Hotels & Hospitality Group January 2018 Q1 2018 Hospitality Debt Market Commentary
2 Market Overview Over the past 24 months, JLL s Hotel Investment Banking team, which is dedicated exclusively to hospitality financing, has sourced almost $8 billion of hotel loans, giving us keen insights into the state of the hotel debt markets. As we begin 2018 the hospitality debt markets are exceptionally strong. All major lender types - banks, CMBS and debt funds - are actively originating hotel loans, and lender sentiment is overwhelmingly positive. This trend, which began in early 2017, coincided with improvements in the public debt and equity markets, coupled with continued RevPAR growth and the lodging segment s strong performance relative to other asset classes. Over the past 12 months, we have witnessed credit spread compression ranging from 50bps 200bps, depending on lender type, with the most pronounced tightening coming from floating rate CMBS lenders and debt fund/mezzanine lenders. A snapshot of current lending spreads compared to one year ago is provided in the table below: ILLUSTRATIVE FINANCING METRICS & PRICING FOR HOTEL ASSETS Current Market Comparative Spreads Target Leverage Minimum Debt Yield Q1 2017 Q1 2018 Banks 60% - 65% 10.0% - 12.0% +300-350 bps +225-300 bps Debt Funds 70% - 75% 6.0% - 8.0% +475-525 bps +325-400 bps Fixed CMBS* 65% - 70% 9.0% - 10.5% 4.00% - 4.50% 4.25% - 4.75% Floating CMBS** Up to 80% 6.0% - 8.0% +375-425 bps +200-275 bps Construction (Bank)*** 45% - 55% NA +350-425 bps +350-425 bps Construction (Debt Fund) 60% - 75% NA +550-700 bps +550-700 bps * Represents the loan coupon (5, 7 and 10-year fixed rate) ** Spreads for floating rate CMBS loan through B/B- Credit Rating (approximately 65-75% LTV). *** Typically requires 15% - 50% repayment guaranty and completion guaranty We expect a continuation of these trends in 2018, likely to be led by additional spread compression of 50-75bps, greater liquidity and more aggressive underwriting and loan structures. Key drivers will be: Strong U.S. GDP growth/fiscal stimulus Weaker dollar Limited supply of refinancing opportunities Debt fund liquidity
3 Strong U.S. GDP growth/fiscal stimulus: RevPAR growth is highly correlated with GDP growth, and the US economy may be entering the strongest period of sustained growth since the financial crisis. US GDP growth exceeded 3% for the second and third quarters of 2017, which is the first time the economy has had two consecutive quarters of 3%+ GDP growth since 2014. Many economists are projecting similarly strong GDP growth for Q4 2017, which, if achieved, would mark the first time that the economy has generated three consecutive quarters of 3%+ GDP growth since 2004. Expectations for strong GDP growth are further bolstered by recently-passed federal tax reform, which should provide a boost to both business and consumer travel spending in the near term, followed by a favorable longer-term impact on group travel. All told, the underlying strength of the US economy should result in solid RevPAR growth in 2018 (consensus estimates range from 1.7% - 3.7% growth), that will support aggressive credit underwriting. Weaker dollar: Over the course of 2017, the dollar weakened meaningfully against a number of major currencies, including the Euro, the Yen, and the Chinese Yuan, as well as against the currencies of a number of emerging markets. The weaker dollar will benefit the gateway markets as foreign travel to these markets will increase. Moreover, many domestic travelers may opt to vacation in the US due to the higher price of vacationing abroad. Limited supply of refinancing opportunities: 2016 and 2017 were significant refinancing years of 10-year fixed rate loans that were originated during the CMBS boom years of 2006 and 2007. Now that this wall of maturities has passed, many lenders, particularly CMBS, are concerned about the source of new financing product. As a result, many of these lenders are looking to substantially increase their balance sheet lending programs and are considering originating smaller (i.e. $50mm - $200mm) floating rate loans for securitization. This is meaningful considering that throughout most of this cycle floating rate CMBS has primarily been limited to loans in excess of $200 million. Debt fund liquidity: In 2017 we observed an increase in the number of debt funds and the amount of capital available for these funds to deploy. We expect this trend to continue particularly as we get deeper into the cycle and some investors become concerned about a potential economic slowdown. Debt funds provide an attractive opportunity for such investors to obtain solid returns while investing higher in the capital structure, mitigating potential recession risk. Potential Headwinds Potential for higher all-in loan coupons: Although we expect 50-75bps of spread compression in 2018, we also expect that both the floating and fixed rate indices will rise over the course of the year. We anticipate that LIBOR, which generally tracks the Fed Funds Rate, will increase by 75bps, consistent with the Fed guidance that it will raise rates three times in 2018. As a result, there will be upward pressure on all-in floating rate loan coupons. We also expect 5- and 10-year Treasury rates to increase, which will put upward pressure on fixed rate loan coupons. Ultimately, we believe that the spread compression will largely offset the increase in the indices, such that all-in loan coupons will generally remain flat. New supply growth: New supply continues to be an issue in many of the Top 25 markets, which will challenge ADR growth. We are, however, beginning to see a declining rate of growth as evidenced by STR pipeline data, which shows supply growth declining or remaining flat for three consecutive months. In December 2017, the number of hotel rooms under construction was 3.7% lower when compared to December 2016, which is the largest year-overyear construction decrease in the US since September 2011.
4 Market Overview by Lender Type CMBS JLL has been tremendously active in the floating rate CMBS market in 2017, having placed almost $2 billion of such loans with spreads in the low 100 s over LIBOR for very low leverage, high-quality assets, to spreads in the mid/high 200s for 75% LTV loans. The floating rate CMBS market is undoubtedly the star of the current market run, and more specifically, so-called SASB securitizations (single asset, single borrower). This market, which is typically loans of at least $200 million on cash flowing assets, experienced the greatest increase in liquidity increasing from $2.7 billion to $14.5 billion of hotel issuance, a 5.4x increase and the most significant spread compression, ranging from 150-200bps. HOTEL CMBS ISSUANCE - FLOATING RATE 35,000 30,000 25,000 Volume ($) 20,000 15,000 10,000 5,000 0 2013 2014 2015 2016 2017 Floating 5,854 11,395 7,557 2,714 14,491 For large assets and portfolios with strong cash flows, floating rate CMBS currently provides the lowest cost of capital, with spreads generally in the high 100 bps to low-200 bps over LIBOR range for low leverage and +250-295bps for higher leverage. Notwithstanding the extraordinary strength of the floating rate CMBS market, we believe this market has significantly more room to run, particularly as it relates to small balance floaters (ranging from $50mm - $200mm), which have not experienced the same depth of liquidity as larger ($200mm +) floaters. A number of the Wall Street banks are considering starting smaller balance floater programs to offset an expected decrease in fixed rate CMBS lending opportunities. The performance of the floating rate CMBS market is relevant to all hotel borrowers because it competes directly and indirectly with the banks and the debt funds for loan opportunities. Typically, floating rate CMBS availability and pricing will move the rest of the hotel debt markets. We saw this in early 2017 as several large floating rate hotel deals were securitized at significantly tighter pricing than had been previously available. We subsequently saw bank and debt fund pricing tighten as those lenders sought to catch up to compete with CMBS pricing.
5 Fixed rate CMBS hotel originations have largely remained flat year-over-year. HOTEL CMBS ISSUANCE - FIXED RATE 35,000 30,000 25,000 Volume ($) 20,000 15,000 10,000 5,000 0 2013 2014 2015 2016 2017 Fixed 8,821 8,315 13,448 9,961 10,101 We did, however, see 10-year fixed rate benchmark spreads come in to +77bps, which is close to the post-recession tights. With tightening across the balance of the fixed rate CMBS capital stack, we saw whole loan fixed rate spreads tighten by approximately 25bps. We expect a similar trend this year in fixed rate CMBS, with tighter spreads, but with higher index rates, fixed-rate loan coupons could end the year flat or slightly higher. Currently, fixed rate CMBS loans on hotels are generally pricing at coupons in the mid/high 4% range for leverage of approximately 65%-70% LTV. 250 10-YEAR AAA NEW ISSUE SPREADS 200 150 100 50 0 09/2011 11/2011 01/2012 03/2012 05/2012 07/2012 09/2012 11/2012 01/2013 03/2013 05/2013 07/2013 09/2013 11/2013 01/2014 03/2014 05/2014 07/2014 09/2014 11/2014 01/2015 03/2015 05/2015 07/2015 09/2015 11/2015 01/2016 03/2016 05/2016 07/2016 09/2016 11/2016 01/2017 03/2017 05/2017 07/2017 09/2017 11/2017
6 Debt Funds & Mezzanine In 2017, JLL was very active in placing loans with debt funds on a range of asset types and qualities in primary and secondary markets. We were particularly active in New York city, having financed several assets with no cash flow or limited cash flow at spreads in the mid-300s to low 400s over LIBOR, at leverage levels ranging from 55%-75% LTV. The debt funds have become a major source of hospitality financing and are expected to be active in 2018. Debt fund spreads compressed by 75-100bps in 2017, and are anticipated to tighten further in 2018. Debt funds are generally providing the most flexible debt capital and have been willing to lend at up to 75% loan-to-value ( LTV ) at spreads ranging in the low/mid 300 bps to mid/high 400 bps over LIBOR. Also, as the competition for deals has heated up, we ve seen the debt funds become more willing to finance hotels with no cash flow as they are opening, or coming out of a renovation. Pricing for these deals generally has a 25-75bps spread premium over cash flowing deals. Debt funds willingness to finance these deals is notable because very few lenders were willing to finance such deals even one year ago. The debt funds have also been active in the direct origination of mezzanine debt. Pricing for mezzanine debt became extremely competitive in 2017, with spread compression of at least 200bps. We also saw Korean investors becoming very active in the mezzanine space, with some originating five and 10-year fixed-rate mezzanine loans with all-in coupons of 5.25%-5.50% for high quality assets. With strong underlying fundamentals and substantial liquidity, we believe that the strong mezzanine bid will continue in 2018.
7 Bank Existing Assets JLL placed a number of loans with commercial banks in 2017 on asset types that included ultra-luxury boutique, urban full service and seasonal resorts at leverage levels ranging from 50% to 65% LTV, at spreads generally ranging from +200-300bps. In 2017 banks continued to be active hospitality lenders, with spreads compressing by 25-50bps. Banks continue to offer the lowest cost of capital, except in the case of large loans against cash flowing assets, in which case floating rate CMBS pricing is more competitive. National Money Center Banks are generally lending at up to 60% - 65% LTV at spreads in the mid/high 200s to low- 300s over LIBOR. Regional Banks are generally lending up to the lesser of $75 million or 60% - 65% LTV. These loans may be partial recourse or non-recourse (lower leverage). Local Banks are generally able to originate loans up to the lesser of $25 million or 60% - 65% LTV. These loans generally require partial / full recourse, depending on deal characteristics. We expect another 25-50bps of spread compression among bank lenders in 2018 in response to a rising LIBOR index and the strong underlying credit environment. Bank Construction JLL has been active in the construction lending space, primarily focusing on sizable opportunities in primary markets with strong sponsorship. LTVs have generally ranged from 45%-60% with spreads in the mid-300s to mid-400s for limited recourse bank financing. Hotel construction financing continues to be the most challenging sector of the debt markets. Construction financing is available, but lenders continue to be incredibly picky about projects and sponsors. Bank LTVs for construction have in many cases, gone down approximately 10 bps to 45-55%, whereas previously bank LTVs were in the 55%-65% LTV range. However, more debt funds are moving into the construction financing space with a willingness to provide either non-recourse whole loans or non-recourse mezzanine loans. Pricing tends to range from +550-700bps for senior loan and 11%+ for construction mezzanine debt. Conclusion Based on the underlying strength of the economy and hotel fundamentals, coupled with strong lender demand, the JLL Hotel Investment Banking team expects 2018 to be an exceptionally strong year for financing. We expect greater liquidity, more aggressive underwriting and tighter credit spreads. We invite you to contact our team to discuss your financing needs and help you take advantage of this incredibly strong market.
Kevin Davis Managing Director New York +1 212 812 5727 kevin.davis@am.jll.com Bill Grice Managing Director Atlanta +1 404 995 2154 bill.grice@am.jll.com Jeffrey Davis International Director New York +1 212 812 5962 jeffrey.davis@am.jll.com www.jll.com/hospitality 2018 Jones Lang LaSalle IP, Inc. All rights reserved. All information contained herein is from sources deemed reliable; however, no representation or warranty is made to the accuracy thereof.