In Today's Hotel Market, Ready Cash Can Buy Real Value

Reprinted from Advanstar's Hotel & Motel Management Magazine

Our current economy rests on tight money, low inflation and a focus on cash flow. The lodging industry is further affected by segmentation-induced franchising and the development of new rooms in many markets. This is producing a reduction in commercial real-estate values - including hotel properties - that is accentuated by the Tax Reform Act of 1986. Few buyers or owners I know see any magic reason for a near-term shift in this outlook.

The environment of the hotel-investment market has been tempered by reality: A deal has to make sense or it'll sit on the shelf. Now, a "make-sense" deal doesn't always mean that it has to have current cash flow. Chains looking to expand their presence are acquiring hotels in un-represented markets. Rather than pay a premium for strong current earnings, they'll buy a low-priced, well-located hotel and increase profitability via upgrading and strong management - thus creating solid "value added." These buyers aren't looking for one-property acquisitions; we're finding that single-property deals are not as well-received as multi-property offerings.

Discerning Buyers

Naturally, individual buyers are more discerning than they've been in the past. It's pretty easy to slip on a banana peel today if you haven't thoroughly researched an acquisition before putting down the cash. Buyers must purchase earnings at an acceptable capitalization rate and hope to build from there.

Chain buyers and individuals are both finding the same difficulty in doing acquisitions. Tax-wise, the new tax law makes selling more expensive - there's less incentive to sell unless forced to because of economic or psychological reasons. Prices are held up by owners unwilling to accept the lower cap-rate environment, or unable to "take the hit" that a sale might imply.

Enter the banks, insurance companies, FSLIC, FDIC and Chapter 11's. We're seeing a growing volume of property from such sources. These owners are motivated to sell. Generally, the secondary debt and equity have been squeezed down significantly. Institutions, government agencies and creditors in a Chapter 11 proceeding are more motivated by the "all-cash" offer than by the broad menu of "work-out" formulas most buyers present.

Hotel operators with good bank relationships and solid equity can purchase fine value today. I certainly see this trend advancing as more hotels are foreclosed or go through Chapter 11 bankruptcy. I'm seeing deals being offered at 60 cents on the dollar and less - all required to bring property prices in line with current value.

Since I see no reason why inflation should go above 4 or 5 percent in the near future, it is highly unlikely that interest rates can rise much. The major reason rates have climbed is because of the Federal Reserve's current tight-money policy. It is far more likely that our current mini-recession, which has been encouraged by the Fed's 1987 money policies, will give way to a healthy drop in rates by late 1987. This, in turn, should encourage a new round of U.S. prosperity in 1988 and - to no one's surprise - a healthy economy going into the presidential election. If rates drop, property values improve.

Right Time To Buy

Logic would seem to dictate that if you've got good equity reserves and are "mortgage-able," this just might be the time to make a hotel purchase. Prices are down, values are available, and no one sees any reason to reach for a deal.

Supporting my theory, by the way, is the fact that industry market-analysts are starting to see transient demand rise faster than supply. This is counter to most observers' predictions.

All things considered, purchasing a hotel in a conservative real-estate market is just what the doctor ordered. And I believe the prescription is available to us today.