NOT-SO-RISKY BUSINESS

Despite the pandemic, investors are finding promising opportunities in the hotel sector

BY DENISE DEVEAU

With inflation, rising interest rates, supply-chain challenges, and the fallout from the pandemic, it would be natural to assume that the risk landscape has deterred investors. But experts are saying there is every indication that the risk factors that slowed down investment in 2020/2021 are no longer an issue.

“Hotels are still a sought-after asset class given yields, availability of financing — despite higher interest rates — and a clearer outlook on future performance,” says Robin McLuskie, managing director, Hotels, for Colliers in Toronto.

Overall investment in the hotel market has been quite strong, despite what happened through COVID, says Sylvia Occhiuzzi, senior vice-president and principal, Beechwood Real Estate Advisors in Toronto. “Ownership groups in Canada have shown great resilience. They are a well-capitalized group and have managed to withstand a lot of ups and downs in what is very much a cyclical market.”

Historically the hotel market has been riskier than other classes of commercial real estate, including retail, she adds. “Other classes have the benefit of long-term leases. Hotels are unique in real-estate ownership in that ‘inventory’ is old on a day-to-day basis, so the stability of cash flow is different from other commercial assets.”

It was a different picture throughout 2021, where transaction volume was impacted by the dramatic drop in demand and revenue. “Owners sat on the sidelines and focused on liquidity preservation, cost reductions as well as pivoting to target new sources of the limited demand in the market,” explains McLuskie.

“COVID had some effect, especially if we look at hotel sales in 2020 and into early 2022,” says Peter J. Gaudet vice-president, Horwath HTL Consultants Montreal. “Distressed sales tended to be related to COVID and the location. For example, hotel sales in Western Canada outside of B,C.”

Given so much uncertainty in the market at the time, hotel values were very difficult to measure, and the bid/ask gap was too wide, which led to limited market transactions, explains McLuskie. “However, generally speaking, values held and once transactions started taking place, we didn’t see much discounting on pre-pandemic pricing, if any.”

What stood out for Occhiuzzi was the fortitude of owner/operators in not discounting rates. “In other downturns that was typically the theme. It helped to highlight to investors the advantage of hotel ownership, especially in an inflationary environment.”

On the plus side, the recovery from

COVID has been faster than expected, leading to strong investor optimism and an overall healthy hotel-investment market in 2022, says McLuskie. “When evaluating acquisitions for ongoing hotel use, investment volume was up roughly 10 per cent year-over-year in 2022.”

For years, investors have been operating in historically low interest and lending rate environments, notes Occhiuzzi. “Yes, that has had an impact on the amount of cash flow available to service debt, but on a relative basis, we’re not seeing double-digit interest rates. Investment is no riskier than it was 10 years ago.”

The pandemic provided an additional advantage in the eyes of investors, as it forced operators to cut back on expenses and do more or the same with less in order to increase their profitability and bottom line. “Now they are in an environment where they are able to increase their rates as the market continues to show improvement,” says Occhiuzzi. “Average Daily Rates (ADR) continue to pace well and will continue to grow ahead of expenses. That’s a good sign and places hotels in the position of being a good hedge for inflation and on the radar of investment groups.”

Urban assets in major markets such as Toronto, Vancouver, Montreal and Ottawa, are still highly sought after given their size and profile, notes McLuskie. “However, extended stay as well as limited/select-service assets in secondary and even tertiary markets across the country proved to be the most resilient during the pandemic so we are seeing stronger demand to diversify portfolios in stable, higher yielding markets in assets that don’t have large convention business. Overall, we are seeing a big push for extended stay and lifestyle hotels.”

The most attractive properties for investors depend on how they want to grow their portfolio, says Occhiuzzi.

“Limited and selected service in the secondary and tertiary markets showed remarkable strength through the pandemic, because the market relied on regional travel when air travel was restricted and borders closed. But resort and leisure markets also came into view for investors.”

There was a lift in the quality of the resort market providing strong opportunities to increase room rates, she explains. “That came about with the rise in domestic travel and people taking the work-anywhere philosophy. They began to spend time in markets that were once only considered traditional vacation destinations. This flattening of the seasonality typically experienced in reports has given time for investors to look at this segment.”

Major urban markets continue to be strategic for buyers despite the impact of COVID, says Occhiuzzi. “These are global gateway cities with strong barriers to entry. For buyers that can afford to buy, these are still very much a strategic target.”

There continue to be flags that investors are keeping a close eye on, including higher interest rates, inflation, escalating construction costs for new construction and renovation projects, and concerns over operating performance once the pent-up demand that has been driving growth stabilizes, notes McLuskie. “High construction costs are keeping new-construction levels low, providing a heathy demand-andsupply balance.”

Gaudet believes the current concerns regarding interest rates and inflation might have a shorter to mid-term effect on hotel investing than COVID. “Some projects are being postponed or cancelled given the higher interest rates. Meanwhile, buyers looking for upswing potential in their investment can use inflation to improve ADR. The reserve is that inflation is increasing operating costs.”

Despite these factors, owners are generally optimistic on performance this year with many operators beating January and February budgets on top and bottom line, observes McLuskie. “Despite interest rate increases, the positive news is lenders are still actively looking at the hotel space with the right sponsors.” ◆