The Looming Crises in Commercial Real Estate Part 2: Hotels

Warren Buffet has famously said that he likes to buy “when there’s blood in the streets.”

The biggest surprise of the Covid Crises is the lack of blood – at least thus far.

But we do know that the hardest-hit real estate asset class is Hotels.

So how does a real estate investor take advantage?

Hotels were the first hit, and hardest hit, by Covid. They were simply shut down at the onset, with no revenue coming in and large debt obligations.

In fact, the City of San Diego recently announced a plan to buy distressed hotels and turn them into homeless shelters.

If a City is getting into the distressed-asset investment game, it must be a huge crisis.

The impact on hotels can be summarized as:

• Vacations have shifted to camping and outdoor activities. Just try to rent an RV or camping spot – they are unavailable. Many people are discovering a new passion, so even after travel is safe again, some percentage of people will skip hotels in favor of an RV or tent. Long term hotel-vacation demand could decrease 5% - 10% - 15%, even after a vaccine.  
• Large conferences will not return until Covid is a thing of the past. Virtual conferences are the new normal, and I do not expect that to change; conference organizers may stick to a virtual model even after Covid is gone. And conferences are huge money makers for hotels.
• Work travel is unlikely to ever return to pre-Covid levels. Who wants to fly to a meeting when Zoom is so much more efficient?

The overall, post-Covid, “new normal” impact could be a 30% decrease in hotel demand. That creates distress. And that “new normal” could be 18-36 months out; many hotels will already be in foreclosure at that point.

How hotels will hit the market: I spoke to a CMBS loan consultant, whose job is to facilitate loan work outs and restructuring. He is currently working on massive debt restructuring on the Las Vegas strip. If those cash cows are in trouble, you can guarantee virtually every hotel in the country is in some form of financial distress.

Eventually this will lead to short sales, foreclosures, and re-capitalizations with new equity injected.

When: The debt crises is already here, although loan forbearance and restructuring are slowing the short sale and foreclosure process.

Thus, many hotel operators are holding on for now, hoping for relief and a return to a stabilized economy. And some hotels will survive – the best located and hotels with low leverage. 

But the hotels that were marginally profitable before the crisis, those in less-than-stellar location, and those with high leverage are all in deep trouble.

How Investors Can Take Advantage:  If I were an experienced hotel operator, I would be raising as much equity as possible right now to go after the distress. Look for these operators who are raising private investment funds through Private Placement Memorandums. If you are not in that network, take a deep dive into crowd-fund platforms.

I have personally been contacted by large institutional equity funds who have raised capital and are desperately looking for operators. Not me, sorry!

There may be more capital to chase these deals than experienced operators who can manage them.

So for the rest of us – how can we take advantage?

• Passive investments: Look to crowd-sourcing investment websites like crowdstreet.com, fundrise.com, and others. Do not try to become a hotel owner / operator if you have never done it.
• Adaptive re-use: can hotels be converted to micro-apartments? If the asset does not have kitchenettes already, then retrofitting to add kitchens is a huge and costly task. But in theory, hotels lend themselves to micro-apartment conversions. Adding plumbing and kitchens is not easy, though, make sure the operator / sponsor has done their due diligence with detailed cost analyses and permits in hand.

Who should pursue this asset class: 

Experienced hotel operators – I hope you are raising money right now.

Passive investors – find those operators, and underwrite the opportunity carefully. What are the stabilized assumptions of the pro forma, and how does that compare to the past performance of the asset? If the assumption is “back to normal,” then I would stay away. Be conservative and assume the new baseline net operating income is well below previous levels.

Developers – target “suite only” hotels with kitchenettes for adaptive re-use.

Word to the wise:  This is an incredible buying opportunity, but only at truly distressed prices. Pick your investments wisely, as this asset class will continue to struggle, even after a vaccine / herd immunity.

About MV Properties:

MV Properties exists to serve our clients in building their wealth through real estate investments.

We guide our clients through creating customized real estate investment strategies.

We analyze our clients' portfolios, looking at return on equity (ROE), debt strategies, and tax efficient planning, to develop a plan specific to each clients' needs. 

We let the numbers tell us the strategy, as each situation is different.

Keegan McNamara is a real estate developer, investor, and broker. He owns MV Properties, a residential brokerage and property management firm, and McNamara Ventures, a development and investment company. Keegan can be reached at [email protected]