by RUSHI SHAH
Commercial real estate is a large asset class that allows investors to diversify outside of equity, bond, and commodity investing. The commercial real estate master asset class is further divided into multiple sub-asset classes or food groups such as industrial, retail, self-storage, office, multifamily, and of course hotels. According to the Commercial Real Estate Finance Council, the commercial real estate industry generates more than $400 billion in total annual deal volume, of which hospitality contributes 10%-15%. This leaves a healthy 85%-90% of the industry focused on other property types. Investors set thresholds for the required yield they need from any real estate investment for a given risk, so they are continually looking to find loans or loan products to invest in at all stages of the cycle. Motivated by this investor demand, capital markets search for assets that will continue to perform even amidst economic turmoil. Mezzanine debt and preferred equity capital is also typically more readily available for commercial real estate assets outside hotels because there is more investor appetite for the risk from other asset classes. This is because these type of capital providers, such as private equity funds and family offices, are often underwriting the underlying leases as security for their investment, and they do want to take on the operational risk of a hotel.
To better determine if branching out from hotels is an option, let’s explore a few of the most popular asset types and how they compare to owning a hotel.
The commercial real estate industry classifies hotels as an operating business, and a hotel’s closest commercial cousin is self-storage. In self-storage, an owner or self-storage management company will purchase a cluster of storage units and rent them out on a monthly or short-term basis to individuals and businesses that need extra space for items they don’t need to access on a regular basis. This need for offsite storage has weathered the economy’s ups and down, and the asset has proven to be a resilient investment during recession and through economic recovery. Self-storage assets can be evaluated similar to hotels because the main driving metric is revenue per available unit. However, the financing market views self-storage slightly more favorably than a hotel when it comes to terms of leverage and risk. One of the main reasons for self-storage’s edge is its cashflow durability and supply constraints in the market. Many municipalities have imposed moratoriums on new built self-storage assets. This is often because storage doesn’t typically beautify the community and may even be considered an eyesore, but more importantly, it’s because self-storage doesn’t generate the same levels of local tax revenue like other asset types, including hotels. Self-storage’s resiliency is also appealing to the commercial mortgage-backed securities (CMBS) market, which was further demonstrated during the recent pandemic.
Retail is another asset class many hotel investors are eying. Right now, retail assets are challenging to finance, as a large portion of tenants in the U.S. are restaurants or restaurant-related businesses that have been pummeled by COVID-19 shutdowns. There are pockets of opportunity, however, where capital markets are willing to still provide financing. For example, retail centers that are home to service-provider tenants such as hair salons, daycare center, fitness center, paint-mixing/hardware shops, and other essential community businesses that have been dubbed “Amazon-proof.” There is also opportunity within retail centers anchored by grocery stores. Grocery stores have continued to be a necessity throughout the pandemic, drawing traffic to the stores themselves, as well as to their neighbor tenants.
For hoteliers looking to diversify their portfolios, multifamily has emerged as the logical option. This is partly driven by how similar the multifamily construction and management process is to that of a hotel. The availability of government financing for multifamily properties is also attractive to hoteliers.
Office assets have been particularly challenged during the pandemic. The market doesn’t know how many tenants will return to offices, at what level they will return, and how long will it take. This makes it difficult for lenders underwriting on projections.
CHOOSING THE RIGHT FOOD GROUP
All commercial real estate asset types are extremely market dependent, and choosing where to acquire an asset is just as important as selecting which type of asset to buy. Right now, there are several markets in the Southern part of the U.S. that are getting a lot of attention. This is because of the inward mobility from higher tax jurisdictions and more lenient local government restrictions on businesses.
There are opportunities in the market for hoteliers looking to diversify into other asset classes. It’s important to consult with an expert who understands all asset classes and their underwriting metrics to ensure all options are understood, obstacles are identified, and the most viable financing solutions are leveraged.
Rushi Shah is principal and CEO of the commercial mortgage and real estate investment banking firm and AAHOA Allied Member Mag Mile Capital. As a leader in hospitality financing, Shah specializes in structuring and placing high-leverage, nonrecourse 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.