Two years ago, hotel properties faced one of the most difficult periods in their history as covid-19 rampaged across the globe. Travel stopped and, even as it has returned in some capacity, the asset class faced a myriad of questions.

The nadir for hotels arrived at the end of 2021, when uncertainty over the Delta variant and the subsequent outbreak of the Omicron variant gave investors pause after a brief period of recovery. According to the NCREIF Property Index, one-year total returns for hotels at the end of Q1 2021 stood at -24 percent, the worst performance among the five traditional real estate asset types in the quarter. Performance rebounded to a 5.5 percent total return for the full year.

The large swing in returns in just three quarters was the biggest improvement of any real estate asset type, including darlings industrial and multifamily. The road to recovery for hotels is still bumpy, particularly in certain subsectors, but the outlook is getting brighter, with many different sorts of capital keen again to invest in hotels, says Gilda Perez-Alvarado, JLL Hotels & Hospitality global CEO.

“What’s interesting is the composition of that capital and how diversified it is,” she says.

Sources of capital

Private real estate firms continue to make up the lion’s share of capital chasing hospitality product. Since 2019, 21 vehicles focused solely on hospitality were sponsored by 15 fund managers, closing on almost $5 billion of aggregate committed capital and almost doubling their $2.75 billion target, finds PERE data. The biggest vehicle, Azora’s European Hotel & Lodging, raised almost $1 billion in fund and co-investment capital. KSL Capital’s Credit Opportunities Fund III and Schroders Capital’s European Operating Hotels Fund each raised over $600 million.

Other sources of capital chasing hotels include traditional hotel REITs and less traditional non-traded REIT structures, an increasingly popular tool for private equity firms to access retail capital. In fact, two raises by MCR Hotels, a New York-based hospitality specialty manager, were non-listed structures. Private equity managers, including Blackstone and KKR, have also closed diversified funds which include hospitality as part of the mandate.

Another area of capital looking closely at hotels are sustainability funds, says Perez-Alvarado. Hotels are the least environmentally friendly asset class, using more energy and water than any other type of commercial real estate. Sustainable funds have amassed almost $4 billion in AUM, per JLL data, of which 87 percent are in Europe. Many hotels require rethinking post-pandemic. Capital targeting repositioning projects related to sustainability adds to the pool of capital chasing hospitality.

Perez-Alvarado notes that there is abundant capital from investors in the US, Europe and Asia looking to invest both domestically and across borders. Dan Peek, chief operating officer of brokerage firm Hodges Ward Elliott, says sovereign wealth funds are also showing interest in the sector again after spending some time on the sidelines.

Recently established hospitality partnerships include Canadian investor PSP forming a joint venture with Eurazeo to invest in European hotels and Singaporean sovereign wealth fund GIC forming a JV with Summit Hotel Properties. “There is an unprecedented degree of liquidity from an equity standpoint,” Peek observes.

The availability of liquidity also extends to the debt markets, which returned to being fully functional last year, Peek says. This followed a period early in the pandemic where few to no new loans were originated before some lending returned, but pricing was very high.  Since then, greater transparency around how assets have been priced has encouraged the return of life insurance companies, banks, CMBS and debt funds willing to lend to hotels.

The opportunity set

Despite different stages of recovery in product types and geographies, many market participants say capital is flocking to assets that are stabilized. While cap rates are compressing due to competition, the stability of the returns is making underwriting easier.

Geographically, investors are mostly avoiding Asian cities because of strict restrictions not allowing travel. The Maldives, however, still remains one of the premier leisure destinations in the world. In Europe, major cities and resorts are still where capital wants to be. Perez-Alvarado says Madrid and Berlin are seeing interest because they invested in infrastructure during the pandemic and reinvented themselves.

In the US, the South continues to do well, with cities like Austin cited as markets in which investors want to own. Matt Mering, executive vice-president, hospitality, at manager Waterton, says the Northeast generally is challenged.

Most capital is still looking to invest in leisure, targeting both resorts and destination-based hotel properties. Drive-to resorts in the US performed well in the pandemic, market sources say, especially given people’s inability or desire to get on planes. The headline deal in that space since the beginning of the pandemic was Blackstone’s joint venture with Centerbridge to take a 65 percent ownership stake in Great Wolf Resorts. KSL Capital Partners, a global travel and leisure investment manager, continues to view drive-to resorts as a key part of its strategy, but Eric Resnick, the firm’s chief executive, tells PERE the market risks overheating.

Another area of significant interest is select-service hotels. The low cost to run these assets is attractive to investors that want to deploy into the hotel space, but are concerned about the operational intensity of the asset class. In 2021, around 55 percent of institutional transactions were select service, Peek notes, versus a normal rate of around 30 to 35 percent.

“You can buy select-service at some very attractive, unlevered going-in yields that are, say, 7 percent or higher,” Perez-Alvarado says. “If you put favorable financing on that, you’re immediately at a low double-digit cash-on-cash return. That is very attractive to institutions.”

Reservations about select service still exist, however, due to a potential erosion of demand driven by a return to a normal and therefore fuller service. Pricing has also decreased on portfolio transactions, Resnick says, meaning an aggregation strategy can work best. He notes that it is a very labor-intensive and difficult strategy for institutions with large amounts of capital to undertake.

Value-add investors are likely to see plenty of opportunities to invest in properties that need significant environmental overhauls or a rework of amenities. The latter type of property has seen more change during the pandemic, with occupier demands shifting. With hybrid working widely adopted, travel earlier in the week is something many workers are already doing and are likely to continue. Hotels that cater to this clientele – providing co-working space, video-calling facilities and strong, reliable wifi – are likely to fare better and command higher room rates.

“Thursday used to be one of the quietest nights in the hotel business,” Mering says. “Now it’s becoming one of the busiest.”

Transactions and pricing

Hotel transaction activity returned to normal last year after a 10-year low of $28.6bn in 2020

Almost $67 billion was deployed in 2021, the most since 2017, with over half of that in the Americas, per data from JLL. Dan Peek, chief operating officer of real estate capital markets adviser Hodges Ward Elliott, says three-quarters of transactions in the US in 2021 took place in the South or California. Momentum in 2022 is expected to be slower, with around $6.2 billion reported by March 6, 2021, a 28 percent decrease from the same period last year.

The recovery in transaction volumes has accompanied an increase in pricing, with pre-covid levels now breached and many areas of the market breaking records. California saw the highest price per key ever recorded in the US when Alila Ventana Big Sur, a 59-room luxury resort, was sold twice in 2021. In the second transaction, Host Hotels & Resorts, a REIT, was the buyer. The property was acquired for $150 million three months after Hyatt Hotels Corporation bought it from Geolo Capital, the private equity arm of the John Pritzker family office.

Secondary US markets like Austin, Nashville, Charleston, Savannah and Orlando also performed well. “You saw transactions at the highest price per key those markets have ever achieved,” says Peek. “In some cases, you saw the record broken a few times.”

Despite record pricing in most markets, the market is fragmented and there is room for managers with capital to find opportunities. Pricing is also difficult to discern because of a significant amount of capital raised for distressed assets. One area that has yet to recover is internationally driven markets and other gateway cities that rely on business travel. Chicago, as an example, has specific challenges, namely high property taxes that eat into returns, says Matt Mering, executive vice-president, hospitality at Waterton. For others, like San Francisco, London, New York and Singapore, a lifting of pandemic restrictions and a requirement to return to the office as economies move on from the pandemic could see a return in travel, and consequently, a recovery in hotel assets in business and leisure markets.

“I would say we are definitely getting more and more interest for urban assets in the major gateway global markets, especially now that restrictions are being lifted and we are seeing ‘the great return’ to work, school and city centers,” says Gilda Perez-Alvarado, JLL Hotels & Hospitality global CEO.