A 'Big Disconnect' Between Hotel Fundamentals and Debt Markets Has Opened

A ‘big disconnect’ exists between hospitality market fundamentals and debt markets, as rising inflation stokes volatility. But a ‘substantial tightening trend’ could be on the horizon once the markets have better visibility into what’s to come in the future.

The debt markets are slumping even as hospitality fundamentals are showing strength – exceptionally so for many assets, according to JLL. But “in the current environment, inflation and the Federal Reserve’s response have taken center stage, despite the strong fundamentals,” the firm’s analysts note in a new report. “The credit markets fear that aggressive monetary tightening by the Fed could tip the economy into a recession, which has resulted in higher credit spreads and all-in loan coupons.”

Balance sheet lending spreads have increased by 25 to 75 basis points, with SASB CMBS whole loan spreads broadening by more than 150 basis points. JLL also notes that the floating rate index SOFR, which tracks the federal funds rate, has ticked up by nearly 150 basis points since the beginning of the year. It may increase by between 200 and 250 basis points by the end of 2022, the firm predicts, and all-in loan coupons currently stand between 175 and 300 basis points higher today than in January, depending on lender type.

But “while spreads and loan coupons are higher, liquidity for hospitality loans on existing assets still exists, with all major lender types – banks, debt funds, life insurance companies and fixed/floating rate CMBS lenders – continuing to quote hotel loans,” the report states. “Lenders are becoming more selective on the types of hotel loans they will originate, and some may begin to offer lower leverage.”

While banks provide the lowest cost of capital and have adjusted spreads the least as of late, they are focusing on “the best deals and/or existing clients,” according to JLL. Maximum leverage for banks is clocking in around 65%. Debt funds are still active and offer the highest leverage at between 65% and 70%, but their spreads have increased by between 50 and 100 basis points.

“We expect these leverage levels to decrease as a result of greater economic uncertainty,” the report notes. “A significant challenge with debt fund execution today is that many funds are reliant on the CLO market for financing, and dislocation in the CLO market has created greater pricing and closing risk with some debt funds.”

JLL also notes that life insurers have been “selectively active” in hospitality lending with leverage up to 70% and spreads that have widened by approximately 25-50 bps over this year. And SASB CMBS has  widened the most, with AAA CMBS bond spreads increasing by over 100bps since early 2022 and whole loans spreads by 150bps + depending on leverage.

“The floating rate AAA spreads that we’re observing represent post-COVID highs and are by far the widest levels that we’ve tracked going back to 2013,” JLL notes. “SASB CMBS leverage remains available down to 75%, however, as pricing has increased, we’ve seen borrowers voluntarily reduce leverage to drive down whole loan pricing.”