Stage is set for hotel real estate recovery.

Hotel real estate appears to have ended its long decline, and 1994 holds promise as the first of an expected multi-year recovery in hotel real estate values. These conclusions are based on data reported in the just-released 1994 edition of TransActions by HMBA, a hotel real estate reference guide compiled and published annually by Hotel & Motel Brokers of America (HMBA).

According to the study, momentum continued to build over the last 18 months for a hotel real estate recovery - a record number of hotels changed hands, prices completed a three-year bottoming pattern marked by all-time lows, and lenders increasingly were willing to make money available for hotel transactions.

For the 12 months ended December 31, 1993, HMBA offices sold 226 hotels, up 14 percent over 1992's total and the third consecutive year of double-digit increases. The nationwide organization of 150 brokers, headquartered in Kansas City, MO, accounts for approximately one-fourth of all hotels sold nationally and one-third of all mid-market hotels. Consequently, the organization is considered a reliable indicator of future industry trends.

According to Patrick Ford, CCIM, ISHC, editor of TransActions and president of HMBA's New England office, National Hotel Realty Advisors of Portsmouth, NH, the outlook for hotel real estate investment is the most optimistic in years. Record-level buyer interest and an improving financing picture are setting the stage for recovery in 1994.

Also expected to push hotel real estate prices higher are an improving economy, higher occupancy rates, better hotel operating results and virtually no new construction. Hotel occupancies are forecasted to reach 65.4 percent in 1994, the highest level in more than a decade. Operating results, which positively influence prices, have been slowly improving since late 1991. Generally two or more years are required for improved results to be reflected in higher selling prices. These improvements are beginning to show up in recent listings, according to HMBA President Noah Canfield, who also is president of Clearwater-based Greene & Canfield Associates, Ltd.

The record high sales activity in 1993 was largely the result of an uninterrupted flow of REO properties for sale from lenders, including state and local banks and the FDIC. REO properties accounted for about 45 percent of the total number of hotels sold, unchanged from 1992.

On the buy side, investors were attracted to the hotel market by the lowest prices in recent memory. Record numbers of buyers entered the market while prices remained in a three-year bottoming pattern.

Hotel real estate devaluation nearly over

Hotel real estate prices have been relatively steady since 1991, typical of a market bottom. Average price per room reached a low of $17,411 in 1993, down from a high of $23,630 in 1988. The rooms revenue multiplier fell from 3.5 to 2.4 during the same period, reflecting an approximate 25 to 30 percent decline in hotel real estate values over the past six years.

Regional market overview

Mountain Pacific: While the recovery gained momentum in some areas of the country, it had yet to take hold in others. Sales activity was stagnant in Southern California in 1993, where the economy remained in a recession. West Coast brokers look for a turnaround to begin in late 1994, as investor interest shifts westward and competition for attractive properties heightens. Although prices in this region were down from the previous year, they continue to remain the highest in the nation, nearly $23,000 per room.

South Central: The South Central region - the first to feel the effects of the recession, which began there some six to eight years ago - continued to be a hotbed of sales activity. Prices moved higher, with selling price per room improving nearly $1,700, to $15,736. Some buyers who had acquired troubled properties several years ago sold their investments at a profit and re-invested in larger hotels. Today, some new construction is underway, primarily small, limited-service properties.

North Central: Hotel real estate sales volume increased nicely in 1993, compared to 1992, although prices declined somewhat. The Midwest, unlike other regions, did not have the high level of lender-owned properties on the market, and already is seeing the return of conventional-owned properties.

South Atlantic: Sales activity in 1993 was brisk, with selling price per room remaining essentially flat at $18,343. The Florida market remained a bit sluggish, although the Washington Corridor area was robust.

New England/Mid-Atlantic: Hotel real estate sales activity increased somewhat, although it remained below historic levels of the 1980s. The economy, while improving in this region, is not as vigorous as in other recovering markets.

Full-Service hotels attractive to investor groups

High-performing, large, full-service properties with food and beverage operations that maintained or increased market share have been attractive to various investor groups, including management companies who have access to investment pools or newly formed REITs. In 1993, RFS Hotel Investors, Inc. of Memphis became the first new hotel REIT in 20 years. Two other hotel REITs have since gone public, and as many as 20 more are reportedly in the pipeline.

Older, full-service properties continue to be the object of strong buyer interest as well. Despite their being well into their product life cycle, these hotels remain attractive investments because owners can buy them at all-time low prices. Even after refurbishing, owners can operate on a low, re-capitalized investment base and generate attractive returns by instituting new marketing strategies, such as repositioning and reflagging.

Limited-Service hotels attract owner/operators

Smaller, limited-service properties continue to attract large numbers of individual foreign and domestic investors who intend to be owner/managers. This property type has been very popular with travelers, particularly the new franchised products developed in the late 1980s. While fewer of these newer properties came up for sale in 1993, those that did reach the marketplace were in great demand and have proven to be good investments.

Financing returns to hotel real estate

According to the "HMBA 1994 Hotel Financing Survey," lender willingness to finance hotel real estate acquisitions and new construction began to resurface in 1993, the first time since the late 1980s. This trend continued to slowly improve throughout the first half of 1994. Although activity still remains somewhat restrained, financing related to most performing, mid-market hotels is available from more than one source. Acquisition financing generally is available, but investors must contribute substantial equity.

Lenders are willing to provide about 60 to 75 percent of appraised value, far short of the more aggressive lending policies of the mid-1980s. The survey found debt coverage ratios averaged between 1.3 to 1.6 times historical cash flow available for debt service, after management fees and reserves for replacement.

Despite the increasing availability of funds and funding sources, financing for "turnaround" situations still remains very difficult to obtain. Lenders are reluctant to offer high loan amounts and view these loans as very high risks. When financing was available, lenders required more cash from investors, which resulted in loans of 50-60 percent of appraised value or less.

Conventional financing now is more readily available for performing hotels. Loans under $2 million can be financed by SBA-licensed lenders or at local or regional banks.

More flexible financing should become available as the economy strengthens and competition for yield among lenders escalates.

New construction at six-year low

According to the "HMBA 1994 Hotel Development Summary," new construction reached a 6-year low in 1993. After subtracting rooms opened in Las Vegas, only 23,500 net new rooms were added to the nation's supply. Typical hotels built last year were smaller-sized prototypes of successful brands introduced in the late 1980s. Practically all construction was in the budget and economy sectors, with properties located primarily in smaller communities. The average size of a new hotel built in 1993 was just 74 rooms, compared to 121 rooms in 1989.