however, do not have additional equity capital and are forced into survival mode. In the most severe cases, owners have lost their investments altogether.
While owners are concerned with protecting their investment, operators confront declining revenue streams due to lower management fees resulting from lower occupancy and room rates. In many cases, owners demand cost cuts and service standards that are less expensive to maintain. Faced with these demands from their business partners, operators are attempting to manage their risks, which include damaged reputations, costly litigation, or contract termination.
One would think this distressed environment would be ideally suited for hotel investors. However, buyers are sitting on the sidelines as industry fundamentals, a lack of realistic valuations, and scarcity of debt capital are conspiring to choke off any appetite for risk.
According to Jones Lang LaSalle, Commercial Mortgage Backed Security ("CMBS") issuance, once the primary source of hotel debt financing, dropped to $10 billion in year-to-date 2010 from the high of $315 billion, set in 2007. This precipitous drop in the availability of debt capital has had the predictable impact on transaction volumes. In fact, the same LaSalle report shows that global hospitality transaction volumes are expected to be $13 billion for 2010, an alarming decline from the $120 billion peak set in 2007.