News

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Key Takeaways

• RevPAR outlook modest – Expectations for RevPAR growth trajectory have moderated following a deceleration throughout 2018 (1H up 3.5%, 2H up 2%). YTD 2019 RevPAR (up little over 1%) has disappointed vs. budgets which at one time pointed to a pick-up in growth in 1Q19 (Easter benefit) vs. 4Q18 (hindered by hurricane compares). After a modest Jan/Feb, the first few weeks of March have also been disappointing. The last week of March and first week of April should get Easter benefit but the outlook for the remainder of April is quite modest. Outlooks for the year remain near 2% which seems to imply a better 2H, resting on the premise of easier compares. Occupancies at record highs but rate growth frustratingly low. 
• “No such thing as an expiration date on an expansion” – Last year, Bob Hunter said it best...Cycles don’t die of old age. In ‘14 and ‘15 we were in the 6^th inning of a double header. In ‘16 we were concerned. In ‘17 we were in the 10^th inning of an 18 inning game. In ‘18, we are tired of baseball analogies.  In 19, we agree we are late in a cycle with an unpredictable end. 107 out of past 108 months have shown positive RevPAR vs. 56 months in 00’s cycle and 111 months in the 90’s cycle.
• Econ 101: GDP decel, wage growth accel, lodging taking share of wallet but real ADR disappointing – GDP growth expectations are moderating following the synchronized global growth theme from 2018. US expected to be low 2’s following the 3 in 2018. Downside risks to growth have risen. Wage growth made progress throughout 2018 now running up near 3.5% which reflects how tight the labor market is. Lodging spend up 45% vs. 2011 outpacing consumer spending which is up 30% over the same time period. Despite share gains and wage pressure, rate growth continues to disappoint and remains negative in real terms.    
• Negative impacts of new supply – Headline industry supply numbers are not getting worse (remain dialed in near 2% in line with 2018 levels) but the cumulative effect of years at this level, coupled with moderating demand growth is leading to a step up in supply impact complaints amongst owners, developers, lenders etc. New supply immediately impacts hotel values when announced followed by a rate impact when the property actually opens. Construction costs still high keeping a lid supply. Currently near 200k rooms under construction up 2% vs. last year. 
• Labor, construction, and taxes all rising – The chatter around rising labor costs and construction costs has only gotten louder relative to 12 months ago. More moderate RevPAR growth is amplifying the margin impacts of rising costs. Property tax increases got more attention this year (point of disagreement between buyers and sellers, a potential hold up to deals) and sounds to be a trend that more cities/municipalities are looking to as a revenue source.
• Debt still competitive; pulling back leverage a little; more cautious on underwriting assumptions – Even with a more cautious backdrop due to some heightened macro/growth concerns, lenders appetite remains strong and spreads are narrowing a bit even with falling interest rates. There is “liquidity but not euphoria.” Regional and local banks relatively more aggressive but “not to the point of being unhealthy.” Most investors sounds to be reducing leverage levels modestly (if it was 70% last year, it is 65% now for some) and unlevered return expectations have eased slightly. More caution embedded in the underwriting assumptions in deals today vs. 12 months ago involving more moderate topline assumptions and higher expenses, pressuring returns.
• It’s cap rate, it’s price per key, it’s IRR – Can’t just look at one in the deal, have to evaluate all three. Cap rate is one of the first questions asked b/c it says how a seller is thinking about the deal. But it is really just an output to a variety of the other inputs. Cap rates matter more for core stabilized assets (better for industrial, multifamily, etc.). Look at price per key in the market and cost to build in that market. Think about a reasonable per key exit in that market, and if it is tertiary, will it be able to attract that type of capital years down the road. If selling an asset, evaluate it from the perspective of a buyer and consider the IRR.  
• Those unpredictable interest rates – A year ago, the 10 year was at 2.75% with broadly consensus expectations for a rise. Rates peaked in Nov of 2018 at 3.25% and have since moderated to 2.35% today. The consensus now is for stable rates.
• Cap relatively stable through 2018, expecting more of the same in 2019 – The consensus amongst hotel investors points to stable to moderately higher cap rates in the next 12 months as the spread over the 10 year is expected to hold to widen slightly. While debt is readily available, the growth outlook has changed which should put some upward pressure on cap rates. This follows 2018 which saw cap rates hold stable near 8% and spread over the 10 year narrow ~50bps through the year (as interest rates rose) to ~475bps in November 2018 but then widen in the last five months back towards ~525bps (as interest rates fell). In 2017 cap rates were also stable near 8% despite a rise in interest rates exiting 2016. For reference, 2007 cap was ~6.5%, ~150bps premium to the 10yr.
• Deal $ volume should be down in 2019 on tough compares from portfolio deals in 2018 – When asked, most industry participants expect to be a net buyer this year, but most expect deal volume to be down yr/yr in 2019 due to a high number of portfolio deals which padded growth last year. According to HVS, 2018 deal volume of $41B was up 47% yr/yr from the $28B last year, marking the 2^nd highest volume in the last decade, still below the $50B see in 2015. A greater number of higher priced portfolio deals (worth $12.5B of 2018 vs. $3.9B of 2019) drove the growth, while individual property sales volume was only up mid-singles.
• Net buyers on average, still a decent bid ask spread – For 2019 there still sounds to be more buyers than sellers, but buyer appetite is not as strong as it was this time last year. Bid ask spreads between buyers/sellers sounds relatively unchanged with sellers still aspirational and buyers concerned on new supply, margin, and growth trajectory. As a reminder, 2017/2018 buyer interest recovered/bid-ask spreads narrowed. During 2016 the appetite for deals was “anemic” following 2014/2015 which was “on fire.”
• Evaluating distribution; focusing on topline vs. bottom line: Discussions continue to highlight the industry’s need to reduce the focus on market share/RevPAR and elevate emphasis on “net RevPAR” or profit. Some point to the topline focus as indicative of the separation of brands (collecting fees off the topline) and owners (reliant on profits). The brands in the room emphasized that they are working to maximize the bottom of the P&L given their understanding of the topline and the middle of the P&L (as mangers).  Distribution and reliance on the OTA’s remains a conversation point, and different agreements with OTA’s based on brand, geography, and day of week probably make sense. 
• Brand Proliferation – New brand launches persist. While the brands are attempting to meet growing consumer interesting in differentiated, unique products, owners are still not happy about the supply/rate impact of similar properties with different names in the same brand family popping up across the street.

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Vince Ciepiel, CFA

(216) 649-7253 vciepiel@cleveland-research.com

Henry Gerlach, CPA
(216) 649-7206 hgerlach@cleveland-research.com

Matt Varabkanich
(216) 649-7316  mvarabkanich@cleveland-research.com