Pandemic’s Effect on California Development Could Increase Hotel Values

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California’s Project Homekey Boosted Transaction Volume

Chatham Lodging Trust sold the 192-room Residence Inn By Marriott San Diego Mission Valley for $67 million in December 2020 to the San Diego Housing Commission, which intends to turn the property into permanent housing for the homeless. (Chatham Lodging Trust)
Chatham Lodging Trust sold the 192-room Residence Inn By Marriott San Diego Mission Valley for $67 million in December 2020 to the San Diego Housing Commission, which intends to turn the property into permanent housing for the homeless. (Chatham Lodging Trust)

The COVID-19 pandemic has had opposite effects on California hotel transactions and development in 2020, slightly increasing the number of deals while slowing the pace of new construction.

The slower pace of development and delayed openings last year, combined with temporary and permanent closures, resulted in a decline in California hotel supply in 2020, creating an unusual situation for hoteliers going forward, said Alan Reay, president of Atlas Hospitality Group.

Reay’s company released its California Hotels Sales Survey 2020 Year-End Tuesday and its 2020 full-year development survey in late January. The sales survey found that while hotel sales in every other U.S. state fell compared to 2019 — even by as much as 62% in New York and 54% in Texas — California’s sales volume increased by 0.3%.

Of the 298 hotel transactions in California amounting to nearly $3.3 billion last year, the state of California acquired 78 hotels for $890 million through Project Homekey. Without Project Homekey, California’s sales volume would have been down 26%, and the total dollar volume would have decreased by 61% instead of 46% compared to 2019.

“There’s no question this has had a huge impact on hotel sales in California, and that’s the reason that, from my statistics, we are the only state that shows an increase in the number of sales, not a huge decrease,” he said.

On the development side, the survey found 66 new hotels opened in 2020, representing 7,179 rooms. In the pipeline, there are 168 hotels and 23,451 rooms in construction and another 1,245 hotels with 165,685 rooms in various phases of planning.

The 28.2% year-over-year decrease in the number of hotels opened in 2020 is the result of construction delays as well as many developers choosing to delay their opening, Reay said. Many of those delayed projects will open this year.

Deferred or abandoned hotel projects, though not covered in Atlas Hospitality Group’s survey, also were a factor in the state.

“That makes sense, because certainly with the pandemic, the decline in the sales values means that a lot of these projects now are at or above replacement cost in terms of where you can buy existing product, and last, but not least, construction financing is just pretty much dried up,” he said.

What This Means for Hoteliers

Because of the delays in construction projects, there will be a spike in hotel openings in 2021, Reay said. There might still be some hotels opening in 2022 that were already under construction as well, such as large resort projects that take longer than 12 months to complete.

“We will not see any new hotels, in my opinion, break ground in 2021,” he said. “I think that we will see a huge drop-off in 2022 in terms of hotels opening. It will be almost non-existent in 2023 and 2024.”

Many developers with existing hotel projects will try to pivot their project into another use, most likely multifamily or condominiums, he said. As difficult as the pandemic has been for the hotel industry, it’s been extremely hard for office and retail as well, and that includes financing.

The pandemic is turning off the spigot for new hotel development in California, which should have an interesting effect for owners of existing or soon-to-open properties, Reay said.

“It’s going to be better for existing owners because of supply and demand,” he said. “We have less supply, and as long as demand comes back to close to what it was in 2018 and 2019, that is going to make hotels very profitable, and it will push up rates, no question.”

Looking back at deals in 2020, while the number of transactions was nearly identical to 2019, the dollar volume was down substantially, which means the hotels transacted were smaller with lower prices per room, Reay said.

However, one thing to note from the 2020 sales survey is there was not a huge spike in distressed sellers, he said. The situation now is different from the Great Recession when there was a tremendous amount of pressure on financial institutions to get rid of defaulted loans and sell foreclosed real estate as quickly as possible.

“If the banks had followed that same path that we had in the Great Recession, you would have seen quite simply carnage in the hotel industry,” he said.

With the forbearance offered by lenders, as well as federal aid, the vaccine rollout and hope for the return of hotel demand, many hotel owners who made it through 2020 are optimistic about what’s to come, Reay said.

Given all that, it could quickly turn into a seller’s market, he said. There is huge pent-up demand from buyers who have hundreds of millions of dollars waiting for a deal.

“It didn’t seem like a day went by that we didn’t get a new distressed fund starting up,” he said. “The problem is they’re sitting on hundreds and hundreds of millions of dollars with no distress.”

Reay said many of those distress funds will change to opportunistic funds. They’ll make deals with owners who aren’t distressed but might have other problems because of the pandemic, such as not having enough money to put into the next property improvement plan.

What should help owners looking to sell, however, is the lack of new supply coming to California’s markets, as that will drive hotel values up, Reay said.

Building in a Pandemic

OceansV Hotel Management is developing the Cambria Hotel LA Spring Street, which is currently under construction and scheduled to open in late August or September. OceansV CEO Sagar Kumar said the company purchased this property in 2012 with plans to develop it into a 180-unit hotel. It was originally a 14-story parking garage built in 1922 and later converted into an office building that once housed the Los Angeles Police Department after the 1994 earthquake.

Partnering with Choice Hotels International for the project was a great help as the brand company offered some key money and helped get the project’s capital stack and financing in place, he said. Development in California can be difficult under normal circumstances, with the permit approval process taking two to three years.

The pandemic created another complication in working with the local government, Kumar said. While construction workers are considered essential workers in Los Angeles, allowing them to continue their work, the city’s inspectors are not coming on-site. Instead, the developer has to show inspectors around the property using a phone video conferencing app. The LA Department of Water and Power also won’t come on-site now, which means it takes even longer for plans and resubmitted plans to receive approval.

The hotel was originally scheduled to open in February or March, but the company had to push back the opening to late August or September because of an unexpected lead abatement project and pandemic-related delays, he said. There was an outbreak on the job site. One of the superintendents died from COVID-19.

At the moment, the hotel is undergoing a $15 million seismic upgrade project.

“Basically we’re building an entire building inside the building’s concrete structures,” he said.

The hotel is a few months away from being finished with the concrete work, Kumar said. After that, contractors will move on to wiring, drywall and finishing it up.

Selling in a Pandemic

Chatham Lodging Trust sold its 192-room Residence by Marriott San Diego Mission Valley for $67 million in December 2020 to the San Diego Housing Commission. The housing commission intends to turn the property into permanent supportive housing for the city’s homeless population. Chatham owned the property since acquiring it out of bankruptcy in 2011.

A representative of the housing commission approached the real estate investment trust about buying the property, said Dennis Craven, executive vice president and chief operating officer at Chatham. The housing commission was interested in the Residence Inn because it’s an extended-stay property with in-suite kitchens and large public and meetings spaces. The property also was up to date in all of its fire and life safety standards, a priority for the commission.

They were able to negotiate a price that worked for both parties, he said. The price was attractive to the REIT, and it gave the housing commission an existing building to quickly address the city’s housing needs without having to pay for new construction.

“I think they looked at it as, ‘Hey, we can get in, we can move in quickly and with little additional expense and provide a solution pretty fast,’” he said.

Chatham has other properties in California, including another in San Diego, and is a long-term believer in certain markets in the state, Craven said. The company is currently building an extended-stay property in the Los Angeles suburb of Woodland Hills for about $70 million.

That said, the company will consider any opportunistic sale that benefits the long-term interest of its shareholders, he said.

“Certainly, it’s difficult to build, it’s expensive to buy, but generally speaking, I think when we get out of this pandemic and things return to mostly what is normal, it’s generally paid off in terms of providing good returns on our investments,” he said.

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