Disconnect Over Prices Keeps Buyers, Sellers at Odds

The Fairmont Century Plaza in Los Angeles sold for $760 million in a foreclosure sale during the first half of 2023. (Accor)

By Bryan Wroten / Hotel News Now

August 16, 2023 | 6:07 AM

The number of individual hotel sales in California during the first half of 2023 dropped by nearly 53% year over year.
 
According to Atlas Hospitality Group’s California Hotel Sales Survey 2023 Mid-Year, the number of sales dropped from 263 in 2022 to 124 this year. The average sales price grew 33.6% year over year, but the median price fell by 9.4% to $6.88 million.

However, the average price per key increased by 14.3% to $220,276, while the median price grew 12.1% to $160,851.

The number of transactions over $5 million dropped from 175 in the first half of 2022 to 79.

The overall drop in transaction volume eclipses a decline in 2009 during the Great Recession, Atlas Hospitality President Alan Reay said.

“That’s the steepest decline we’ve ever seen in our any of our surveys,” he said.

The sales volume in California during the pandemic was a bit of an anomaly, he said. The number of deals was so high due in part to the state-funded Project Homekey, which allowed cities and counties to purchase older hotels to convert to housing for the homeless. Removing those from the count would have put California on par with other states’ transactions figures. Most of the Project Homekey deals factor into the second half of the year, so he estimated the state program accounted for about 10% of deals in the first half.

The reason for the drop in volume isn’t distressed markets or declining hotel performance, which is in fact improving, Reay said.

“It’s pure and simple,” he said. “It’s down to interest rates.”

A Disconnect Over Pricing

How motivated a buyer is to close a deal depends on their situation, Reay said. A buyer doing a 1031 Exchange who has already sold a hotel is going to be more aggressive in terms of pricing than a buyer just entering the market.

A general buyer will have to figure out whether the pricing on a deal is justified by the expected return, he said. If they could previously borrow in the low 4% range in a prime location, they could historically trade a hotel between 1.5% to 2% above the cost of money, resulting in a 5.5% to 5% cap rate or a return on their investment if they didn’t have any debt.

Now, with interest rates between 7.5% to 8%, the buyer is looking to buy at a 9% to 9.5% cap rate.

“That’s a big, big price swing if there’s been no substantial increase in net operating income,” he said.

Would-be sellers are anticipating prices other hotels sold for in 2021 and 2022, Reay said, but at those valuations, with the higher cost of debt, buyers aren’t biting.

“Buyers are looking at that going, ‘Wait a minute. I can’t borrow at 4.5%. I can’t afford to buy a deal at a return that’s less than my cost of capital,’” he said. “What we have now is this standoff between buyer and seller.”

A seller who doesn’t have a loan or major renovation project coming due can hold on to their hotel, he said. Those who can’t afford a major project or to refinance a loan may be forced to sell.

And unless the buyer is motivated by something like a 1031 Exchange, there’s not a lot of pressure to make a deal happen. Buyers can wait for pricing to come down, he said. As more distressed deals occur, that will bring down prices generally, including the non-distressed properties held by owners who are considering selling.

“We very, very quickly have moved away from a seller’s market to a buyer’s market,” he said.

Distressed Hotels

The most well-known distressed hotels in California are the Parc 55 San Francisco and the Hilton San Francisco Union Square, owned by Park Hotels & Resorts, and six, out of a total of 19 hotels, are owned by Ashford Hospitality Trust. Both hotel real estate investment trusts announced in recent months plans to stop servicing loans on these properties.

Both companies saw what they were going to have to pay to refinance and how much they would have to reinvest in their properties and then compared it to the hotels’ cash flow, Reay said.

“They’re saying, ‘It doesn’t make economic sense for us to stay with these deals. We’re going to give you the keys back,’” he said.

Because the loans on these properties are commercial mortgage-backed securities, they aren’t personally guaranteed, so both Park and Ashford are able to walk away from the hotels without any penalties, he said.

There’s a question over the future of Park’s two San Francisco properties, in particular, Reay said. There are opportunities now for hotels that weren’t as readily available for distressed properties during the Great Recession.

With San Francisco struggling to attract meeting and convention business similar to pre-pandemic levels and tremendous vacancy in the office market, there’s less demand for hotels with thousands of rooms, he said. Travelers are more likely to stay in smaller hotels unless they’re there for a conference or convention.

“I think you’ll start to see alternative-use buyers,” he said.

There’s a shortage of affordable housing in the U.S., especially in cities such as San Francisco, Reay said. It’s not unheard of, as the former Fairmont Hotel in San Jose through bankruptcy was converted to Hilton’s Signia brand while one its towers was sold to be used as student housing for San Jose State University.

“People are trying to look at it and say, ‘Well, what else can I do here? What are the alternative uses there?’” he said. “Obviously, hotels lend themselves much more to conversion to residential than an office building.”

There could also be opportunistic buyers who want to keep these properties as hotels, Reay said. They could end up buying them at a fraction of replacement cost and know that even if they close half of the rooms, it could still work out economically. The buyer would need to come in with a substantial down payment, if not all cash, however. Buyers like that are few, and these types of deals can drive prices in the market down.