In this Q&A series, “Reimagining Real Estate,” Brian Carrozza, Associate Director of Strategic Growth at Goulston & Storrs PC, sits down with attorneys from the firm’s market-leading real estate practice to talk about how they see the pandemic reshaping commercial real estate in 2021 and beyond. This month, he spoke with Cecilia Gordon and John Ratino, attorneys in the real estate practice and co-leaders of the firm’s Hospitality & Recreation Industry Group, about the current and future state of the hotel market. 

Q: Talk about the state of the transactional market. Are we seeing too much cash chasing too few deals? To what extent do you agree with the notion that hotel pricing recovery is far ahead of fundamentals in many markets? Are sellers who could not cash out in 2019 and 2020Q1 getting their prices today?

Gordon: We are not currently seeing a huge number of hotel deals, in contrast to some other asset classes such as multifamily, office and industrial, which seem to be booming. While there are many buyers looking for deals on distressed hotels, there are few sellers interested in selling at distressed prices. Many hotel owners are seeing significant improvement across wide swaths of the industry and do not believe they are sitting on fundamentally distressed assets. And for hotels that benefitted from the boom in “drive-to” vacations, pricing is above pre-COVID levels. As a result, equity investors who thought this would be a good moment to pick up hotel bargains are pivoting to explore opportunities in other asset classes.

Despite the overall lack of deal volume, there is a lot happening at the corporate level of the hotel industry, as we see the pace of mergers and acquisitions activity picking up. Right now, the action seems to be in corporate growth through consolidation, as opposed to asset-based transactions.

Our clients that provide hotel receivership services are also quite busy as some lenders take over properties. It’s important to note, however, that these receivership arrangements are not leading to a wave of foreclosures.

Q: Inflation is typically favorable for hotel rates, and indeed, we have seen prices steadily rising. On the other hand, we have also seen increases in wages for operating personnel, escalating construction and renovation costs, and higher material and freight costs. How do you see these upward and downward pressures affecting the industry in the months and years to come? 

Ratino: That is the “64-thousand-dollar question.” In addition to the factors listed in your question, many hotels have workout arrangements with their lenders and franchisors/managers, that are going to result in either increases in the amounts they ultimately are required to pay under their loans or under their agreements with those other parties. That means the hotel industry is going to be under real pressure over the next few years to raise rates. Their ability to do so, however, is linked to the larger economic environment, including what happens with business travel. If that picks up, it will be positive for hotels.

Q: With the lack of corporate and group recovery visibility and limited urban trades, are you seeing increased focus on leisure-driven assets, due to greater certainty of performance in the near term? 

Gordon: The interest in leisure-driven assets and in luxury assets, which was a marker of last year, continues. Beach resorts in the U.S. are doing very well.

We have a number of leisure and luxury clients that have continued to work on expansion plans through the pandemic, including by continuing to identify and pursue potential new sites. In some cases, these properties are several years away from opening, but the development process is in full swing. For many leisure and luxury clients, their hotels’ success in making it through this crisis has given them confidence that they can continue to expand.

Q: Which hotel product types and geographies are in favor right now?

Ratino: We’ve seen an increase in personal travel to locations outside of cities, especially to so-called “drive-to” vacation spots. Hotels in those locations have done quite well over the last couple of years. On the other hand, traditional downtown convention hotels driven by corporate and group business haven’t fared as well.

Many believe this may be the start of a long-term trend that is likely to last well beyond the pandemic. I guess we’ll all have to see how this plays out.

Q: How have terms changed for hotel transactions during the pandemic? Have you seen shifts since vaccines became widely available and the recovery—albeit an uneven, unsteady one—began in earnest?

Gordon: The fundamentals of contract terms have not shifted much because there have not been any real weaknesses exposed in franchise or management agreements during the pandemic. Owners are more focused now on rights to close hotels under these contracts (i.e., who has the right, who doesn't have the right, and what would trigger the right). COVID was such a catastrophic event, but major corporate franchisers like Marriott, Hilton, Hyatt and others came together to help their owners get through it, which means there has not been as much stress on normal contract terms.

What I do see shifting longer-term is how hotel owners select lenders. Having strong lender relationships has made a huge difference for owners struggling to navigate the pandemic. While interest rates will always be a key driver, owners are going to be asking themselves now more than ever: “Is this lender somebody I can talk to, who’s going to understand I have a real problem?”

What remains to be seen is where we end up. The wave of loan extensions in spring and summer of 2020, which for the most part deferred interest and principal payments but didn’t forgive them, has delayed the impact on loans. For most lenders, taking back a hotel that had no revenue stream for the foreseeable future was not an attractive option, because the out-of-pocket costs (real estate taxes, insurance, maintenance, etc.) to keep a closed hotel afloat are substantial. Now that hotels are opening and generating revenue again, however, what happens when the deferral period ends? As the recovery continues, and hotels come back online, it’s possible that lenders could start seeing foreclosure as an option.

Q: In what ways have the impacts of the Coronavirus Recession on the hospitality industry differed from the effects of the Global Financial Crisis (2007­-09)? Are there similarities in how the industry was impacted by these events?

Ratino: In both cases, the impact to the hotel industry was significant and rapid, but the pandemic brought on a quicker and deeper drop than anything I’ve seen in nearly four decades of practicing law. The Global Financial Crisis was painful for many, but it was followed by about 12 years of steady growth, so in retrospect the industry was well-positioned coming out of it.

Unlike other real estate sectors that are covered by long-term leases that somewhat mitigated the adverse effect of the pandemic over the short-term, the impact on the hotel industry was immediate and deep. However, the lack of long-term leases may prove to be a benefit to the hotel industry as the economy recovers. At this point, we still don’t know where this will all shake out, since hotels are still being affected by the crisis. It is possible that in a few years, when we look back at the past decade—including these COVID years—we may be surprised by how well the hotel industry has fared overall.

Q: Which changes do you believe will outlive the pandemic? 

Gordon: One thing I expect will outlive the pandemic is the return to seeing value in the brands. Before the pandemic, some hotel owners were moving away from putting a major franchise flag on their properties, but there has been a resurgence of interest in the larger brands that I expect to last. Why? Throughout the pandemic, franchisors have done an enormous amount to help their franchisees get through a crisis that none of us have ever seen before. They were at the forefront of developing the necessary protocols and best practices that franchisees need to close and reopen their hotels safely. The support of franchisees has been phenomenal and it’s going to have a positive, long-term impact.

At the property level, the focus now is on diversifying revenue management plans. If you have a hotel that is primarily driven by one market segment (e.g., business, conventions or domestic/international leisure), local revenue streams should be added wherever possible, and not simply as short-term, pandemic-driven stopgaps, but on an ongoing basis. Even when traditional revenue streams return, hotel owners should have safety nets in place, and relationships with the local community and proximate consumer base should be prioritized.

Q: Are we seeing or are we going to see substantial distress in the hotel market? When and where are we likely to see it? 

Ratino: At the beginning of the pandemic, lenders and franchise owners were quite accommodating to hotels, in terms of relief and flexibility. That said, everyone thought the industry would be well on its way to recovery at this juncture, and the Delta variant has to varying degrees upended these predictions. The potential for substantial distress in the hotel industry is still very much in play.

Cecilia Gordon and John Ratino are co-chairs of the Hospitality & Recreation Industry Group at Goulston & Storrs PC. Gordon advises clients on investments in and management of hotel and resort properties across the country. Ratino has broad hospitality industry experience including financings, restructurings and workouts, capital markets, REITs, joint ventures, developments, and acquisitions and sales. Brian Carrozza, a member of the firm’s business operations team, focuses on business growth and practice management, serving as strategic advisor to Goulston & Storrs’ Real Estate Group and as “chief of staff” to the group’s co-leaders. They can be reached at cgordon@goulstonstorrs.com, jratino@goulstonstorrs.com, and bcarrozza@goulstonstorrs.com.