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The outlook seems sunny for United States hotel investment in the year ahead. Although increases in interest rates have some worried, there is still plenty to keep hotel investors smiling.
Peter L. Nichols, national director, National Hospitality Group for Marcus & Millichap, breaks down five things that hotel investors should have on their radar this year:
Interest Rates Set to Rise
The Federal Reserve expects to increase interest rates three to four times in 2018. The potential for higher inflation could lead to an aggressive approach, but the Fed should remain cautious about pushing rates too quickly so that it doesn’t stall the economy, according to Marcus & Millichap’s “2018 Hospitality North American Investment Forecast.”
“Rising interest rates should create pressure on the market,” Nichols told Hotel Management. “Buyers will want to lock in lower interest rates as quickly as possible, and sellers will want to leverage the lower rates to maximize pricing.”
Meanwhile, concerns about inflation and rising interest rates have driven volatility in equity markets, according to Marcus & Millichap. That has caused investors to worry that rising rates will eat at their returns because higher borrowing costs have the potential to cut into profits.
Tax-Law Changes a Win for Investment
Uncertainty regarding tax and fiscal policy slowed the transaction pace last year. But as the results of tax reform continue to become more clear, Marcus & Millichap expects sales activity to increase in 2018. For example, changes in favor of pass-through entities such as limited liability companies could support an increase of passive capital this year.
“The biggest impact from the changes in the tax code will be twofold: The lower corporate tax rates will spur reinvestment, particularly during this period of lower interest rates; and secondly, the accelerated depreciation for capital improvements,” Nichols said. “This should encourage investment in assets, spurring improved product quality for travelers, increased average daily rates as well as the aforementioned tax advantage.”
Hotel Development to Normalize
Hotel supply in the U.S. is set to grow 2 percent this year, but that doesn’t necessarily mean there’s a supply oversaturation.
“On a macro level, we do not see the market as oversaturated with new supply. What we do believe is that coming out of a period of significantly reduced development we are now returning to a more normalized rate of development,” Nichols said.
Historically, the long-term rate of new supply has sat at about 2 percent, he said.
“This is significant when analyzing markets to develop in,” Nichols added. “Focusing on markets that are performing well, have diversified demand generators and low supply growth could yield the best opportunities.”
Lenders Becoming Disciplined
Supply growth is on developers’ minds, so it’s no surprise lenders also are taking note.
“Supply growth is one of the factors lenders are evaluating when making new loan or refinancing decisions,” Nichols said.
More importantly, he said lenders are being disciplined in their analysis—evaluating new supply, demand generators, historical performance, brand affiliation, borrowers’ strength, business plans and overall project metrics.
“This is good for the market as it maintains a healthy level of deals being executed without overheating the market,” Nichols said.
Limited-Service Continue to be the Darling
That said, limited-service hotels should remain in focus, according to the Marcus & Millichap report. Private investors continue to take a larger share of the transaction volume and comprised more than half of all capital flows last year. Many of these investors have their eyes on the economy and upper-midscale segments, comprising more than half of all the flagged property deals last year.
“Demand for economy hotels, in particular, drove property values up and compressed cap rates to the mid-9-percent band, roughly 50 to 100 basis points higher than the industry average,” according to the report. “Well-located upper-midscale hotels changed hands with yields in the mid-7-percent band.”