Hotel Underwriting: Staying Above the Waves

What is the ultimate impact of the current lending environment on hotel owners? CBRE Hotels has ongoing dialogue with potential buyers and sellers about the two primary considerations affecting hotel values today:

1. The simple math that influences levered buyer underwriting
2. Practical implications in today’s transaction market

The Simple Math

For each incremental percentage point of debt cost, there is a 2.5- to 3-percentage point impact on levered buyer values.

Figure 1: Representative Impact of Cost of Debt on Levered Buyer Hotel Values*

*Assumptions: T-12 cash flow stream of $7M growing by 4% annually; Sale at 8% terminal cap at end of Y5; 65% LTC; 5-year full-term I/O; Solving to 18% Levered IRR.
Source: CBRE Hotels.

The Practical Implications

Many variables impact hotel values, and growth is being driven by counterbalancing factors:

• Hotel Performance: Hotel Revenue per Available Room (“RevPAR”) has accelerated dramatically over the last 90 days recently achieving premiums to same-week-2019 performance. This has been a materially faster ramp than most investors anticipated causing underwritten short-term performance to increase.

Figure 2: 2021 and 2022 RevPAR Change Relative to 2019

Source: CBRE Hotels Research; Kalibri Labs, Weekly Sample.

• While the cost of both debt and broader U.S. equity capital have increased, for most hotel companies, the cost of equity is lower than historical levels.
• Hotel REITs are outperforming overall U.S. equities:

Figure 3: U.S. Lodging REIT Index & S&P 500 YTD 2022 as % of YE 2021

CBRE Hotels Research, 2022.

• As illustrated below, there is currently an unprecedented level of uninvested capital allocated for commercial real estate, contributing to strong demand for hotel assets and declining target returns for many hotel investors.

Figure 4: More Money, Less Yield

Source: Green Street, 2022.

• Hotels have historically performed extremely well in inflationary environments (see: A New Horizon: The Case for an Inflationary Bull Market in Hotel Real Estate). Demand is recovering strongly across lodging segments, leading to higher projected cash flow.

Conclusion

CBRE Hotels welcomes conversation regarding this piece. Please reach out to our team.