PKF Consulting USA released its annual Hospitality Investment Survey, which showed hospitality investment indices continue to operate at optimal performance levels. According to the survey, which was conducted this past spring and tracks changes in investment and financing criteria over the prior 12 months, hotel profits are up, debt is more readily available at attractive terms, capitalization rates are stable and values are expected to increase in the near term.
Optimal fundamentals
Driving the optimistic sentiment is the strong outlook for the major lodging metrics. According to the June 2014 edition of PKF Hospitality Research’s (PKF-HR) Hotel Horizons national forecast report, supply growth is expected to remain below the long-run average of 1.9% through 2016 before increasing to 2.1% in 2017. PKF-HR expects this modest growth to keep occupancy strong and allow operators to increase average daily rates and post robust RevPAR growth through 2016.
According to PKF-HR’s 2014 Trends in the Hotel Industry report, property level net operating income (NOI) increased for the typical U.S. hotel by 10.1% in 2013, just below the 2012 year-over-year increase of 10.2%. Double-digit annual gains in NOI are forecast to continue through 2015.
“Many survey respondents indicated that owners are holding on to high-yielding assets as the outlook for NOI growth remains strong,” said Scott Smith, vice president in PKF’s Atlanta office. “Some investors are now targeting alternative asset classes (i.e. select service, extended stay) or focusing on secondary and tertiary markets.”
Investment criteria
The vast majority of investors remain bullish on the near-term outlook for hotel investing. Due to the positive outlook for NOI, the overall capitalization rate (OAR) for hotels decreased slightly to 8.27%. Discount rates (un-leveraged IRRs), terminal capitalization rates and equity yields all remained virtually unchanged compared to last year.
The average expected cash-on-cash return for a hotel investment increased by nearly 1% in 2014, which helps explain the slight increase in the equity yield.
Survey respondents indicated the average holding period for assets has increased by approximately six months.
Investor favorites
Luxury hotels and boutique properties continue to be underwritten on lower cap rates compared to typical, full-service hotels. “Owners have greater flexibility with these types of assets when completing a repositioning or value enhancement project,” Smith saidd. “In addition, these categories are heavily weighted by properties located in gateway cities such as New York and San Francisco.”
Depending on the age of the asset, capitalization rates for full-service hotels continue to vary widely. Full-service properties less than 15 years old had an average cap rate of 80 basis points less than hotels 16 years or older. Limited-service cap rates follow a similar trend with regards to the age of the asset.
Lending criteria
Lenders also appear to be bullish on the near-term outlook for the lodging industry and continue to demonstrate increasing confidence by providing debt for hotel acquisitions and refinancing. Debt service coverage ratios remained below pre-recession levels, while loan-to-value ratios increased 281 basis points compared to last year.
“We did notice a slight uptick in interest rates, however, on average they remain below 6%,” Smith said. “Rates for limited-service hotels were slightly higher than those for full-service properties.”