Archive for December, 2008

Rays Of Sunshine In The Storm

Monday, December 1st, 2008

The real estate industry as widely reported is in the middle of a major slump with commercial values now following residential on a downward path. However, I see rays of sunshine amidst the storm and believe there are sharp differences in areas of the country and property types. My conclusions at this point are:

  • Commercial real estate nation wide is falling and will continue to fall in value
  • Adjustments will be less severe than the residential sector, and recovery could begin earlier, driven by positive cash flows generated by most properties
  • The decline in the Washington area will be milder due to the stability and even potential growth of the federal government and services to government
  • The hotel sector will take the hardest short term hit due to more sudden drop in revenues and massive debt maturities in 2009 and 2010

As an economic forecaster, I have a great deal to be modest about. However, my observations are based on my 18 years as a board member including seven year as Co-Chairman of CB Richard Ellis, the world’s largest commercial real estate services company; eight years as President and CEO of Marriott Hotels and Resorts; and 17 years as founder and Cochairman of Thayer Lodging Group, a buyer, owner and operator of hotels.

Let me comment briefly on the Washington area and then hotels. On November 10, The Washington Post devoted its entire business section to commercial real estate, and you won’t do better than that for a comprehensive view of our area. In one interesting side to the story, Dana Hedgpeth reported that the bail out itself increased demand for office space and suggested that “between 2 million and 4 million square feet of office space could be gobbled up over the next three years as new regulatory agencies take shape and as lobby shapes, accounting firms, consultants, and asset managers position themselves to take advantage of government intervention efforts.” Even more revealing to me was an article by Tom Heath who talked to a number of Washington real estate investors who agreed the Washington area was less vulnerable.

So much for the sunshine – now back to the storm. In the same Washington Post article, I was quoted on the hotel industry: “Major hotel chains have reduced their projections for revenue per room and are predicting a decline in profits. If these projections are correct, there will likely be tighter financing standards that could lead to distressed selling.” The most salient measure of hotel performance is the revenue per available room (Revpar), and it was jolted by a 5.9% drop in September, as reported by Smith Travel Research. Starwood Hotels predicted a 10% Revpar decline across its portfolio for the fourth quarter of 2008, and a decline of 5% for 2009. Another industry consultant, PKF, predicts a 4.4% Revpar decline in 2009. These are dramatic and exceed the drop after September 11, 2001. On top of that there are an estimated $5.9 billion of debt maturities in CMBS structures alone in 2009, according to Tropp Management Services (TMS). Declining cash flows, higher financing standards, limited debt availability, and massive debt maturities do not mix well. Thus, while financially, strong owners will be able to inject more equity (which they should do), many owners do not have that ability. So, there will be distress sales and a sharply negative impact on values. Hotel REITs and management companies are already reflecting this distress with sharply lower stock prices.

So much for the storm, now back to a little sunshine. Past downturns have always been followed by sustained growth in hotels Revpar and profits. This occurred after the 1991-92 recession and after September 11, 2001. There is usually a year of drop, a year of stabilization, and then a number of years of growth. Indeed both PKF and TMS are predicting 2010, will show a modest Revpar increase. I personally believe 2010 will be flat, but due to lack of financing for new development/supply addition, the recovery will be robust starting in 2011.

Have you ever tried to movies?

Let me close with a personal experience that demonstrates how rays of sunshine can peak through and eventually prevail.

In 1999, my firm, Thayer Lodging Group acquired Washington’s largest hotel, the 1338 room Wardman Park Marriott. We completed a major refurbishing including redoing all guest rooms, adding and renovating meeting space, and much more. We now had the finest convention hotel in the area, and business began to take off, with 95 percent of it conventions or large corporate group meetings. Then came September 11, 2001, closing Reagan National airport and severely inhibiting travel to Washington. Every single major group cancelled. In November we were running 4 percent occupancy and losing a lot of money. But there was hope – a major convention planned in early to mid December had not cancelled, and it would bring much needed revenues. Then came the anthrax scare. The convention client happened to be the U.S. Postal Service, and it too cancelled.

We couldn’t cover operating costs let alone debt service. However, we jointly agreed with the hotel’s manager and minority owner, Marriott Corporation to put up additional funds to keep the business alive and out of foreclosure. Through 2002 and 2003 we gradually built the business back up, aided by outstanding performance by Marriott, and Thayer’s managing director, Carroll Warfield. The hotel had a record profit year in 2004, and we sold it in July 2005, resulting in a return of 2.4 times our investment. The message – in the middle of a storm, all is not lost. Persevere with determination and belief because eventually the storm will abate and the sun will shine again.