by RUSHI SHAH
As we venture into 2020, we enter a time period that will be volatile yet ripe with opportunities. Technology will play an ever-increasing role, brands will be an important catalyst for getting deals done, and the financing and capital markets will be influenced by interest rates, availability of capital from both domestic and foreign investors, and continuing scrutiny on underwriting and sponsorship quality. Let’s explore what we can expect this year.
INCREASED USE OF TECHNOLOGY
Commercial real estate markets have always been plagued by inefficiencies. Because the markets are somewhat opaque and controlled by intermediaries such as investment sales brokers, leasing brokers, and financing brokers, there is opportunity to exploit these shortcomings. As a result, wherever there are market inefficiencies, there lies opportunity. As we start the new year, we will see the industry weaving technology throughout the transaction process to deliver faster and more accurate outcomes at a cost savings for both the lenders and borrowers. As a byproduct of this trend, all players will enjoy greater transparency system-wide.
For commercial real estate, including the hospitality industry, the advent of artificial intelligence, machine learning, and data-driven decision-making will be at the forefront for developers, owners, lenders, and all stakeholders involved. For example, there are three types of data repositories that are used across our industry: proprietary data that is controlled by the owners of real estate, data available for a fee (i.e., Real Capital Analytics and CoStar), and publicly available or open-source data (i.e., Census.gov and the Bureau of Labor Statistics). Technology will allow these isolated datasets to be merged, facilitating faster and more accurate decision-making for owners, fewer transaction errors, and the ability to identify where there is potential for profit.
These technological efficiencies will shape the future, even beyond 2020. An increasing number of lenders, as well as sophisticated intermediaries, are starting to overlay technology on top of data to deliver a better experience for their clients. As profits are squeezed in a late-cycle phase of our economy, every company will look to find savings by leveraging technologies and eliminating redundant processes. Additionally, we will see even more consolidation in the industry. We’ve already seen this in play with CoStar acquiring STR, Aimbridge Hospitality, and Interstate Hotels & Resorts merging, LaSalle Investment Management purchasing Latitude Management Real Estate Investors, and Orix USA buying Hunt Real Estate Capital.
Technology cannot operate in a vacuum, however, and human experience and relationships will continue to be the bedrock of this business. When there is fast change, people still look to do business with other people. There is also renewed need to do business with people they trust who have the relationships and ability to convince investment committees and credit committees to reach a favorable investment decision. This business is based on negotiations and computers can’t negotiate. Humans will still be integral to getting deals done, because there will always be issues that require the expertise and creativity that comes from track record and experience.
BRAND AS A CATALYST FOR SUCCESS
As the hotel industry faces external competitors such as Airbnb, brand strength and its contribution to a hotel’s bottom line will matter more and more. Both business and leisure travelers are looking to capture the highest amount of value during their travels, while assuming the least amount of risk for the highest amount of certainty of comfort. Strong brands backed by a large corporate infrastructure attract demand, because they can deliver on this need time and again. Like travelers, in 2020 the capital markets will also continue to view brands as a favorable catalyst for an asset’s success. B-piece buyers (the buyers of the first-loss position of a non-recourse loan) focus on the hotel’s ability to meet the quality standards prescribed by the brand, the continual capital expenditures the brand requires, expected PIP and the asset’s RevPAR penetration compared to its competitive set.
The capital markets will continue to think that an asset without a strong brand and the backstop of a franchise agreement is a higher risk. As we head toward a sustained slowdown, investors are becoming wary of providing high-leverage loans on a non-recourse basis on assets that are not backed by a strong brand or that don’t have a longstanding history of occupancy and ADR compared to their competitive set.
As supply becomes a massive concern throughout the industry due to a slower growth rate resulting in slower demand growth and steady supply absorption, the capital markets will look at the local supply very carefully before making financing decisions. For example, a select-service hotel in a very strong market in the Florida panhandle may look great on paper. What hasn’t been factored in, however, is a new full-service hotel is being built by a local city government across the street that will directly compete with it. While this type of risk is difficult to underwrite, it is realistic and can lead to a negative investment outcome.
CAUTIOUS OPTIMISM IN CAPITAL MARKETS
Since 2020 is an election year, we are likely to see a high level of volatility in the capital markets and an environment clouded with trade tensions, political headwinds, global instability, and a polarized American electorate. Investors and lenders will still be open to good deals but will be more hesitant to put their risk capital on the line, creating an atmosphere of cautious optimism in the markets. The United States is likely to still be one of the best destinations in which to invest amid the global slowdown and instability. This global instability will also help our country to continue to attract foreign capital. However, foreign investors have also become more astute, and like their U.S. counterparts, are underwriting deals to stricter standards. Thanks to our ongoing low interest rates (albeit higher than those in nearby countries), countries in Europe, Asia, and the Middle East continue to look for investment opportunities in the form of both debt and equity in the U.S.
LOW SHORT-TERM INTEREST RATES
As we head into elections, short-term interest rates controlled by the Fed will likely remain low. Long-term interest rates will be of interest to market participants because their levels will signal whether we can expect a prolonged period of recovery or a recession. The winner of the election will also have a defining impact on both the interest rates and growth rates, as well as market sentiment post-election.
PRUDENT UNDERWRITING STANDARDS
Given the available context, lending markets will remain disciplined in their underwriting and leverage they are able to extend. Capital markets will structure deals to ensure that a) loans can be refinanced at maturity, b) there are sufficient capital expenditures available to meet brand requirements, and c) terms reflect prudent leverage assumptions.
CONTINUED GOOD NEWS FOR BORROWERS
Overall, 2020 will be a year people remember for elections, volatility, and prudent deal making. There will be plenty of capital available for good deals with appropriate leverage and proper underwriting. This will not be a year for owners to be speculative or swing for the fences. Prudent risk-taking will prevail and capital velocity will continue to occur in what I consider an otherwise healthy market. This will be the year where relationships will be even more important because there will plenty of deals chasing capital. Those deals will be better received and have more certain outcomes when shepherded by people who have a proven track record and trusted relationship with the capital providers.
Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Club Blue Member Mag Mile Capital. As a leader in hospitality financing, Shah specializes in structuring and placing high-leverage, non-recourse bridge and permanent debt with cash out for full – and limited-service hotels nationwide. Since joining the firm’s predecessor, Aries Capital, in 2015, Shah has structured and closed hundreds of millions in financing for all property types. Shah has held previous positions at Northern Trust and has an MBA from the University of Chicago’s Booth School of Business.