Hotel owners and operators know that the past few years have been unique economically for their business, including when properties change hands. The latest figures from the most recent mid-year survey by Atlas Hospitality confirm that—but in two seemingly contradictory ways.
The results from our mid-year 2023 hotel sales survey saw two new records set. First was a median price per room of $160,851, the highest in the more than 20 years that we have been conducting the survey.
Yet at the same time the industry in California experienced the steepest decline in individual sales ever, down by over 53%.
So, what conclusions can we draw from this most recent survey and these very mixed results?
First, we see some similarities to 2009, which was the only time we experienced a similar steep decline in individual hotel sales, down 52%. The main factor influencing the decline in sales in 2009 is the same as in 2023: a disconnect between buyer and seller price expectations.
In 2009, California hotel owners experienced a steep decline in room revenues but still wanted to achieve the same sales price that sellers had closed at in 2008. Buyers viewed the market a lot differently—hence the steep decline in hotels sold.
Fast forward to 2023 and we are seeing strong growth in revenues in most markets (post COVID), but the increased cost of financing has resulted in buyers adjusting their price expectations. We have moved quickly from interest rates in the low 4% range to now at 7.5% and above. We also have a lot fewer lenders in the market, and those lenders that are still willing to finance hotels are applying stricter underwriting and lower loan-to-value ratios.
As we saw in 2009, hotel owners that do not need to sell simply pulled their hotels off the market to wait until market conditions improve. If a hotel owner is not under pressure to refinance in the next 12 to 24 months, they are holding. For those owners that need to re-finance, due to loan maturity or to switch out of an adjustable-rate loan tied to prime, they are now faced with much different valuations than just 12 months ago. Not only are they looking at much higher interest rates, but they also must come in with additional equity to make up the refinancing shortfall.
In many cases we are also seeing the requirement to complete property improvement plans (PIP’s) that so many owners have postponed and are now past due. This creates additional financial pressure on owners.
Moving forward, we see that most markets in California are now back to or above pre-COVID revenues, the exception is the markets that were heavily relying on commercial convention business and high-tech, e.g., San Francisco/Silicon Valley. The travel and leisure markets have rebounded very strongly and are performing substantially above pre-COVID revenues.
As we all know, revenues are just one part of the equation. The rapid increase in expenses is applying strong downward pressure on net operating incomes (NOI), especially in labor and insurance. We do not see this trend reversing anytime soon, as the big question for owners today is whether they can push revenues higher and faster to outpace the increase in operating costs.
For this to happen, we will not only have to avoid a recession, but we need the Federal Reserve to curb inflation as quickly as possible and bring down interest rates.
California has always been viewed as highly desirable for hotel investors and we do not see this changing anytime soon. In fact, as we view the economics of supply and demand, we see California becoming even more desirable. The cost to develop new hotels in the state has always been expensive and now with higher interest rates and fewer lenders, we have seen a very sharp decline in new supply.
The number of new hotels opened so far in 2023 in California is down by over 31% as compared to the same period in 2022 and we do not see this trend reversing anytime soon. In fact, California is one of the few states that is experiencing a decline in supply due to the number of hotels being sold for alternative uses, such as housing for the homeless and conversion to affordable apartments. We have even seen a hotel in Orange County being sold to an industrial developer; this is a first, where a developer has purchased a hotel in a strong market only to demolish it and build an industrial complex.
The loss of hotel rooms throughout the state will eventually push values even higher as increased demand runs into lower supply resulting in higher room rates. Another factor that we see impacting values is the position that many cities are now taking on banning short term rentals (Airbnb), with New York City being the most prominent.
In summarizing, we see some clouds on the horizon for the remainder of 2023 and in to 2024, due to the high cost of financing and lenders pulling out of the market. In the long term, we predict strong appreciation in California hotel values as demand outstrips supply.