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Smart Hotel Investing Ahead of an Imminent Recession

About 7 month(s) ago by Geoff Davis

Recessions cannot be timed or predicted but are a part of our history that always seems to repeat itself. We are now in the most protracted recovery in our history, but storm clouds are forming. It's just a matter of time before we feel the effects of another recession. The combination of rising interest rates, trade wars, arms races, the national debt, corporate earnings, and consumer spending all point to the inevitable. Sound bad? Well, it isn't, and a recession will create opportunity for hotel Investors.

 

There is good forward momentum for the U.S. economy this year, or at least for the first half of this year, but we would not be surprised to see a recession take hold in the second half of 2019 or early 2020. That said, we think it will be a shallow and short recession, possibly lasting two years. We can also expect to see some recovery shortly after the next Presidential election, regardless of who wins.

 

If you are a hotel developer, a recession can be a great time to be in the ground. An economic downturn may help pull back the cost of construction, which has climbed 20 to 30 percent in a high number of markets over the past two years.

 

Occupancy and Rate compression is likely to happen in markets scheduled to receive a great deal of new supply, so who does well in a recession? Select service hotels with core brands from the big hotel companies. Less labor and better distribution systems are what you need to weather the storm. Select service hotels are also easier to finance and provide an added benefit when it comes time to exit the investment. 2019 should see overall supply grow by 2 percent, but in hot markets that supply growth could easily reach 5 to 10 percent of existing inventory just from what is under construction today. Revpar gains or losses have to be looked at on a market-by-market basis, and yes, there will be winners and losers mostly based on what your cost basis is in a particular asset. Even though a market is getting a lot of new supply, you are better off in a primary growth market like Denver, Nashville, or Austin, not to mention gateway cities on either coast.

 

Ahead of rising interest rates, do cap rates have to go up? Not really. Most Institutional Investors are lowering their cap rate hurdles so they can get some deals done today. There still exits a bid-ask spread between Buyers and Sellers, but it is narrowing ahead of what most Investors know is coming. Does a 7.5 cap rate sound bad on a core asset in a good market when construction costs are spiraling upward? Coming out of the next recession we predict price per key will be less of a determining factor on exit values than barriers to entry, flag, and cash flow/yield. It is a great time to sell or refinance, as demand is high ahead of the inevitable headwinds.

 

So here we go again. Expect a Bounce the first part of this year, then a mild Crash, then a quick Recovery. Rinse, Dry, Repeat, as history has taught us.

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