Q&A with Goulston & Storrs: Reimagining Real Estate in the Hotel Industry

The COVID-19 pandemic turned the transactional real estate market on its head.  And that uncertainty forced reshaping in the commercial real estate industry, particularly for hotel properties. 

In 2022, leading Real Estate attorneys John Ratino and Cecilia Gordon shared collective thoughts about the state of the hotel market. But how are things faring as we start a new year? 

John Ratino revisits our conversation, providing his vision on what took place in 2022 and what he foresees for hotels for 2023.

Q: Let’s 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’s 2022 Insights: 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.

Ratino’s 2023 Insights:  We did not see very many individual hotel deals in 2022.  There certainly were buyers looking for deals on distressed hotels, but there were few sellers interested in selling at distressed prices. Today, the market dynamics are changing.  Many hotel owners saw significant occupancy improvement over the course of 2022, and therefore were able to raise rates to address inflationary pressures.  Today, room rates are significantly above pre-COVID levels for most hotels and many hotel owners are forecasting more profitability in 2023.  At the same time, interest rates are up, and many hotel owners still have to address deferred maintenance hanging over from the pandemic years.  This could result in a classic liquidity crisis for some hotel owners and an opportunity for buyers looking to acquire hotels in a recovering market. 

Furthermore, the improving hotel business throughout 2022 contributed to several key mergers and acquisitions.  Our expectation for 2023 is that the trend towards consolidation in the hospitality industry will continue at an even more accelerated pace as industry metrics continue to improve.

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’s 2022 Insights: 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.

Ratino’s 2023 Insights:  Indeed, many hotel owners were able to rapidly raise room rates to offset the extraordinary inflationary cost increases we saw in 2022.  As inflation now appears to be easing, hotel owners’ ability to continue to raise room rates likely will become more constrained.  At the same time, increased costs, particularly increased wages are now sort of baked into the cake and interest rates have increased, and this will put pressure on hotels that are more highly leveraged.  For such hotels, 2023 may prove to be a very challenging year.   

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’s 2022 Insights:  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.

Ratino’s 2023 Insights:  The leisure and luxury markets remain very strong, although they may be beginning to plateau at a very high level.  Perhaps the surprising news is that group travel (for example, large conferences) really picked up in the second half of 2022 and appears to be headed for a very strong year in 2023.  Even corporate travel started to show some signs of life in 2022, but the consensus view is that corporate travel will remain below pre-pandemic levels for the foreseeable future.      

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’s 2022 Insights:  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.

Ratino’s 2023 Insights:  The pandemic is now, thankfully, behind us, and the hospitality industry is well into recovery mode.  That said, interest rates are up, deferred maintenance is an issue for some hotels and the ability to raise room rates is becoming more limited.  Also, lenders will be less likely to be as flexible in 2023 as they were during the pandemic.  This could mean trouble for some undercapitalized owners who are facing maturing loans and perhaps opportunities for some potential purchasers seeking to acquire distressed hotel assets.        

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’s 2022 Insights:  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.

Ratino’s 2023 Insights:  Yes, in many ways the terms of hotel franchise and management agreements were stress-tested by the pandemic—and passed.  This was due in part to the flexibility shown by the major corporate franchisers like Marriott, Hilton, Hyatt, etc.  They were able to grasp the seriousness of the situation early on and, for the most part, responded in a highly constructive manner. I think this bodes well for the hotel brand model going forward.

Additionally, lenders responded with appropriate flexibility during the pandemic.  However, as the market dynamics change, it remains to be seen how lenders will respond. Now that the hospitality industry is recovering and many, if not most, hotels are showing positive cash flow, foreclosure may once again become a viable option for some lenders.  It remains to be seen, but 2023 could see lenders more actively asserting their rights under their loan documents, putting hotels into receiverships and, in some cases, foreclosing.            

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’s 2022 Insights:  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.

Ratino’s 2023 Insights:  In 2022 we saw one real strength of the hospitality business: hotel owners were able to increase room rates rapidly to offset extraordinary inflationary increases in the costs of good and wages.  We may see the flip side of this paradigm in 2023.  As inflation eases, hotel owners will not be able to raise rates as easily.  Whether hotel owners were able to raise rates sufficiently and have adequate equity in reserve to cover the now built-in cost increases in goods and wages, as well as the current increased interest expenses in a less flexible lending environment, will be significant in determining how they fare over the next few years. However, in general, the hotel industry appears to be once again well-positioned for a period of growth.    

John Ratino is co-chair of the Hospitality & Recreation Industry Group at Goulston & Storrs PC. He has broad hospitality industry experience including financings, restructurings and workouts, capital markets, REITs, joint ventures, developments, and acquisitions and sales. For more information about real estate transactions in the hotel industry, reach out to John Ratino at  jratino@goulstonstorrs.com.

Cecilia Gordon, co-author of the original Reimagining Real Estate interview, is the co-chair of Goulston & Storrs’ Hospitality and Recreation Industry Group. She advises clients in the hospitality industry regarding investment in and management of hotel and resort properties across the country. She can be reached at cgordon@goulstonstorrs.com.