Plummeting property values, frozen credit markets and empty beds
dominated the discussion among hotel industry powerbrokers at an industry
conference here today. The recently high flying sector is now steeling itself
for what is likely to be a prolonged North American downturn while capital flows
from middle eastern investors to Chinese
and Indian projects.
“Property values are a shot in the dark. Nobody knows what 2009 and 2010
are going to look like,” said Noble Investment Group CEO Mitesh Shah. “These
things are out of our control.”
The hotel industry, which expanded room capacity at an unprecedented rate
since 2003, is now suffering from an oversupply of rooms and declining
demand.
“This is the first economic downturn led by a credit crisis,” said Jones
Lang LaSalle Hotels CEO-Americas Arthur Adler. “This is different.”
The sector, like the residential housing industry and financial services,
is now waiting for the details of the U.S. government’s plan to restart
stalled capital markets with an expected investment of up to $700 billion in
possibly worthless Mortgage Backed Securities (MBS) and related derivative
securities. The commercial real estate industry depends on similar financial
instruments called Commercial Mortgage Backed Securities (CMBS) to fund new
construction, property modernizations, and mergers and acquisitions.
“The CMBS market is closed and likely dead,” said David Loeb, a senior
real estate research analyst at investment bank R.W. Baird. Loeb placed the blame for the current crisis
on the Securities and Exchange Commission (SEC) and U.S. President George W.
Bush for relaxing a key rule in 2004 that had been put in place in 1975 to
prevent exactly this type of cascading economic spiral.
The “net capital rule” required investment banks to limit their
debt-to-net capital ratio to 12 to 1; to
issue an early warning if they approached that limit; and to stop trading if they exceeded it. To
ensure compliance with the rule, most firms kept their debt-to-net capital
ratios well under the rule's
mandate.
In 2004, the SEC allowed firms that met certain conditions to increase
their debt-to-net capital ratio to as high as 40 to 1. This meant that for every
$1 billion in debt, the firms would only need to keep about $2.5 million in
capital on hand.
The five investment houses that qualified for the 2004 exemption were
Bear Stearns, Merrill Lynch, Lehman Brothers, Goldman Sachs and Morgan Stanley.
Bear was bailed out by the U.S.
government earlier this
year. Last week, Lehman Brothers
declared bankruptcy, Merrill was bought by Bank of America and Goldman and
Morgan converted to bank holding companies to avoid the same fate. Republican
U.S. Presidential Candidate John McCain called for the firing of SEC Chairman
Chris Cox although it was William
Donaldson, the founder and former chairman of 1980’s investment banking giant
Donaldson, Lufkin and Jenrette who was the regulatory
agency’s chairman when the rule was changed. Donaldson’s firm was acquired by
the Swiss banking conglomerate UBS more than a decade ago.
The current lack of credit now puts every new hotel project that has not
yet broken ground – more than 300,000 new rooms planned for 2009 - in danger of
delay or cancellation, according to PKF Hospitality Research President R. Mark
Woodworth.
The market for existing properties and mergers and acquisitions is
similarly bleak.
While the average dollar value of all hotel real estate transactions in
2007 was near $37 billion, the total value of transactions so far in 2008 is
just $7.3 billion and headed downward, Adler said. By comparison, the average
transaction volume between 1991 and 2007 was $8.1 billion per year and $20
billion in the high flying years between 2004 and 2007. In previous economic
downturns, volume dropped to an annual average of $2.5 billion between 1991 and
1995 after the last
U.S. government bank bailout and to
$5.2 billion between 1999 and 2003 after the bursting of the tech stock bubble and the September 11,
2001 terrorist attacks.
While North American markets are frozen, capital for hospitality projects
continues to flow in Asia.
“Liquidity is
available for Chinese and Indian projects,” said MGM Mirage Hospitality
President and CEO Gamal Aziz. “We’ve done a great thing by positioning ourselves
globally,” Aziz added saying that companies in strong cash positions would
ultimately benefit from this crisis as
companies that chased easy money earlier in the decade would collapse. “When
airline hostesses and busboys are coming up to you with real estate investment
ideas, that’s a pretty good indication that the market has reached its top,”
Aziz joked noting that the easy money and rising property values made everyone
think they understood complex markets.
Consumers ‘Dead’
When they were not eulogizing the development and financial sides of the
business, hotel executives complained about declining room rates and customer
demand.
“We are going to have to go out and steal customers,” said Wyndham Hotels
and Resorts President Peter Strebel concerned that growth had stopped and
competition among the major hotel brands is heating up. “I think we got lazy
over the past few years,” admitting that high demand allowed his marketing and
sales teams to get rusty. He revealed that his near term plan is to increase his
marketing budget and put “more feet on the street.”
Others were not impressed that a simple increase in marketing
expenditures and shoe leather will get consumers and business travelers to open
their wallets.
“The consumer is dead. And to the extent that the consumer doesn’t know
they’re dead, they’re going to find out soon," Loeb said adding the most recent
30 year fixed jumbo mortgage loan rate from Wells Fargo is now at 9.2% - a rate not seen in decades.
Strebel, however, remained confident that
the market will turn around and that he has a plan for positioning his company for long
term success. He predicted that the
growth of environmental friendly technologies would help drive operating costs
down after watching the cost of electricity nearly triple at his Caribbean properties this year compared to 2007.
He also predicted that in the next decade customers will insist on green
technology in their hotel rooms just as they expect high speed internet access
today.
But the consensus was that such optimism was a reach and that the best
the industry can hope for at the moment is that the U.S. government
acts and things do not get even worse before they get better.
“What the Fed and the Congress is doing is creating the bottom,” said Pat
Ford, president of industry data firm Lodging Econometrics.
(From Barackobama.com)
