Industry leaders: Future cost structure unclear
Industry leaders: Future cost structure unclear
16 JULY 2020 8:29 AM

While hotels have lost massive amounts of revenue, they’ve also cut costs at historically high levels. Members of the Industry Real Estate Financing Advisory Council say it’s hard to tell how those costs might eventually creep back up.

REPORT FROM THE U.S.—While hotels are making significantly less money today than they were just months ago, they have also made unprecedented cuts to their operations, drastically changing the amenities and guest expectations.

Speaking during the ALIS Summer Update – New York online conference, members of the Industry Real Estate Financing Advisory Council said it has yet to be seen how those amenities and costs might come back in a more normalized environment.

“I’m not sure there’s a single answer” in terms of what comes back, said Anthony Capuano, group president of global development, design and operations services at Marriott International. “We’re operating in 140-some odd countries, and the answer to those questions are driven by what consumers want.”

Kevin Jacobs, CFO for Hilton, agreed.

“It will vary market by market. … and it’s going to depend on the standard and service,” he said.

It’s clearer in the short term, he noted, saying things like buffets are off the table. But in the medium term, “some (amenities) will come back and others won’t,” he said.

“In the long term, the (amenities) that come back are those (guests) will pay for,” he said. “The model has to work. We can’t grow if our owners aren’t profitable.”

Neil Shah, president and COO of Hersha Hospitality Trust, said that attitude has been more reflected in this downturn than previous ones.

“I’ve seen more so than any previous cycle more responsiveness and sensitivity to owners’ plight this time,” he said, noting he’s not sure “how long that will last.”

Shah said it’s been an exceptionally difficult environment for owners, which is what necessitated many large institutional hotel owners to seek relief through governmental initiatives like the Paycheck Protection Program. He said his company did so before returning PPP funds “once it was clear the narrative had changed.”

“At first, it was using the (Small Business Administration) as the technology to get capital out to as many employers as possible,” he said. “But once the narrative changed and it had to be used as last-resort capital, it was clear as public companies we have other ways to access capital. I wish there weren’t fits and starts. We put a lot of effort into getting that capital, but it was clear it didn’t make sense to take it.”

Making sense of the transactions market
Mark Elliott, president of Hodges Ward Elliott, said his company is still selling hotels and getting financing for clients “albeit it’s quite difficult and expensive compared to where we were before.”

But he noted the vast majority of funding they source is for “runway capital” to help survive the crisis rather than financing for transactions.

“Every single hotel has been impacted by the pandemic, every single one,” he said. “Every single hotel needs a capital infusion. Owners can put that capital in, but there has to be capital advanced into the asset. The question then is does that owner have capital and is that owner’s capital more expensive than what they can access in the market.”

Elliott said it’s been remarkably difficult to predict and time the deals market, particularly in terms of foreclosures. He said if he was asked two months ago when foreclosures might start hitting, he would’ve been wrong. Most hotels are seeking relief from lenders, and he believes that flexibility will soon run out.

“Going forward, (lenders) will not be making any modifications or extensions (for forbearance) without a major interest reserve or CapEx reserve or a paydown on the loan or an increase in the interest rate,” he said. “Otherwise, they’ll take the asset.”

Capuano agreed it’s been exceptionally hard to guess when things will happen.

“This is unlike past, more conventional recessions where it was easier to predict the timing,” he said. “Everyone had an economic model they felt good about. But there are no models about the pace and speed of this recovery.”

He also agreed that lenders’ patience is running thin.

“What’s interesting is in the first 90 days we saw empathy, but that’s running out now,” Capuano said.

Jacobs said the market is more financially sophisticated than during the Great Recession of 2008 and 2009, and he believes it will be less likely that owners are encouraged to “extend and pretend” this time around.

“I think we end up in a rational place, but there will be more activity this time,” he said.

Shah said by the end of 2020, there are likely to be “a lot of unintended owners who will have to hold for a while” as mortgage real estate investment trusts and credit funds are already starting to take over assets.

He also said it’s too early for large ownership groups like the REITs to make significant strategic changes in what types of assets they’ll invest in, and that likely wouldn’t be well-received in the market, even if it’s clear for the time being that extended-stay and select-service assets are better poised for success.

He said it is still unclear how markets will recover from this downturn, but his company “hasn’t lost faith” in them. Ultimately, this could be helpful for hotels in top markets because it could mean some of the worst properties won’t reopen.

“This may lead to (a return in) obsolescence,” Shah said. “The hotel industry used to have an obsolescence factor that just went away with things just hanging on by a thread.”

Both Capuano and Jacobs said their companies have seen continued strong interest in developers from their brands, and those who build now will be well-poised coming out of the downturn, especially as many existing properties are delaying renovations.

“They believe new wins, and with deferred maintenance, they’ll be opening in the teeth of the recovery against unrenovated competitors,” Capuano said.

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