By any measure, 2021 has been a banner year for hotel deals in California.
The 2021 Year-End California Hotel Sales Survey reports that there were 510 hotel deals for the year, up 71% from 2020 and above the record high. 2014 of 399 offers. Total dollar volume was $9.93 billion, a 204% increase over last year and more than the 2015 record high of $9.5 billion. At $265 million, the Montage Healdsburg was the most expensive deal in the state.
The state also set new record prices per key. The median price per key reached $137,877, a 23% increase over 2020 and higher than the previous high of $121,907 in 2019. Thirteen offers included a price of $1 million per key, another record , and that includes the Alila Ventana Big Sur twice because it sold twice in the year for over $2.5 million each time. Three other hotels also sold for more than $2 million per key, another record.
Looking at company records, Atlas Chairman Alan Reay said California has never sold more than 400 hotels before, but in 2021 they topped 500. The state has typically average transaction volume in the low to mid-$300s. In terms of total dollar volume, hotel sales are typically around $5 billion in total.
The state saw a number of high-priced bids, including Montage Healdsburg; the La Quinta Resort & Club, Curio Collection by Hilton; the Alila Ventana; the Luxe Rodeo Drive hotel in Beverly Hills; and the Four Seasons Resort and Residence Napa Valley, which helped boost dollar volumes and prices per key, but many of the transactions that increased total sales were for smaller properties.
One of the main factors driving up total transactions was portfolio sales, namely the sale of Extended Stay America and its stapled real estate investment trust, ESH Hospitality, as well as CorePoint Lodging, did he declare. The Extended Stay America deal included more than 500 hotels across the United States, and many of them were in California.
The Extended Stay America deal with Blackstone and Starwood Capital was struck because extended stay hotels are a highly desirable commodity, not only from a new construction perspective, but also from a resale perspective, a- he declared. Overall, labor costs go up and the extended stay product doesn’t have the same labor requirements, especially when people stay longer.
“These assets are trading at really high prices per room,” he said. “It’s been a pretty quick shift from people who have owned them for a long time to people who have opened them for the past few years, where they look at what they thought they could trade and then sell today because they’re sell at such a price. great premium over what they signed these projects for when they first built them.
Blackstone selling Motel 6 pools also accounted for a large portion of transactions recorded in 2021, he added.
In 2020, California’s Homekey Project provided funding to local and state governments to purchase 78 hotels for $890 million to turn them into housing for the homeless. The program has purchased and converted so many California hotels that, coupled with fewer new openings, the state’s hotel supply has shrunk in 2020. This year, Project Homekey only paid for one hotel, according to Atlas records.
Even though there are several properties under contract, the process is taking much longer to get deals done, and many will happen in the first quarter of this year, Reay said. There’s been a lot of push back on how quickly the state responded to hotels in 2020 and how liberal the reviews were. The program had paid above market value with the argument that sale prices were still below the cost of buying land and developing housing from scratch.
People are now looking more closely at transactions, and underwriting and ratings have to go through a review process, which slows down some transactions, he said. There has also been much opposition from local businesses and residents who fear that hotels in their neighborhood will be converted into housing for the homeless.
“There’s definitely a lot more pushback than there was in the first round, and that’s because people have something to measure today,” he said.
The money chasing hotels in California doesn’t come from overseas, and it’s not the owners who sold a hotel through Project Homekey to use those funds for another deal, Reay said. The state had a record number of first-time hotel buyers, and the vast majority of them were private equity.
Private equity raised billions of dollars in anticipation of a wave of foreclosures, but it never materialized, Reay said. Investors know they won’t gain anything by putting that money in the bank, so they buy hotels.
“Private equity goes out and puts the money in and sees, even at high prices and low cap rates, that it is able to generate a better return for its investors than it would if it let it just in a bank,” he said.
Due to conversions through Project Homekey, other players entered the space, Reay said. They buy hotels and convert them into social housing. California, among other parts of the country, is under pressure to provide more housing for low-income people. State and local governments have been more open to these conversions due to the costs associated with developing new housing and the lack of suitable locations.
These conversions take away supply from the economy and midscale segments, and no one is developing budget hotels, he said.
With the worst of the pandemic likely over, hotel owners who have held on to their properties have the rest of the recovery ahead of them, meaning they won’t necessarily find themselves bracing for struggling sales. But still, there are many reasons why homeowners find for sale.
One of those motivations is that owners get older and find they can’t work as hard as they used to, and their kids aren’t interested in taking over the family business, Reay said.
“So we have these people who are selling and looking to replace that money with triple net investments, at least less management intensive investments and to take a little more time off,” he said.
Other owners are selling not because their hotels are struggling, but they have seen a drop in business due to COVID-19 and have reviewed their balance sheets, wondering how they will be able to service debt, make payroll and cover other expenses, he mentioned. The prices charged by other hotels offered a promising exit strategy.
The third category is owners who buy and sell to keep trading, Reay said.
“The prices that were generated in 2021 exceeded everyone’s expectations, and I think it was really price as the main driver,” he said.
So far this year, his office hasn’t seen a slowdown in calls seeking hotel deals, and there are still more buyers than sellers today. He expects the first six months of the year to continue to see strong demand from buyers, and it will be a matter of finding available hotels for them.
If the proposed interest rate hikes come in March and then in the middle of the year, he said history indicates there will be a slowdown in transactions. There is always a lag between the rising cost of money and the cap rate a buyer pays for a rising hotel. Similarly, there is always a delay between a landlord seeing the neighboring property selling for $300,000 a room and thinking they should be able to sell for that amount.
“There will be a bit of a disconnect between buyer and seller expectations, and that’s what I think will happen in the second half of the year: we’ll see a slowdown,” he said.
Incoming interest rate increases are not expected to accelerate transactions, Reay said. The increases aren’t like deadlines for things like 1031 exchanges or tax law changes starting the following year.
Buyers have benefited from historically low interest rates on hotel loans, and a quarter to half point hike from the Fed translates to higher interest rates on a loan, a- he declared. An increase of one-half to one point corresponds to a 25% increase in debt service.
“It’s going to have a big impact on what you can pay for hotels in the future,” he said.
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