Will the new California hospitality market please stand up?

Welcome back to another Installment of the Apex Assessment! I received some incredible feedback from you all in Volume I so let’s keep the train rolling.  The goal of the Apex Assessment is to create open conversation amongst hospitality professionals regarding some of the hottest topics facing hoteliers today.  Again, keep the feedback coming and thank you for reading.

So here we are, the year of 2023 has just about come to a close, and it feels like over the past 5 years trying to anticipate the hotel market was about as easy as going 12 rounds with Iron Mike in his prime.

Let’s do a quick 5-year recap to help understand where we came from so we can potentially shed some light on where we are going:

2018 - Interest Rates between 4.6% - 5.3%

• we are in year 9/10 of what has been an incredible real estate cycle 
• Hotel revenues are at an all-time high, so are property values 
• If you owned hotel[s] in California life was good  

2019- Interest Rates between 3.3% - 4.8% 

• Consumer confidence was high and you were riding your California hospitality dream all the way to the bank
• Pundits and analysts warned of the 10-year cycle but the economy was too strong and interest rates were too low for anything to derail the good time

2020 - Interest Rates between 2.4% - 3.7%

• A global pandemic that shook the world as we knew it.  This had to be the event that was going to correct the real estate market, right?  For a moment, absolutely.  Business was obsolete
• The Federal Reserve reintroduced quantitative easing and printed 3.3 trillion dollars (yes, you read that correctly and that was just 2020) into our economy to ensure everyone stayed afloat  
• Interest rates were low, property values both commercial and residential skyrocketed and the markets were on fire . . . what pandemic  

2021 - Interest Rates between 2.6% - 3.0%

• While many expected that other shoe to drop in 2021, it really didn’t.  Money was too cheap 
• Hotels were still selling at outrageous valuations, banks were lending on low, low cap rates and it could all work because the revenue was there and the math still made sense
• The revenge vacation summer was in full swing!  We were just going to ride that PPP money through a short blip in the economy and resuscitate the American Dream.  

2022 - Interest Rates between 3.0% - 6.5%

• Interest rates started climbing at a rate not seen in over a decade, you could feel the tide shifting  
• Or was it?  Most California hotel revenue remained steady, Banks were still lending and transactional volume was consistent, Could we possibly ride this 14-year cycle any further?

2023 - Interest Rates between 6.5% -9.5% and rising

• If you read my first post you know 2023 is where gravity reminds us its king.  
• Transactional volume is way down, rates are getting higher by the month, numbers at most hotels in California are 10%-30% off and buyers can no longer justify purchasing a hotel with a subprime Cap Rate. 
• But somehow, we all think hotel values should still be going up.  Why?

Certain banks in California have shut down their hospitality divisions entirely.  Hard money is about the only money getting deals closed right now.  If you are a buyer, you better have some cash because banks are going to be tough on numbers for a while.  Interest rates are about to hit 10% (SBA 7a has already) and lenders want higher down payments and higher Cap Rates.  Most of the deals buyers are looking at in California can't even turn a profit.  It’s why transactions are way down and treasury bills have never looked so sexy!  The gap between sellers’ expectations and buyers’ tolerance is tough to bridge in our current environment. 

So where does it go from here and when will the gap start to narrow?  The short answer is when sellers are forced to accept these shifting market values out of necessity.  I’m a firm believer that history will always repeat itself.  If we look back just 50 years on our history, we see that interest rates in the 70’s started at 7.5% and rose all the way up to 12.9% later in the decade.  Interest rates hit an all-time high in 1981 at 18.6% (thank you, OPEC) and finished the decade around 10%.  The 90’s started at just over 10%, shortly dipped below 7% and ultimately rolled into the new millennium around 8%.  The 2000’s brought more stability with interest rates starting above 8% and then steadily declining into the Great Recession at just over 5%.  Then from 2010 until March of 2022 we experienced a renaissance of mortgage rates unlike anything many of us had ever experienced in our lifetimes.  Rates stayed between 3%-5% for over 12 years.  

If I had to predict the future, I would look back to the 70’s. In our immediate future, expect that  interest rates will continue to rise before they stabilize in the coming years.  if they don’t, expect the 2030’s to become the new 1980’s.  I honestly don’t see that happening as the record high interest rates in the 80’s were spurred by the oil embargo and tariffs then in place.  However, the current lack of trust in our economy and the geopolitical climate could bring unforeseen and unpredictable challenges that will create instability and uncertainty in our own economy.  This volatility would continue to send inflation and interest rates into a tailwind.  Ultimately, I don’t see this happening but it is a possibility.  What I think is more realistic is the US economy will rebound.  Consumers will move from annoyance to acceptance and  rates will settle in the 6.5%-8.5% range over most of the remaining decade.  Transactional volume will ramp up as hotel prices adjust inline with this new normal.  However, I think we are still 12 to 24 months away from finding our footing, especially in California.

If you have great equity in your hotel and run a profitable operation, congratulations!  Hotel ownership has and will always be a very wise and lucrative business move.  As with any business move, there has to be an opportunity to turn a profit.  When the majority of deals I underwrite pencil out to be losers there will obviously be a dip in transactions.  The real estate market has always operated on cycles.  It goes up, it goes down, it comes back around.  Right now the market is down, if you don’t have to sell, don’t!  The inflated value you want for your property is not there, trust me.  Hotel buyers are eager but not stupid.  My goal is to always help buyers and sellers find the acceptable middle ground.   

If you are a hotel owner that is starting to feel the squeeze there is no shame in wanting to sell.  Call me. Let’s talk about some options.  I know this is not the most popular opinion but it feels like the winds have shifted and values will get worse before they get better.  What I mean by this is rates will continue to rise.  And when rates go up, property values go down.  It’s not personal, it’s just logical.  Remember, pride cometh before the fall.  Don’t wait until it’s too late to make a move.  

Thank you for reading and I look forward to your feedback.  

Contact me anytime: 303-883-6788 / Peter@ApexLodgingAdvisors.com