As part of the Americas Lodging Investment Summit’s Patron sponsorship program, ALIS asked Kevin Davis of JLL eight timely questions as we prepare for the 20th annual event July 26-28, 2021, at the JW Marriott/Ritz-Carlton Los Angeles L.A. LIVE. Following are his responses.
How would you characterize the mindset of institutional owners in general as the start of the recovery appears to be close at hand, and what is the general approach they are taking when it comes to transactions?
Institutional owners are approaching the recovery with cautious optimism as many are beginning to see an improved booking pace and there’s a growing feeling that we will see sustainable demand as we get deeper into the spring and summer seasons.
Owners are aggressively looking to acquire hotels. In fact, unlike prior recessions, owners maintained an acquisitive posture throughout COVID; the problem has been a lack of product on the market, so very few acquisitions have gotten done. As demand picks up and as the debt markets improve, I would expect hotel sale activity to increase very meaningfully this year.
What will be different about coordinating financings for large properties post-pandemic?
There will be debt capital available for large transactions, but initially the amount of debt capital available for such transactions may be limited. Historically, the floating rate CMBS market has been a primary source of capital for large hotel financings. While this market shut down as a result of COVID, it remains selectively open. Starwood did a $265mm CMBS financing in Oct 2020 and my understanding is that Blackstone and Starwood’s acquisition of ESA will be financed in the CMBS market. Assuming that transaction is well-received by bond investors, that could lead to a re-opening of the financing markets for large assets and acquisitions.
What role are conversions playing in the lodging capital markets?
The question around conversations is really market specific and asset specific. In NY for example, where we are working through a sizable increase in supply over the past 8+ years, there have been many conversations about converting hotels into other uses such as affordable housing or for sale residential.
The challenge thus far is that pricing has generally not gotten to a place where such conversions make economic sense. Nevertheless, many developers are still considering this. We’ve also seen properties trading in tertiary markets for $75,000/key or less, which pricing generally works for conversion to multifamily.
In most cases, those have been older assets, which because of their age and physical plant are not suitable for franchises by the major flags, so conversion to multifamily made sense.
What about all the “dry powder” that we keep hearing about—when will there be an opportunity for the capital currently sitting on the sidelines to be invested in hotel assets and what might those deals look like?
I’ve seen estimates that there is $300 billion of dry powder on the sidelines to invest in commercial real estate. Unfortunately, there is very little product for sale in the current market to absorb that capital. As a result, there is a significant supply/demand imbalance between available capital vs available product. This imbalance has provided a floor on pricing, and it’s one of the reasons why there hasn’t been the level of distress that most observers initially anticipated.
Nevertheless, there are deals that are getting done. One trend that we are seeing is that a number of owners are negotiating sales directly with buyers. Similarly, many owners are hiring intermediaries to run quiet processes where a small group of potential buyers are approached. The benefit of the direct and targeted marketed campaigns is that they maintain confidentiality and protect owners from market chatter about failed processes if desired pricing is not achieved.
As the financing markets and operating fundamentals continue to improve, I’m expecting a significant pickup in sales volume later this year.
How do you view the situation with distressed assets in the lodging landscape? What word would you use to describe the role they will play in the transaction market during the next 12 months and why would you use that word?
I’m not sure we will see widespread distress over the next 12 months. The opportunities that arise will be fairly selective because lenders and regulators worked with borrowers and did not exercise their remedies or force sales.
The federal government responded quickly after the onset of the virus with the CARES Act, which put money into the hands of owners and of workers to mitigate the impact of COVID. As a result, owners were able to hang on. There was very little forced selling.
Now that we are starting to see a recovery, I would expect that many lenders will continue to work with owners. To be clear, there will certainly be distressed situations that arise, but it won’t be to the degree that most people were expecting.
With lenders playing it close to the vest, what is the outlook and timing for new-construction financing?
Construction financing is available at reasonable pricing, but only for the best assets and best sponsors. Construction lending remains constrained for two reasons: 1) the banks, which have historically been large construction lenders, are only originating hotel loans very selectively and it’s much easier to get approval to originate a loan on an existing asset with a proven history of performance; and 2) the debt funds, which have also historically been active in construction lending, are able to get attractive spreads on existing assets.
As our team evaluates whether to take on a construction loan assignment, we consider several factors, including: barrier to entry; entitlement timelines; a demand story; competitive advantages; the availability of public subsidies; whether the hotel is part of a mixed-use development with other “in favor” uses at the project; and the project’s cost basis and projected performance.
As a general matter, most construction lenders prefer to maintain leverage below 60%, and to the extent that a senior mortgage embedded in a whole loan, the senior component is generally between 40% to 50% loan-to-cost. The pricing for construction loans remains bespoke.
In general, what is the transactions outlook for 2021?
With the recent announcement of the $6bn Extended Stay America transaction, it’s reasonable to see total transaction volume doubling in 2021. The ESA transaction alone is equal to 80% of 2020 sales volume. Away from ESA, we expect sales volume to be up approximately 35-40%, with much of the increase being weighted toward the second half of the year.
What’s the one takeaway people should know about Kevin Davis?
Many people may not know that I started my career very far removed from hospitality and real estate finance. I am trained as a lawyer and spent the early years of my career doing banking policy work on Capitol Hill for members of the House and Senate Banking Committees. It was pretty heady stuff to be a young kid participating in meetings with a US Senator and high-ranking government officials such as the Fed Chairman or the US Treasury Secretary. My experience on Capitol Hill has certainly given me a unique perspective on how Washington works, which is particularly helpful since Washington is now more involved in the economy than at any time in recent history. Also, before my JLL career in hospitality, I worked as a lender with several investment banks for 13 years.
In short, I’ve had an eclectic pre-hospitality career, and I believe that those experiences have made me a better advisor to our clients because I’m able to call upon unique, but highly relevant perspectives.