Despite Renewed Demand, Hotel Development To Be Uphill Slog

Travel and hospitality have recovered in a big way from the long sparse summer of 2020, but hotel development nationwide is caught in a vise, squeezed between high interest rates and the high cost of everything else, especially construction labor.

It's not a full stop for hotel development, especially because business travel is coming back to life, but developers and investors in the space face headwinds even as tourism gets back on its feet.

Interest rates are a prime drag on development these days, Peachtree Hotel Group Senior Vice President of Investments Michael Ritz said during a panel called Hotels: The Great Awakening at the National Association of Real Estate Editors' annual conference, held in Atlanta this week.

“We're getting to a point where the cost of debt is approaching the cost of equity, and that's where deals won't pencil,” Ritz said. “You get a spigot that turns off.”

Ritz added that his company, as a debt provider, has over 200 loans on the books, and is one of the few sources of debt left for limited-service hotel construction financing. Such projects, he said, need to be the right projects for the right assets, and be good brands.

Investment in hotels hasn't dried up completely, according to JLL Managing Director Charlotte Kang, who is the firm's national practice lead for the Hotels & Hospitality Group. But, as for development deals, the assets have to be top shelf.

”If you have an asset that is well-located, with a strong outlook in a strong economic environment, those are very resilient so far,” Kang said. “In markets that are at peak levels, investors are taking a look.”

Yet buyers want certainty that the capital stack works, and sellers are enjoying the strong fundamentals and cash flows, which makes them more hesitant to sell, Kang said.

Complicating the picture for hotels, as it has for multifamily and other property types, is the cost of construction, Cooper Carry principal T.Jack Bagby said.

“It's a combination of interest rates, but also inflation,” said Bagby, who is in the firm's Hospitality Studio. “The supply chain is a portion of it. But when it comes to construction costs, there's a significant shortage in skilled tradesmen, such that the ability to schedule subcontractors is more difficult.”

With that lack of supply, labor prices are way up, he noted. It is putting a dent in activity.

“Brands have been approving new construction deals, but actual construction starts are down about 40% versus 2019,” Noble Investment Group Chief Investment Officer Ben Brunt said.

For hotel owners and operators of existing properties, there are pressure points as well, Brunt said, one of which is a legacy of pandemic closures, namely the lack of capital investment in properties during that period.

“Most capital in those days went to debt service,” Brunt said, leaving “a lot of work” yet to be done on many properties, a prospect that can pose a challenge on par with new construction in some cases.

Still, everyone on the panel was glad to have moved on from the depths of the pandemic, when virtually the entire industry shut down and faced a highly uncertain future.

“It's kind of a blur to look back on that period,” Brunt said, with properties operated by five- or six-person skeleton crews.

“We spent a lot of time digging to find what demand was actually there, such as traveling nurses or government-related demand — really anything would generate revenue,” Brunt said.

Sales in negotiations at the time were delayed, but many of them eventually went through, Kang said, because so much effort had already been put in.

“I also remember a couple of sales unwritten based on alternative uses that had nothing to do with hotels,” Kang said.

“We did see an opportunity to buy distressed debt, and potentially getting assets at lower valuations,” Ritz said of the shutdown period in 2020. “While the market was turned off, we tried to raise [investment] capital in the dislocated environment.”