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The buy side of M&A in US

The big radical in how many assets in the U.S. come to market focuses on what happens when bank and CMBS concessions end and deferment payments come due. Lender forbearance “just extended the day of reckoning,” said Anthony Sherman, founder and principal, Terrapin Investment & Management Corp., Aspen, Colorado.

Currently, borrowers are struggling to pay down principal. With average occupancies in the 40s and average RevPAR below US$40, according to STR, any company with a weak balance sheet could be in trouble late this year when first-round forbearance ends.

Contributed by Mary Scoviak

Even power player such as Colony Capital are feeling the pinch. As of mid-July, two of the firm’s largest CMBS-financed hotel portfolios had defaulted on loans: the 89-property Tharaldson portfolio, which defaulted on a US$768 million loan, and the 48-hotel Inland portfolio, which defaulted on a US$780 million loan.

Colony’s Q2 report stated the company was still in active negotiations to lenders and services to protect the value of individual investment-level portfolios or appoint a receiver for one portfolio. “Individual asset sales have been put on hold as a result of COVID-19. When market conditions permit, the company will evaluate all monetization opportunities, including single asset sales, portfolio sales and overall platform exits,” according to the statement. Colony hired Moelis & Co. to evaluate those options, which could put more than 15,000 rooms on the market, and enable the REIT to further its expansion in data center real estate investments.

What, who’s hot?

Given their cashed-up status, big players such Starwood Capital will have their choice of deals. But, with former A-list contenders such as Blackstone and Colony both opting to or having to sell CMBS-related portfolios, there’s a new competitive landscape shaped by investor goals. It’s impacting who’s shopping and what’s on their shopping lists. In terms of portfolio deals, Sherman sees well-capitalized management companies targeting their smaller competitors.

Getty Images
Getty Images

Art Adler, president Adler Hotel Advisors, also foresees more mergers among private management companies. With fee income down 75% in some cases, more operators “could come together to cut overhead as recovery starts.” Take-private deals are recessionary staples but, as he pointed out, “Those types of deals are usually done with debt financing, and debt financing for hotels is hard to find.”

Private equity and institutional investors are also eyeing existing operating platforms, especially those “that may be struggling now but have a reasonable footprint of complementary assets,” Crandell said. He acknowledged that “hot” is a relative term, in today’s market. In his view, the “most desirable” properties “might be those with highly efficient labor model, limited guest services, are relatively new with limited capital requirements and, perhaps, located in a suburban and/or densely populated area. Oh, and you have to be able to drive there. So, you’re looking at a first-to-recover asset portfolio—which will be few and far between.”

John Pritzker, founding partner and director, Geolo Capital, San Francisco, calls the buy side this way: “Hot property types are centered on imminent financing situations (i.e., owners who have looming debt maturities or who may not be able to continue to provide additional capital to hold on to their properties through short-to-medium term closures),” he said.

Barring any government shutdown efforts, Pritzker sees resorts and suburban properties as likely to continue to outperform in the short-term. The next 12 to 24 months will be a challenging time for urban/city assets, as those assets are more dependent on corporate and group business that is unlikely to materialize for some time, he added.

Sherman offered something of a contrarian view. “I’m most interested in higher-end, distressed properties selling at big discounts to replacement costs,” he said. “They have to be in or near major markets. If Southwest doesn’t fly there, I’ll pass.”

Already stressed, some upscale hotels could prove to be big bargains as investors sidestep them amidst gloomy predictions on business travel recovery. Homi Vazifdar, CEO, Canyon Equity, Larkspur, California, sees acquisition opportunities at both ends of the spectrum: drive-to select-service and unique, ultra-luxury properties in remote locations.

Michael Cahill, CEO and founder, HREC—Hospitality Real Estate Counselors, Denver, Colorado, predicted heightened interest in extended-stay portfolios. That’s true for pure plays. STR reports extended-stay properties posted an almost 20% occupancy premium over the industry as a whole throughout the pandemic.

It’s also valid for the increasing number of investors looking for niche plays. “I’m getting a lot of calls from investors asking if a property has a kitchen,” Cahill said. “We’re seeing growing interest in serviced apartment models. In the past, valuations on extended stay properties to make this kind of conversion attractive. But, with today’s pricing, there could be some aggressive buying.”

Consolidation is also going to be a driver. Crandell forecasts further consolidation among brands/franchisors and third-party operating platforms.

REITs may also be ripe for some deal activity. As Vazifdar pointed out, REITs “have been decimated,” losing more than 50% of their market cap. The “smart ones” reconfigured their capital stack, negotiated admirably with their lenders and tightened their belts. “They’ll ride out the storm,” he said.

It’s the ones with “weak management and historically erratic strategies” that are scrambling, Vazifdar added. If they’re lucky, they can flip assets to boost their balance sheets. If not, they’re prey for larger private equity houses that want to reel in portfolios trading at huge discounts to net asset values. “The big private equity players are licking their chops because prices are so low,” Sherman added.

Pritzker agrees that, if share prices remain depressed and the downturn and cash burn to hold assets extends into 2021, private equity could aggressively pursue not only the assets but entire companies. One thing he doesn’t see is REIT-on-REIT consolidation or mergers. As he pointed out, there’s no incentive for REIT management teams to consolidate while stock prices are depressed.

“Mergers would result in reduced equity realization payouts and executives effectively losing their jobs and robust annual cash compensation packages,” Pritzker said. “The REITs are in a difficult spot. They are focused on conserving cash to ensure they can make it through the pandemic. That said, we believe most are poised to ride this out and become active again once their businesses and share prices stabilize.”

Host Hotels & Resorts, Bethesda, Maryland, could be the exception, Pritzker added. “It’s historically been one of the most conservatively capitalized companies. It recently increased its liquidity and amending its lending facilities. That could enable it to be a buyer.”

Who else will be on the buy side for hotel deals generally? Cashed up private equity is at the top of the list. Institutions are in the hunt. Foreign investment is a big question due to the strength of the dollar and other considerations.

“Chinese investment has all but evaporated in our industry the last few years,” Pritzker said. There have been some highly publicized situations for Chinese companies that has cast a negative light on Chinese investments in the U.S. “In addition, the Trump administration’s policies toward China has all but shut down inbound China interest for US properties. EB-5 financing, which helped fuel a number of U.S. ground-up developments, has all but dried up.  We are not seeing any green shoots from investors from China,” he added. The strength of the dollar should keep most European investors at bay.

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