Branded Economy Hotel Sales Dominated by Motel 6 and Red Roof Inn Dispositions in 2019
By Rod Clough, MAI President - Americas , HVS | March 08, 2020
Sales of economy hotels in 2019 registered a healthy level, despite a decline in the number of limited-service hotels that sold during the year. Approximately 10% fewer hotels sold in 2019 than the number that traded hands in 2018, according to Real Capital Analytics (RCA). This decline was attributed entirely to a dearth of major portfolio transactions, while individual property transactions increased slightly for the year.
The U.S. economy continues to hold strong, showing great resiliency. The overall strength in consumer spending and confidence has benefited the U.S. hotel industry, driving this healthy transactions market as hotel demand remained at heightened levels, and most economy hotels have profited accordingly. By year-end 2019, gains in hotel demand had almost kept pace with new supply that opened in 2019, allowing economy hotels to retain strong occupancy levels overall.
From our database of limited-service hotel sales for 2019, which comprises data from RCA, buyers, sellers, and brokers, we further analyzed those properties that were affiliated with a national economy chain at the time of their sale. Transactions that fell into this category numbered 263 at the time this writing, encompassing a total of 26,413 rooms; these sales totaled $1.25 billion in transaction value, or just over $47,000 per room. It important to note that more 2019 sales will be continually added to our database as we learn about them over the course of the first and second quarters this year.
The average age of the economy hotel sold in 2019 was 33 years old, reflecting a 1986-build date. The oldest hotel sold was built in 1958, while the newest opened in 2017. The majority of economy hotels sold were built in the 1980s. The average size of the branded economy hotel sold in 2019 was 99 rooms.
Blackstone and Dune Real Estate Partners Take Advantage of 2019 to Streamline Their Respective Portfolios
Of the aforementioned 263 transactions, the big sellers in 2019 were Blackstone and Dune Real Estate Partners. Blackstone sold 67 Motel 6 and Studio 6 properties out of its owned portfolio; the company purchased the U.S. holdings of the Motel 6 and Studio 6 brands in 2012 from Accor for a reported $1.9 billion. Dune Real Estate Partners sold 19 Red Roof Inn hotels.
Together, these companies' properties represented roughly 33% of the number of sales. A handful of other sellers disposed of two or three hotels in 2019, including Bestford Capital, Global Hotel Group, Kana Hotel Group, Oceanic Enterprises, and Positive Investments. The majority of sellers sold just one property in 2019.
Kalthia Group, Westmont, and KPG Hotels Among Most Active Economy Segment Buyers
While the sellers' group was dominated by Blackstone and Dune Real Estate Partners in 2019, the pool of buyers was more diverse. Kalthia Group picked up 10 of the 67 Motel 6 hotels in the survey, while Westmont purchased 7 of the 19 Red Roof Inns sold by Dune. KPG Hotels purchased one Motel 6 and three Red Roof Inns. Most of other buyers of economy hotels in 2019 purchased only one or two hotels.
Construction costs keep rising, which makes buying an existing asset a more attractive investment opportunity than building a new one in many markets. Moreover, markets that have high barriers to entry and/or are perceived as stable (with strong demand generators) drive more asset appreciation. This in turn attracts buyers to enter these and other similar hotel submarkets. Furthermore, various municipalities benefit from favorable tax laws, which continue to make hotel investing an attractive option. We would expect the pool of buyers to remain healthy through 2020.
Texas and California Most Active for Economy Sales in 2019
Not surprisingly, the two states with the most sales in our survey were Texas and California in 2019, with 45 and 38 transactions, respectively. Together, they represented 32% of the transactions in the survey. Florida was third most active with 19 sales, and Arizona was not too far behind with 17 sales. The Mountain, Midwest, Southeast, and Mid-Atlantic regions were all fairly active, with fewer transactions noted for the Northwest region, and even fewer in New England.
Strong U.S. Economy Bolstered Healthy 2019 Transactions Environment
Key demand segments that benefit the economy hotel sector include construction, oil and gas exploration, transportation companies, highway travelers, and relocations, among others. Demand should remain strong from these sources in 2020, which should help set the stage for another favorable year of transactions. While demand remains heightened, demand is not anticipated to expand significantly beyond where it already stands. With the nation at virtual full employment, it is difficult for companies to realize further expansions.
This in turn limits hotel demand, as expanding companies drive significant room nights to nearby hotels with relocations, training, and related activities. In many markets, companies have begun to pull back their near-term requirements for room nights, as they move into a maintenance and defensive mode rather than a position of expansion. This change in position also reduces demand from the construction sector, as large-scale projects to support growth at corporate campuses in some markets recede. Pulling off expansions is further complicated by rising construction costs and labor costs within the construction sector itself.
Economy hotels are typically less affected by new supply, as these newly opened hotels launch operations at rates well above what economy hotels charge. Accordingly, these new hotels target a different customer base, and not the more-price-sensitive guests that typically seek out economy properties. The hotel projects that began construction when new supply starts intensified a couple of years ago are now readying to begin welcoming guests in 2020; however, the effect on economy hotels should be muted.
Nonetheless, we do note that the economy sector is susceptible to continued competition from alternative lodging sources including Airbnb and VRBO, among others. These alternatives can siphon off demand that would otherwise be accommodated by economy hotels. The effect of these alternative options experienced in 2019 will continue to be in place through 2020.
With 2019 statements looking strong, and with not as much upside readily evident for 2020 due to these factors, an increase in transactions may ensue in some markets where hotel owners want to capitalize on a strong trailing-twelve-month statement with which to market the property. In markets where new supply entering in the near term is set to have a more direct impact on a hotel's operating statement, owners of existing economy hotels may be prompted to consider exiting while their TTM statements reflect particularly strong performance.
The peak NOI may be behind us in many major markets and may not return until the new supply is absorbed. Rising labor costs and low RevPAR growth are putting significant pressure on NOI. This may shift those markets to a buyer's market if more assets are available for the choosing and if sellers are significantly motivated.
Cap Rates Average Just Under 10% for Branded Economy Hotels in 2019, While the Rooms Revenue Multiplier Lands at 3.1
Capitalization rates for branded economy hotels averaged 9.8% in 2019, for those transactions where a rate was reported. The range was wide, from roughly 2% to over 20%; however, cap rates registered predominantly between 9.0% and 11.0%. In the economy sector, cap rates can vary widely in some cases, as independent owners charge owner-related expenses heavily to the property, thus driving the cap rate down; alternatively, they may not bill for all self-managed costs and owner salaries, thus driving the cap rate up. These abnormalities tend to cancel each other out in a sample size that is as large as all the economy sales over the course of a year.
The rooms revenue multiplier (RRM) for our sample averaged 3.1, which is considered a normal and healthy level for an economy, limited-service hotel. RRMs tend to fall under 3.0 when a property is significantly older, has exterior corridors, and has little upside. If major capital is needed to maintain the operating viability of the hotel at the time of sale, this will drive the RRM below 3.0, as well.
Interior-corridor properties that are newer and/or in very good condition, particularly those without a major PIP/brand renovation requirement upon sale, would be expected to generate multiple bids from credible buyers. For these types of transactions, we tend to see RRMs at 3.5 or higher. The 3.1 level is considered normal for an economy property that may be aging to the point where achieving a multiple-bidder scenario on a sale is becoming increasingly difficult.
2020 Outlook Looks Strong, Particularly for First Half of Year
In conclusion, whether or not 2020 is ultimately as strong as 2019 in economy hotel transaction activity will likely depend on several key factors, but the stage is set for a good start to the year. As seen in 2019, transaction activity will be bolstered by major limited-service portfolio holders and their decisions to retain or dispose of assets in their portfolios.
Uncertainty regarding the upcoming election could mute transaction activity as we approach the fourth quarter, and concerns about the looming recession continue to cloud the longer-term outlook. Operating statements may not reflect as strong as performance by the end of 2020 as in 2019, which may contribute to more owners exiting during the first two quarters. With the economy hotel sector outlook for 2021 less clear, owners seeking to dispose of assets in the near term may want to take advantage of the market now.
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