Bondholders losing sleep as US hotel revenues slow
Hotel revenue growth is slowing, and it may spell trouble for commercial mortgages that were bundled into bonds.
The weakness in lodging comes after a construction boom that has created more than 200,000 new rooms over the last three years in the US, a 4.5pc increase. Builders aren't slowing down either: they're putting up enough additional rooms to increase supply by 20pc in cities such as New York and Miami, according to Fitch Ratings.
Home-sharing companies such as Airbnb Inc. are siphoning off some consumer demand. Those factors are pressuring the prices that hotels can charge.
Slower revenue growth is bad news for investors in the biggest part of the more than $500bn market for commercial mortgage bonds. The securities have been increasingly stuffed with hotel loans as investors have sought to reduce their exposure to mall- and shopping centre-mortgages.
Lodging-related loans accounted for about 15pc of the mortgages backing the securities on average in 2017, up from about 10pc before the financial crisis, according to commercial real estate research firm Trepp.
"We've never been through a cycle where deals have such high exposure to hotels," said Gary Horbacz, head of commercial mortgage bond research at PGIM Fixed Income, which manages $709bn. "At some point, the recession is going to come. Those most recent deals will probably face the most potential loss."
Trouble with hotels has historically been an early indicator of US economic downturns, albeit an imperfect one.
Lodging offers the shortest-term possible leases of any type of commercial real estate, so it can be the first to weaken when good times are fading. Average hotel-room-revenue growth slowed between 2005 and 2007. In 1991, revenue growth figures fell before the recession as well.
In this case, any weakness in the lodging industry mostly seems to be because of excess building in some markets rather than decreasing demand for, say, luxury travel, said Greg Michaud, who oversees a portfolio of commercial mortgages at Voya Investment Management, which manages $232bn.
But if the economy does start slowing, figures like revenue per hotel room in Hawaii could be an early warning sign, he said. "You worry that right now the numbers are OK, but not great," Michaud said.
"When the economy slows down, hotels will be the canary in the coal mine."
It isn't completely clear that pain for hotels will persist. Tax cuts are expected to boost business and consumer travel, according to an Oxford Economics study commissioned by the American Hotel & Lodging Association, an industry trade group.
At the end of last year, it forecast that average daily rate growth will be 0.5 percentage point higher over the next five years compared to a scenario without tax changes.
And investors aren't shunning all hotel deals when it comes to commercial mortgage bonds. Issuance of "single asset, single borrower" lodging bonds, a type of commercial mortgage-backed bond tied to a single property or a group of similar properties, has been surging, because many individual properties are still generating strong cash flow. The biggest part of the non-government commercial mortgage-bond market, known as conduit deals, accounted for nearly $350bn of the outstanding debt as of the end of 2017, according to data from the Securities Industry and Financial Markets Association, a trade group.
Several commercial mortgage bond deals backed exclusively by collections of hotels have already sold this year. Red Roof Inns, an economy hotel chain, sold a $400m deal last month. In another offering, investors snapped up $179m of bonds tied to full-service hotels from the likes of Marriott, Hilton and Westin.
"We still think the positives are there for the industry, despite flat growth," said Kin Lee, a senior portfolio manager at Angel Oak Capital, which has bought single-asset deals tied to hotels. "As gross domestic product is still relatively high and unemployment is low, you would think people still have money to spend."
Although Airbnb is increasing its market share, average occupancy rates have still been growing for hotels whose mortgages are bundled into bonds, according to Trepp, signalling that demand for both can increase.
But some overall measures of hotel health are weakening, or at least improving at a slower pace.
A metric of rented-room rates known as revenue per available room grew just 2.97pc last year, according to research firm STR, the slowest rate since 2009, when the measure declined amid a recession.
US President Donald Trump's anti-immigrant rhetoric and policies may be cutting into overseas travel demand: in an analysis of online flight searches by travel agency Hopper, foreign tourists looked for US destinations about 29pc of the time this month, down from 35pc of the time before the 2016 election.
Slowing international travel can be particularly burdensome for hotels because global travellers tend to stay longer and spend more relative to domestic visitors, said Jamie Lane, a senior economist at PKF Hospitality Research. Some investors in bundles of commercial-property loans are growing wary.
Joel Jasinski, a managing director at commercial real estate-focussed hedge fund Sorin Capital, said he's been taking a close look at assumptions around future revenue per available room growth, and historical performance in deals with heavy hotel exposure.
"Deals with higher lodging exposure clearly warrant greater scrutiny," Jasinski said. "As you get later in the cycle, we become increasingly con-cerned with how a hotel loan was underwritten."
With assistance from Patrick Clark