The Impact of COVID-19 on Hotel Values

HVS have published an insightful article on the valuation of hotels and hotel/hospitality businesses while they are in effect shut down for an indefinite period.

The "Black Swan"

COVID-19 is a "Black Swan" event, a term popularised by  Nassim Nicholas Taleb in his book of the same name, is a rare and unforeseeable event with dramatic and disproportionate consequences.

Material adverse change

Modern commercial agreements do to some extent provide for Black Swans in material adverse change clauses, where is a change in circumstances that significantly reduces the value of a company, target assets or charged assets.  It will generally allow an acquirer, investor, or lender to terminate the acquisition, investment or loan transaction if a material adverse change occurs.

Extend and pretend

During the last recession in 2008, some lenders were reluctant to value where there was clearly going to be a loan-to-value or income covenant breach; identifying that breach would force them to take a decision whether to enforce. That reluctance to value and a policy of waiting until things improved was termed "extend and pretend" or "extend, amend and pretend".

It is too soon into the current COVID-19-induced downturn to discern any trends in lender stance. However, similar circumstances apply - there is little point in a lender exercising a power of sale or appointing administrators where there is no "healthy" market into which the assets can be sold, unless the banks set up new "bad banks" (like the defunct RBS West Register, which held assets which had "gone west") to trade or hold those impaired assets until the market recovers.  That said, bad banks had some reputational problems by acquiring assets at the rock-bottom of the market and selling them in effect to themselves.

Impact on value of closure

COVID-19 and the market impact will of course impact values. 

In the present environment, the causes of a hotel ceasing operations are clearly external. The hotels which have suspended operations (rather than "closed") have done so with the expectation of resuming operations when demand resumes. HVS consider that, from a valuation perspective, the impact of suspended operations will influence the EBITDA forecasts in the short term, but assuming the property is positioned to resume operations, suspension per se will not have a material impact on value.  

Different hotels - different speed of recovery

HVS identify those hotel market segments most vulnerable to longer-term harm from COVID-19 are:

1. Full-service hotels, dependent on business travel and groups
2. "Gateway locations" that depend on international travel
3. "Fly to" locations that depend on air travel
4. Airport hotels
5. Independent properties (which lack the market penetration of brands)
6. Markets influenced by the energy sector (e.g. Aberdeen)

Those which are likely to recover more quickly are:

1. Hotels that primarily rely on transient segments (e.g. hostels, budget city centre hotels)
2. Locations accessible by public transport and car rather than air travel
3. Urban and suburban locations
4. Extended-stay apart-hotels and serviced apartments
5. Properties with strong brands
6. Limited service, budget- and mid-scale properties

Conclusion

Historical cycles indicate that the hospitality industry as a whole will experience a significant decline in asset values, but that decline will not be spread evenly. The sharp drop in revenue and EBITDA will precipitate debt service deferment, lending modifications and restructuring. The transactions that are likely to occur will reflect discount rates and long-term yields well above historic averages, given the high level of uncertainty.  Acquirers are likely to be predominantly low-leverage or all-cash buyers such as private equity funds and opportunities funds who have the resources to ride out difficult periods. Once hotel performance bottoms out and assets return to the market, those kinds of buyers will be in a position to acquire hotels at prices well below both replacement cost and recent norms, creating an opportunity for high returns.