California Hotel Sales Could Drop Over Bid-ask Gap

HotelNewsNow
01/25/19

California Hotel Sales Could Drop Over Bid-ask Gap
As the price per key hit a record in 2018 California hotel sales, the number of individual sales dropped year over year, perhaps showing a widening gap in buyer and seller expectations.
By Bryan Wroten

http://www.hotelnewsnow.com/articles/292456/California-hotel-sales-could-drop-over-bid-ask-gap

REPORT FROM THE U.S.—In a possible indication of what’s to come, hotel transactions in the state set a new record last year in price per room, while the number of individual sales dropped significantly.

It’s a tale of two sets of numbers, said Alan Reay, president of Atlas Hospitality Group, author of the California Hotel Sales Survey Year-end 2018. Last year’s transactions set a new price-per-key record of more than $121,000, he said, a 14% increase over 2017 and a 77% increase over the past five years.

However, the number of individual sales dropped 24% year over year in 2018, falling from 369 in 2017 to 280 in 2018. It’s the second-largest percentage decline in sales since 2008 to 2009, at the beginning of the meltdown, he said.

Reay said the decline could be an indicator of declining actual sales in California, and buyer and seller expectations falling out of alignment.

The number of transactions in 2019 should continue to decline, and values will remain flat, he said.

The factors at play
There are a number of reasons that could be causing buyers to pull back, Reay said. The first is rising interest rates. It’s not so much the fixed-rate loans, but a big percentage of deals are done through U.S. Small Business Administration 504 loans, he said. The prime rate went up to 5.5%, and as interest rates go up, cap rates have to go up, he said.

“That’s what I meant when I said buyer and seller expectations are not aligned correctly,” he said. “There are still plenty of buyers out there who want to purchase, but if the sellers’ (net operating income) hasn’t increased, they have to adjust their prices.”

As a result, some properties have been sitting on the market longer, and others have had their selling prices revised down, he said.

Buyers are primarily looking at products that are 10 years old or newer, Reay said. They want hotels in or close to primary cities, not tertiary locations, he said. Quality brands, such as Marriott International Hilton or Hyatt Hotels Corporation, remain a selling point, he said.

Among the least desirable are older properties, especially those with exterior corridors, which are struggling to maintain profitability and are functionally obsolete, he said.

The market is shifting, Reay said. Rates have increased and will likely increase again, and the cost of improvement plans has increased as construction and labor costs grow. Sellers have to be on top of those factors to make sure they are pricing their assets correctly, he said.

It’s no coincidence there is a record number of hotels under construction in the state, he said. Many of his company’s clients were active buyers and renovators over the past 10 years, but moved away from that to purchase land and build brand new properties, he said.

“When you are looking at a median price of $121,000 per room versus the cost of construction, I think a lot of potential buyers are saying, ‘Let me build brand new,’” he said.

Owner perspective
Braemar Hotels & Resorts looks at buying opportunities throughout the cycle, President and CEO Richard Stockton said, as it’s possible to find a buying opportunity when it’s not expected while being more critical in a time when there are higher expectations to buy. The pipeline is a little thinner now than in years before, he said, and the company considers dozens of deals a year while only closing on one or two, a process that allows the cream to rise to the top.

He pointed to some notable luxury hotel transactions in California as a sign that there are still good deals possible in the state. While there are challenges with acquisitions, the state still boasts desirable markets with interesting properties, he said.

Braemar announced its intention to acquire The Ritz-Carlton Lake Tahoe in November 2018 and closed on the sale this month. The property fits “precisely down the middle of the fairway” for the company’s strategy, Stockton said. The real estate investment trust currently has the highest revenue per available room of any of the lodging REITs, and this property improves that position further, he said.

The Ritz-Carlton Lake Tahoe is the only luxury hotel in that market, which comes with pricing power, Stockton said. The building codes also are quite strict in the state, which lessens the chance of further supply entering the market. The market has great natural surroundings and year-round demand generators, and it’s at the doorstep of the tech industry, he said.

The San Francisco area is a strong market right now, and RevPAR growth there continues to surprise, he said. The company is currently converting its Courtyard San Francisco Downtown into Marriott’s Autograph Collection, which should increase RevPAR further, he said.

Pebblebrook Hotel Trust announced its strategic disposition plan as part of its acquisition of LaSalle Properties Trust, in which it will sell off $750 million to $1.2 billion in assets, EVP and CFO Ray Martz said. The company intends to maintain a heavy presence on the West Coast, but a few of those sales could come from California, he said.

If there are fewer quality products on the market, that would greatly benefit Pebblebrook’s efforts to sell, he said. As a seller, Pebblebrook looks to take advantage of a significant amount of debt and equity capital that’s out there now, he said.

The state overall has great supply and demand fundamentals, and that trend should continue, Martz said. Pebblebrook has seen California generate great returns over the years, but that requires buyers to buy at the right time, he said. For example, REITs own a majority of the hotels in San Diego, so when a hotel there goes up for sale, buyers pursue it because it could be decades before they get another chance.

The increasing cost of construction does make buying in California more attractive than building, Martz said, as cash flows have not been increasing at the same pace as the cost to build. It’s a difficult process overall to develop in the state, and can be more so depending on the market, he said. The challenge to add supply to certain markets makes them more attractive to owners or potential owners, he said.

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