The CB Richard Ellis Valuation & Advisory Services Hospitality & Gaming Group continuously monitors the major US hotel sale transaction market with its noted Quarterly US Hotel Sales survey of single asset sale transactions above $10 million each that are not part of a portfolio allocation.

The CB Richard Ellis YTD Q3 2008 Major US Hotel Sales survey clearly illustrates a dramatic slowdown in the total number and size of deals, resulting from the difficulty in consummating large transactions in today’s debt capital-starved environment. A year into the 'credit crunch', a now infamous inflection point occurred during September 2008 during which Lehman Brothers filed for bankruptcy, Merrill Lynch was sold to Bank of America, and AIG, Fannie Mae and Freddie Mac were bailed out by the Federal Reserve. Many had thought the worst was over when the Fed instigated the JP Morgan Chase acquisition of the mortally wounded Bear Stearns in March of this year. Much "Monday morning quarterback" analysis and debate has occurred about the how’s and why’s of what went wrong leading up to the stunning events of the past six weeks, events that have forever changed Wall Street and the world’s capital markets. Dark clouds have closed in as a result of the doom and gloom mood that exists across the nation, and clarity appears to be in short supply in the near term.

Similar to most discretionary consumer oriented businesses, US lodging industry investments are confronted by uncertainty in today’s environment. The pressure of decreased operations heightens the risk of mortgage payment default, and/or the breach of debt covenants. Reportedly, some US hotel investments are already approaching debt service coverage ratios (DSCR’s) of 1.0 or lower. US hotel’s-- with loan maturities starting in late 2009 through 2012--face significant risk of not being able to refinance mortgage balances owed, due to the difficulty of gaining favorable terms in a new loan. While debt is--and most likely will be--available for these maturities, it will be based on lending terms more typical of an earlier era including 60% to 70% loan to value ratios, with DSCR’s of 1.4 to 1.6. With reduced profits, many hotel investments will be forced into capital restructuring events requiring additional equity injection or an outright sale. Restrictions on available capital for product improvement programs (PIP) will also become a significant issue in the near term leading to potential franchisor and/or lender defaults.

While it is easy to focus on the numerous current headwinds and challenges that face the US lodging industry today, I believe there are also positives that should be considered for the longer term, including:

• Out of every financial crisis comes opportunity. When global debt markets thaw, the large volume of equity capital that has been building up on the sidelines for some time will rapidly enter the market. That capital flow will create a competitive arena that will bid prices up for a myriad of assets including deeply discounted notes encumbering individual and portfolios of US hotel properties;
• During the past several years, the US hotel industry has experienced record revenues and profits. If declines do occur, they will be taking place from all-time high levels of positive business results. The industry has been, and will continue to be, profitable, as was the case immediately after 9/11. In contrast, during the early 1990’s the US lodging industry was losing millions of dollars a year;
• The supply and demand fundamentals of the US lodging industry are relatively well balanced. The current development pipeline is being rapidly reduced by the lack of available construction financing;
• During the near term, due to a dearth of available renovation financing, the industry will witness functionally and physically challenged hotels permanently closing, thus removing product from the supply side of the equation;
• The US will continue to represent the safest and most stable place in the world to invest in. On a per pound basis, US lodging real estate prices are relatively inexpensive and hotel investment opportunities are well positioned to provide superior risk adjusted returns when compared with other worldwide asset classes;
• The US will continue to be a tourist destination for visitors from throughout the world. New middle classes that are dramatically emerging in many parts of the world, including India and China, will visit and patronize American hotels, resorts, theme parks, and retailers in droves;
• During the past 60 years, an entire generation of Americans has been raised with the belief in their inalienable right to travel. Americans are resilient and, over the long term, they will continue to travel and patronize all types of domestic lodging facilities;
• As evidenced by the declines of the late 1970’s, the early 1990’s and immediately after September 11, 2001, history has shown that every time the US lodging industry enters a downturn, it emerges and flourishes to a peak higher than the one previously achieved;

Smart money recognizes that the world is currently experiencing an adjustment that was overdue, but that an over correction is also most likely occurring. During the short term, conservative investors who deployed modest levels of leverage will survive. Opportunistic capital will be well positioned to take advantage of terrific opportunities that will emerge. These include--but are but not limited to--the purchase of defaulted notes, acquiring foreclosed assets, the issuance of mezzanine bridge capital for gap lending and PIP funds. As investors navigate through the near term, demand will be strong for professional experts in hotel operations and lodging real estate and finance related matters. Long term, United States GDP will benefit from the needs of the world’s emerging markets for American goods, services, and technology. That demand will in turn have a positive effect on US lodging industry economic fundamentals.

During the past twenty eight years, Daniel Lesser is the senior managing director-industry leader of the Hospitality & Gaming Group at CB Richard Ellis (CBRE) based in New York City. The views and opinions expressed in this article are the author's own.