NEW YORK--(BUSINESS WIRE)--The window of opportunity is closing for lodging companies to make attractive hotel acquisitions during this upcycle, according to Fitch Ratings. We are closely monitoring companies' external growth strategies given the risks that acquisition missteps can pose to balance sheet strength. Conversely, sector credit profiles could benefit if companies use this opportunity to sell noncore assets.
Highly liquid debt capital markets, low interest rates and strong property-level net operating income growth have led to intense competition for hotel investments and robust asset pricing. Deals financed at seemingly reasonable loan-to-value ratios (LTVs) today could prove aggressive depending on the timing of the next downcycle. An increase in interest or capitalization rates would exacerbate the hit to values from lower cash flows.
However, the acquisition window has not shut. Real estate is a local business and lodging REITs will continue to selectively find acquisition opportunities. Purchasing assets below replacement cost remains possible in many markets. Increasing land and hard construction costs still tip the scale in favor of acquisitions over new development, particularly in markets such as New York, San Francisco and Miami. However, greater development financing availability and less competition for sites from multifamily developers should narrow the gap between acquisition prices and replacement cost. So-called transitional or 'value-added' property acquisitions could fail to deliver attractive returns if the next downturn begins within three years.
Strong private equity (PE) interest in hotels and accommodative CMBS market conditions increase the odds for REIT privatizations in the near to intermediate term. Several PE firms utilized the CMBS market as a low-cost source of de facto acquisition financing to take lodging REITs private during the last cycle. Conversely, the tight band of lodging REIT trading multiples will continue to dissuade public-to-public REIT mergers. Increased activity by select nontraded hotel REITs, however, is a wild card that could lead to public lodging REIT mergers. Strong financial covenants generally protect unsecured lenders from M&A risk within the (lodging) REIT sector.
Lodging C-Corps continue to look for brand acquisitions, which could strengthen credit profiles if greater scale and cash flow diversification accrue. However, few companies have made deals recently. Marriott International has been the most active acquirer, filling in niches with its 2012 acquisition of the Gaylord brand and its 2014 purchase of Protea Hospitality. Wyndham Worldwide is targeting hotel brands and North American vacation rental companies and has done little to dispel rumors that it was interested in acquiring InterContinental Hotels. Management left open the theoretical possibility of temporarily losing its investment-grade rating to leverage up its balance sheet for the right acquisition, which we view as a credit negative.
Creditors should expect slow, but steady, progress toward asset-light business models from Starwood and Hilton Worldwide Holdings. Neither is likely to spin off their sizable owned hotel portfolios into a REIT structure given the similar valuation multiples between REITs and C-Corps and the dilution from added overhead and transaction costs.
In our report published today, 'M&A-ybe: U.S. Lodging Deals Possible, Spinoffs Unlikely,' we highlight what U.S. lodging C-Corps and REITs are saying about lodging acquisition and corporate M&A trends.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.
Applicable Criteria and Related Research: M&A-ybe: U.S. Lodging Deals Possible, Spinoffs Unlikely (What U.S. Lodging C-Corps and REITs Are Saying)