S&P Wary of Hotel CMBS Despite RevPAR Gains

NEW YORK CITY—Lodging metrics have been on a winning streak for five years running, and Standard & Poor's expects RevPAR to post strong growth this year and next. Yet notwithstanding the sector's currently robust health—and the favorable outlook S&P has given it through 2016—the ratings agency has cast a cautious eye upon CMBS associated with the hotel sector.

“Despite healthy current fundamentals, we believe that hotels are more volatile than other major property types” that commonly back US CMBS deals, according to an S&P report issued Thursday. Unlike, say, office, industrial or net lease, lodging “does not benefit from long-term leases, has higher operating expense levels than most other property types, is operationally and capital intensive and is vulnerable to event risks that affect travel. Moreover, because hotels have high expense ratios, a given percentage decline in RevPAR generally results in a more pronounced decline in net cash flows” compared with what other property types would incur.

Over the long haul, GDP and hotel room demand growth have been closely correlated, but with the level of room demand growth typically lagging GDP gains. However, S&P notes that in three of the five years between 2010 and 2014, lodging demand growth exceeded GDP growth in three of the five years.

“We believe that this demand strength was partially driven by pent-up demand for leisure, corporate and group travel that was depressed during the recession,” according to S&P's report. “We also believe demand growth will likely moderate to more normalized levels in line with GDP growth through 2016.”

Furthermore, the five-year period of strong growth in demand and occupancy levels coincided with a period of extremely low lodging supply growth. Inventory grew by 0.6% in 2011, 0.5% in 2012 and 0.7% in 2013, compared to a 17-year average of approximately 1.8%.

Last year, however, supply growth accelerated by 0.9%, “and given that we expect favorable demand and RevPAR levels in the near term, new construction is likely to follow,” according to S&P. That could mean supply growth of about 1.5% this year, and possibly approaching 2.05 in '16.

S&P notes that it continues to track new supply on a market-by-market basis. “In locations such as New York City, where supply has grown significantly in recent years, we would likely scale back our RevPAR assumptions from recent performance levels because we expect the continued influx of new hotel rooms will negatively affect future performance,” S&P says.

S&P continues to monitor RevPAR for the nation overall as well as the top 25 hotel markets. Of those 25, only four markets—New York City; Washington, DC; Phoenix; and Norfolk/ Virginia Beach, VA—had RepAR levels below the 2007 peak as of year-end '14. Of the remaining 21, nine had RevPAR levels that exceeded the '07 level by more than 25%.

In the case of San Francisco and Oahu, RevPAR exceeded the prior peak by 56% and 44%, respectively. “Although certain markets benefit from barriers to entry, we view properties where RevPAR has continued to grow unabatedly, absent a major capital repositioning project or other extenuating circumstances that justify continued performance improvement, with caution,” says S&P.

In sum, the ratings agency says in its report, “We are cautious about the sustainability of RevPAR levels over a longer cycle,” i.e. a typical five- or 10-year loan term. That's on account of the fact that “overall RevPAR levels currently exceed prior peak levels, hotel room supply growth rates will likely increase in coming years and current occupancy levels are unusually high.”