United States

COVID-19 is accelerating the inevitable in hospitality


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Lockdowns and travel bans ground hospitality private equity real estate (PERE) deals to a near halt in 2020. While some areas still managed to survive, and even thrive, others needed to retool and reimagine to wait out the storm. Technology certainly helped, but the cost-cutting measures to staff and services may be here to stay. When life does return to normal, it will be a new normal of leaner, more efficient properties.

Preqin discussed these trends, as well as the opportunities created for private capital, with RSM US LLP’s Partner, John McCourt and Senior Real Estate Analyst, Ryan McAndrew.

Preqin: Hospitality PERE deals are on pace to fall 70% in 2020 due to COVID-19-related travel bans. Which areas are doing better than others and which do you think could recover quickly?

Certain elements of the hospitality industry actually benefited slightly or didn't dip all that much, after the initial shock. Specifically drive-to destinations: when you couldn't travel internationally, drive-to destinations were the next best option for people still willing to travel. Mobility data showed there is a willingness to make trips of more than 500 miles, and consequently places in areas like the Florida Panhandle, the Gulf Coast, and Mid-Atlantic are doing well.

Extended stays and limited service hotels that are 80- 90% dependent on room revenue are also doing well – and some are more than just surviving. Hotels around campuses are taking on a new life as the colleges come back: when somebody tests positive for COVID-19, they're quarantined in local hotels.

Urban or suburban group convention-focused hotels, however, are hurting and will see a longer road to recovery.

Major hotel chain executives are pointing to China as a region to recover more quickly, predicting occupancy to return to 2019 levels by next year. And that's absent of a vaccine and therapeutics. Properties there have put COVID protocols in place which, while they may be less politically acceptable in the US, have created a model for stateside hotels to mirror, and executives there are taking notes.

Preqin: It’s an interesting point about how the industry's learning to live without a vaccine for now. When and how do you see a turnaround in deal flow?

There are a lot of factors at play that are going to effectively keep deal flow frozen. It all comes back to valuations and deal flow, and we are at a point where the valuations viewed by the seller and the investor are quite far off. The effects of stimulus and support are a factor. What is going to happen when that starts to fall off? Much of this comes down to what the property’s balance sheet has looked like initially. Owners are burning cash right now trying to get to the next week and they’ve received all the help from the banks they can. As such, each property is going to have a different level of distress. There's a difference between a distressed asset and a distressed owner. If an asset is good but the owner is distressed, it’s going to be a property worth dealing later on, likely in Q1 2021. Less attractive properties, however, will continue to sit on the sidelines for the foreseeable future – you're not going to chase bad assets with good money.

I think 2021 is going to be interesting, but it's probably going to be 2022 before deal flows return to a level of normalcy.

Preqin: What common themes have you seen among clients coping with down revenues this year?

Hotels are dealing with this down-revenue environment by finding other avenues to create revenue where it was lost or previously didn’t exist.

For properties where bread-and-butter occupancies are traditional leisure, business travelers, or conventions, that’s no longer feasible. Some hotels therefore found untraditional ways to fill occupancy where it was effectively at zero, such as creating student housing or setting up safe havens for the homeless. Additionally, some properties are finding revenue in new opportunities presented by the COVID pandemic, such as the ‘away from home office,’ private dining, and distance exercise.

For properties that are still able to attract their traditional business, however, it’s critical for the brand to convince the traveling public that it's clean and safe to stay there. For example, Hilton launched a CleanStay campaign and Marriott launched its Commitment to Clean where the companies have partnered with several cleaning brands to educate the public on their COVID protocols.

Preqin: What changes in the hospitality industry will stick post-COVID?

The pandemic has definitely accelerated the acceptance of new technologies. QR-coded menus; cashless transactions; and streamlined, person-less room check-ins are not going away post-COVID. These technologies already existed but there were relatively few adopters at the early end of the acceptance curve – COVID has just boosted everybody up that curve out of necessity.

Human presence is also an interesting change. Housekeeping always stayed behind the scenes – it was something that you didn't see, leaving your room and returning when it was clean. In the post-COVID new normal there's likely going to be fewer people in your room, and some of that payroll will have shifted to more public housekeeping, cleaning things like handrails and elevator buttons – there will be a continuous visible presence in common areas.

Preqin: Some smaller properties that may not have the margins to accommodate this could lag their larger peers.  Will there be a consolidation?

It really depends on the type of property owner. There are large REITs, large ownership groups, and smaller non-public ownership groups that own properties. The larger REITs have a better bargaining position with the brands and debt-holders. They're looking for concessions from the brands and the franchise in terms of lower fees and having to meet particular brand requirements. That takes a lot of capital investment from the owner perspective and also on the debt side, and so I think consolidation or some type of transaction on the owner's side is inevitable.

Most mergers or takeovers are usually for synergies, and it's better for the joint entity. For the mid- and small-sized owners, there might be quite a few out of necessity that are seeing that if they join forces, they may not have to hand properties back to the bank. Then there are groups that are just trying to hold on another six months or a year in the hope of surviving this – and they just may.

While the large public companies have a lot more available capital, it doesn't necessarily mean the small and middle markets are any more or less at risk. They can take advantage of some government programs that the large public companies had to give back due to negative publicity.

On the GP side, there are opportunities for quite a few large private equity companies looking for distressed assets. They're not looking at the large end of the market, but at the small and middle markets. These properties may have a lifeline, but at a premium.

This article was originally published in Preqin. Download the Preqin Quarterly Update: Real Estate Q3 2020.

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