Steve Van participated at the Meet the Money 2012 conference as a moderator on the panel “Creating and Preserving Asset Value – The PIP Challenge and Beyond”. He was quoted in a recent Wall Street Journal blog summarizing the discussion below.
The Wall Street Journal
By Kris Hudson
Hotel owners face a new challenge now that the worst downturn in decades is in the rearview mirror: time to pay up. The brands that manage and franchise their hotels want pricey renovations and upkeep completed after granting owners a reprieve during the tough times.
In context, the issue isn’t as dire for hotel owners as underwater mortgages or the brutal refinancing market. But it’s still going to mean hotels will change hands or swap a pricey brand for a cheaper one.
The topic of these so-called product improvement plans, or PIPs, was a hot one at law firm Jeffer Mangels Butler & Mitchell LLP’s “Meet the Money” hotel conference in Los Angeles this week.
“As we go into this year, we have this massive amount of capital needs building up because loans have been extended,” said Steve Van, chief executive of hotel operator and owner Prism Hotels & Resorts, at the conference. “On a parallel track, the brands are coming in and saying, ‘It’s been five or six years since you’ve renovated your hotel, and you have to do it now.’ If you don’t, you’re going to lose your brand.”
Click Here to read the article in its entirety.
I hope all of you watching the Super Bowl halftime last night and worrying about the future of US real estate….will get a life. But just so you didn’t miss it here’s the single most important economic news of the year and brought to you by none other than Clint Eastwood….
It’s halftime in America and the second half’s about to begin…
“Detroit is showing us it can be done
And what’s true about them is true about all of us.
This country can’t be knocked out with one punch.
We get right back up again
And when we do the world’s gonna hear the roar of our engines.
Yeah it’s halftime America
And our second half’s about to begin.”
Economists are striving mightily to predict our economic future by quantifying human emotions into their predictions….and consistently failing. But anyone who is seeking the most meaningful “data” to predict how the economic future of the United States of America looks should watch the video again and monitor their feelings. And those emotions will tell you that as Clint said “The world’s gonna hear the roar of our engines”. While Europe is still at risk of fundamental economic disruption, China slowing down and most of the rest muddling through the United States is gaining momentum and will come out of this still the favored nation in the world to invest in, to create and to grow. No other nation no other group of 300 million individuals no competitor has the cohesive cultural fabric the spirit of entrepreneurship nor the common values of business honesty and hard work and inventiveness we have.
So look at all the stats from the Fed, the Treasury, the IMF, the OECD and bla bla bla but just listen to your own heart and bet on America and you will win.
Seen the video of a Smart Car running into a Suburban? Ricochets off like a tennis ball. I just test drove both- the Suburban at the CREF Council in South Beach with all the CMBS Special Servicer gurus and the Smart Car at ALIS the major hotel investment conference in LA.
The Smart Car folks in LA are celebrating because the hotel business has recovered ….REVPAR up 8% last year and maybe 4% this year. And no meaningful new supply. Optimism abounds and operators are pushing the accelerator to the floor… RECOVERY! Best time since the collapse of Rome to invest in hotels. And I studiously believe all that is true.
But unnoticed coming towards the one way bridge is the Suburban described at the CMBS loan conference. Listen to them…”CMBS maturities remain a massive, massive, massive, massive problem. (yes he said massive four times)”…”This is a long slow slog and there is no easy way out of this”…”The proceeds shortfall this year in commercial real estate loans coming due between face value and likely replacement loans is $600,000,000,000.00 (I wrote out the zeros to make a point) and the gap in 2016 will be $1,600,000,000,000.00 (stop counting that’s one trillion six hundred billion dollars and no cents).
So the Truth for hotels in 2012 is that the financial mass (not mess) of the very real hotel recovery just won’t be nearly powerful enough to overcome the huge financial mass (and mess) of hundreds of billions of loans coming due without any hope of replacement proceeds.
So if you can buy a hotel do it! If you can hang on to a hotel loan do it! If you are in the Smart Car with heavy loans due….jump!!!
What! Did Mr. Hotel Default say that? Absolutely. The fundamentals for hotel asset appreciation during the next five years have never been better. There is real demand growth, there is an all-time low in new supply, there will be a recovery of the US economy and if and when we resort to monetizing our debt with inflation hotels will BENEFIT more than any other real estate class.
The fortunate few (25%?) who didn’t over leverage their hotels and those who buy now will be real winners in a few years.
Some details:
- Hotel income growth has averaged about 3% annually for 40 years and all predictions for 2012 are between 3.5% to 8% (the latter by Dr. Pangloss). It is directly correlated with GDP growth.
- Supply growth historically averages 2% but now is less than .5% and will stay that way for years (go try to get a hotel construction loan).
- The US economy still leads the world in innovation and productivity and the coming applications in Nano technology, robotics, gene therapy, artificial intelligence, etc. will make us thrive.
- Inflation has always benefited hotels on the recovery side. Unlike office and retail with long term leases, hotels can now raise their rates hourly. Buy a hotel at less than replacement cost, get a fixed rate loan and sit back and watch that appreciation fly.
So hotel defaults will continue to grow because of the maturity proceeds shortfall and PIP demands from franchisors but buying now makes perfect sense.
“I told you so!!” Nanny nanny boo boo as my children used to say. In September I said all the major forecasters will lower their 2012 revenue growth forecasts by about half. This week STR the most definitive source of current growth lowered theirs from 7% to 3.9%. So what? Well, if you are a practitioner of the extend and pretend game (who isn’t ?) you should use this projection when extending loan terms and not the 8-12% ones your borrower is selling you. And I will be surprised if we don’t see the other savants PKF and HVS lower their forecasts soon.
For future reference it is an axiom (and even true) in the hotel economy that the single best predictor of revenue growth is GDP. Say what?
P.S. I told my children it was rude to say I told you so.
The Great Bright Hope for curing hotel defaults- RevPAR growth- is slowing and all the forecast gurus are starting to lower their projections. Two of the big guys- Deutsche Bank and Morgan Stanley just lowered theirs by 37% and 29% respectively (to 4.4% and 5%). This morning at the Lodging Conference additional data on group bookings slowing in August and leisure being flat makes me convinced that the Delphic Oracle of hotel forecasting, the Smith Travel STR report folks, will soon retreat below their current 7% forecast. The economic reasons for this are obvious to all. What is not obvious is what this means to hotel loans.
For RevPAR growth in 2012 to support replacement loans for the Billions in notes coming due, growth would have to be more than 64% (no there is no decimal between the 6 and 4 – I have the math if anyone would like to see it). The single greatest misconception made in the hotel loan industry is that robust annual income growth of 7 plus percent will make everything ok in 2012. Wrong! Despite strong growth the past two years income is still not at the level of 2007. (Remember how hard it was to recover from that 1.5 GPA in your freshman year?) And that is not adjusted for inflation. Without regurgitating the PROCEEDS problem it is clear that today’s downward forecast makes for a messy future.
Will this slow down the industry standard Extend and Pretend game? No. Just make it even more unlikely to succeed. Receiver posses mount your horses.
- Hotel Defaults will exceed 50% in 2012
- The can we have been kicking will turn into an oil drum
- PIPs (if you don’t know this term you must learn it) will cause 25% of defaults
- Hotel Forecast gurus will lower their growth projections this month
- Premature demobilization of workout staffs will cause increasing loan losses
Current CMBS hotel delinquency rates are around 15%. So how will we get to 50% in 2012? Well if we just take the lipstick off the pig we have been kissing we will see that defaults are ALREADY over 50%. Over 2/3 of the loans that were due this year and last have been extended or they would have defaulted. Let’s call them functional defaults. And the functionally underwater credit kidding loans are being extended to what will be the worst year to refinance imaginable- 2012.
Simple addition- 2007 plus 5 equals 2012. Does anyone remember the quality of loans made in 2007? The beauties were 85% to 97.5% leverage with no amortization and coverage projected to GROW in 2008 and 2009 to 1.25. Next year the pig in the python will be triplets.
So? …its all about PROCEEDS- billions needed to replace the five year 2009 and 2010 loans extended into 2012 and added to all those 2007 emaciated loans coming due then. During the three year period of 2005-2007 approximately $14B in CMBS hotel loans with 5 year terms were originated. And almost each and every replacement loan will be way short of proceeds. Where in today’s hotel loan market will $14B in new capital come from? Proceeds shortfall will be 25% to 50% because IF one can find them current new loans are 55-60%, based on trailing 12 results, with lower property NOI than when originated and finally will require major additional capital for the PIPs (to be discussed) Marriott, Hilton, Starwood et al are forcefully demanding.
The combination of stacking all those functionally defaulted loans onto the biggest year ever for loans coming due in what will be a very restrictive hotel lending market and with most hotels needing capital for renovation will make vultures happy and bondholders sad.
Topics 2-5 will come out daily beginning tomorrow.
Hotel defaults are different animals than other real estate products. Soon this will become painfully apparent. How? The Extend and Pretend function for hotels will be disabled this year by the Gatekeepers of Hotel Loan Health (franchisors Marriott, Hilton, Starwood, IHG et al.). Lenders and servicers can kick the can — a process which has been good so far for preserving asset value — all they want but they don’t control a major component of hotel value… the franchise. What’s a deflagged Marriott worth? Less than half. Caveat Lendor.
Franchisors’ patience, like carpet on hotel floors, has worn thin from years of neglect. The hospitality business is recovering rapidly so they are declaring an end to the truce and putting owners on notice that PIPs (required Product Improvement Plans ) MUST be adhered to. If not the flag goes away. Terminal cancer for a hotel’s value.
Here’s what will happen. Joe Ego purchased a branded hotel in his hometown in 2007 for $60M and borrowed $50M. Now the hotel is worth $40M (sorry folks). Extend and Pretend has worked because the borrower and the lender have a common interest — they need time for value to recover. So far so good. But the critical third party, the Franchisor, has a conflicting interest. It has customers who are loyal because of the consistent quality of their hotels, i.e. a brand. And the brand’s competitors are remodeling and updating. To keep its customer base loyal the Franchisor must demand that its hotels are remodeled also. So the Franchisor notices Joe that a $5M PIP is due. Joe has no dough, or if he does, he will not contribute it to a hotel in which he currently has no economic value. So although the loan was extended two years with a token pay down, the asset value on which the loan is based will fall below the loan amount as soon as the property is deflagged.
What can lenders do? First of all make absolutely sure that the notice requirements the Franchisor agreed to in the loan documents are current and valid. Alert Master Servicers to your need for this information. Do whatever you can to preserve the flag. First tack is to work with the Borrower. If that fails, the next step depends on the loan — balance sheet lenders can foreclose and either sell, JV or do the PIP themselves (with professional assistance). Special Servicers are limited by REMIC rules and the Pooling and Servicing Agreement’s limitations on advancing and may find it difficult to do the PIP within the Trust so foreclosing or finding a new capital source to team up the Borrower may be the only alternatives.
If you would like to learn more, we are planning a seminar on PIP Costing, Negotiation and Implementation so send me an email and I will get an invite out.
Here’s something all lenders should know about seasons even if you’re not a Caesar… Delinquent borrowers are clever folks and will use the seasonality of hotel revenue to take your money. Repeatedly season after season I have seen them coddle up to their lender right before the high season in their market and profess a new found sincerity for bringing the loan up to date…and then after a few months of “sincere” negotiations hand the keys back. But what they got during that time was all the income from the high season while leaving the hotel with big payables (except of course the borrower’s management fee).
As the tourists from the ice bound North head South to the warmer climate and the high season begins in Florida and Arizona, lenders should be extra careful to consider the seasonal cash flow when making decisions about whether or not to foreclose or appoint a receiver. A good half step is to get a Cash Management Receiver appointed just to watch cash and approve all checks. This relatively inexpensive action can be a prudent measure in preserving the asset (and just so you don’t think this is all self promotion, Bill Hoffman with Trigild out of San Diego is a great Receiver company also).
Some hotels make ALL their cash flow during their local season of three months and require feeding the other nine months. So get your antenna up when the high season for your distressed hotel loan is coming… be it Spring, Summer, Fall or Winter.
Important groundwork is being laid for the next hotel loan bubble (i.e. huge origination bonuses on Wall Street with ultimate deferred payment by taxpayers). Tuesday the banks had their way (get it?) with the FASB and killed a proposal the FASB itself had put forward last spring to require banks to value loans using market prices. Market Prices! Heavens! That might have required banks to value hotel loans using Reality! And to pay the price for bad loans with their shareholder equity! Hell this sounds like capitalism. Well forget capitalism and focus on bonusism because soon the lifeblood of bonuses — bubble thought — will reemerge.
More tricks are coming.
For Hotels, Time to Renovate
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