The Impact of COVID-19 on Hotel Values: Analysis of Current Conditions
For many hotels, the initial effect of COVID-19 was staggering as many hotels in the U.S. closed in early- to mid-March with the trend continuing to accelerate. The long-term impact on U.S. hotel performance will vary by market, and the duration of the initial decline and the subsequent recovery remains uncertain.
Hotel owners and investors are looking to estimate potential impacts on their assets and asking the following key questions:
• How long will the hotel markets continue to deteriorate?
• If a hotel is closed, how long will it stay closed?
• When the hotel market bottoms out, how long will it take to get back to pre-COVID-19 occupancy levels?
• When will daily average rates get back to the 2019 average rate?
Our hotel appraisers and consultants within Cushman & Wakefield’s Valuation & Advisory platform continue to provide prudent guidance based on the most up-to-date information available, while regularly adjusting assumptions, forecasts and overall outlook.
To assess the current conditions, we are exploring sensitivity analyses with different variables. As with any hotel analysis, the assumptions and findings differ by property type and market and require thoughtful forecasts based on the variables for each asset.
As an example, we have prepared a sensitivity analysis of a competitive, select-service hotel affiliated with a nationally recognized brand that is located in a top-25 urban market using circumstances and data as of March 2020. The baseline scenario assumes no impact from COVID-19, in addition to four potential long-term projections assuming different impacts and outcomes from the current pandemic.
For this analysis, we have taken the following into consideration:
- Operators will adjust property operations and staffing for reduced occupancy and/or closure. All the non-baseline scenarios show a recovery to a consistent stabilized occupancy level.
- The actual resulting net income of a hotel with an impacted RevPAR depends on the asset’s operating structure, management strategy and market dynamics.
- Some vacant hotel rooms are being donated or subsidized for use by healthcare workers and other affected populations, so the specific circumstance for each property would require customized modeling.
- In the forward-looking scenarios, the overall decline in room revenue results in a longer-term contraction of net operating income. The recovery of the average daily rate back to the same level at or near the average daily rate achieved in 2019 dollars represents a real loss in revenue over the long term.
- The contraction of value can be significant in the short term but is likely to accelerate during recovery. External factors including availability of financing, the pool of potential buyers and alternative investments need to be taken into consideration when examining property value.
Baseline Scenario (Pre-COVID-19) – This scenario mirrors the projections that we had assumed at the beginning of 2020 where there was no significant impact anticipated from COVID-19. The underlying premise of this forecast is that the hotel markets were expected to moderate relative to 2019 and that the impact would largely affect the average daily rate.
Scenario 2 – This scenario assumes the current COVID-19 pandemic will directly impact hotel performance beginning in March 2020 and that the market and the property will begin to recover in early 2021. Scenario 2 is modeled to show a rebound to the hotel’s 2019 average rate with a five-year recovery to the 2019 average daily rate.
Scenario 3 – This scenario also assumes the current COVID-19 pandemic, but assumes a more optimistic timeline assuming that 2020 is the nadir and that the average rate returns to 2019 levels in four years.
Scenario 4 – This scenario also assumes the current COVID-19 pandemic, but assumes the hotel will close between mid-March through the end of the second quarter of 2020 and that the average rate will recover in five years back to 2019 levels.
These analyses are not intended to be an actual indication of income, expense or value changes, but a way to benchmark the impact on value. We expect circumstances to be in flux for some time,however these types of analyses could provide some guidance for hotel investors and market participants.
The Road to Recovery
At this point in time, the unknown duration of the pandemic creates uncertainty for the path to recovery. The turnaround of a market and hotel’s performance will depend on several factors, including but not limited to:
- The length of the shelter-in-place orders by governments and businesses
- The discovery of therapeutics and/or a vaccine for COVID-19
- Behavioral changes and/or social distancing requirements following the current stay-at-home environment
- The timing of when group gatherings will become acceptable again
- Meeting size restrictions on groups
- Business travel restrictions post-COVID-19
- Status of proposed hotels and completion of new supply under construction
Leisure travelers are likely to be the first guests that initially come back to hotels. As with the recovery after the financial crisis, drive-to getaways and staycations are expected to be the largest uses of hotel rooms in the early months post-pandemic. Business travel is expected to return secondly, depending on businesses’ available budgets for travel and available airlift. Meetings and groups were the first lodging segment to decline from the pandemic and are anticipated to be last to recover. However, until we see the bottoming out of current trends, it is difficult to determine an absolute recovery pattern.
In the last downturn from the financial crisis, the hotel investment market paused for approximately two years before transactions restarted. While numerous opportunistic funds were lined up for deals, hotel owners who were able support their investments did not sell until they achieved desired pricing. Although hotel revenues for many assets are expected to decrease more severely than the last downturn, the declines are somewhat offset by the CARES Act relief package issued by the US government. However, it is uncertain if hotel owners will be able to sustain the same kind of holding pattern as that of the last economic downturn and how the CARES funding will impact the profit and loss statements for individual assets.
While the current issue is a public health crisis and not a financial crisis, we are witnessing another break in transaction activity. Before the downturn from COVID-19, the hotel market performance was softening. Despite the expectation of moderating hotel fundamentals, the low interest rates sustained acquisitions and refinancing of hotel assets. Assuming the continuation of the low interest rates, hotels may begin to trade once the COVID-19 pandemic is contained and/or testing therapeutics/vaccine is widely available and the bottom is marked. Pricing for hotel trades at this future date is likely to be higher than the sensitivity value changes as nadir of the cycle will have then passed.
With RevPAR and net operating income recovering each year, the net present values increase can be expected to provide investment opportunities going forward. As a benchmark, we have used consistent discount and terminal capitalization rates to evaluate the potential changes in net present value shown in the following chart.
Assuming interest rates remain low, investment demand for hotel assets may also drive lower equity yields, resulting in even quicker and more exponential growth of value.
Because of the uncertainty about recovery timing and the expectation that a full recovery will take several years, we anticipate that modelling assumptions will also change periodically. It is likely that sensitivity analyses are modified as circumstances change to continue to gauge a range of outcomes.