Investors pessimistic about short-term hotel prospects

Real Estate Weekly, Feb 20, 2002

Investors are pessimistic on the short-term performance of the hotel sector, according to Jones Lang LaSalle Hotels' Hotel Investor Sentiment Survey (HISS), the only global hotel investor survey which targets 1,800 of the largest investors and or owners of hotel/resort properties.

However, investors are confident that this downturn will be short lived and are optimistic for the performance outlook in the medium term. Within two years, all markets, led by Europe and the United States, are expected to return to pre-2001 levels.

"Investors have clearly voiced their change in sentiment for the hotel sector across the Americas, as the impact of the recession and terrorist attacks is absorbed," said Arthur Adler, managing director and CEO-Americas, of Jones Lang LaSalle Hotels.

There has been a sharp shift in the short-term outlook for occupancy and room rate to strongly negative, although investors are confident with regard to the medium term outlook.

The strongest negative sentiment was found in the leisure markets of Hawaii and Orlando. This is especially true for Hawaii given its high dependence on air travel.

San Francisco was ranked as the third worst performer, reflecting the additional weakness of its exposure to the emaciated high tech market.

Opinion is also firmly negative for New York, Boston and Chicago's short-term trading performance. Of the 20 Americas markets analysed, Washington, D.C. has the most moderate negative sentiment in the short term -- not surprising given the significant rebuilding, political and defence activity occurring in this city and the limited supply in the pipeline.

Investors remain bullish on the medium-term trading expectations of all markets throughout the Americas. In particular, New York and Washington, D.C. were ranked by virtually all respondents as having a positive outlook over the next two years. Los Angeles, Boston Chicago, and Hawaii are the other top performing U.S. markets over the medium term.

"Despite an apparent firming of leveraged IRRs, the concurrent reduction in interest rates over the same period suggests there has been an actual decline in required IRRs," said senior vice president Melinda McKay of Jones Lang LaSalle Hotels. "Cap rates have changed little across the region during the last six months, implying investors are looking for deep discounts."

As future earnings expectations have lowered, U.S. investors demand a greater return to offset the perceived higher risk of hotel investment. Key U.S. gateway cities such as New York, Chicago, Boston, Washington and San Francisco all have comparatively lower IRR requirements, while the Latin American markets of Buenos Aires, Sao Paulo and the Caribbean all have the highest IRR requirements given their higher risk profile.

"We have also seen very little shift in the cap rate requirements for new acquisitions over the previous survey. This implies that investors are looking for deep discounts; however, there are few distressed assets available at similar discounts to replacement cost that occurred in the early 1990s," included McKay.

In all but two cases, investors expect cap rates to soften (increase) in the short term, indicative of the expectation of further declines in revenue. Los Angeles and New York were the two exceptions, mainly attributed to investors' perceptions that the markets have already bottomed.

Gearing ratios have become more conservative across the Americas, particularly at the corporate borrowing level. Only 27% of investors (at the corporate borrowing level) have a gearing ratio of more than 50%, with the majority in the range of 41%-50% gearing. Compare this to the 44% of borrowers above the 50% mark during the previous survey only six months ago.

The Sept. 11 attacks were considered to have accelerated the movement toward the trough of the cycle, which had already begun in the early part of 2001. Investors placed Hawaii and Miami at the early downturn phase, suggesting that they believe these markets still have further downside risk.

Investors see value in Los Angeles, Toronto, Phoenix, Washington, D.C., Hawaii and San Francisco, which were all ranked by more than 40% of respondents as having a buy rating.

Unfortunately, on average only 5.9% of investors indicated an intention to sell. In the United States' five key "24-hour" markets (New York, Boston, Washington, Chicago and San Francisco), the sell intent ranged from 0-3%, quite different to the ratio two months ago of between 4-13%.