What a difference a year makes. At last summer's inaugural Midwest Lodging Investors Summit, attendees and speakers still hadn't accepted the fact that the hotel industry was at the cusp of a sharp decline in revenues, profits and values. At this year's event, held July 19-21 at the Chicago Marriott, the crowd was much more realistic in assessing current conditions and their expectations for the future.

THE PREVAILING QUESTION WAS NOT HOW MUCH WORSE WILL IT GET, BUT WHEN
will the industry rebound and what will the recovery look like.

“It really sucks now, but in 18 months we'll be saying it's not so bad,” said Laurence Geller, chairman of Strategic Hotels & Resorts, at the luncheon on the first full day of the conference. “There's good stuff happening in the lodging market, even though it may feel like a root canal without anesthesia.”

Calling it a “systemic change in the industry,” Geller cited as positives a benign pipeline of new hotels, the excellent physical condition of most hotels and hotel operators who have become “smarter without panicking.”

While Geller spoke of a rebound by late 2010, most speakers acknowledged timing any market cycle is a precarious exercise, with tops and bottoms typically not confirmed for months and even years after the fact. Most experts insisted visibility has never seemed as uncertain as it does now.

Bill Hanley, a partner and managing director with Vantage Hospitality Group, predicted the bottom of the market will be reached by the fourth quarter this year. “In the fourth quarter we'll be comparing profits and operations to the fourth quarter of 2008, and those comparisons could begin to look favorable,” he said. “If we can say that we're merely flat in the fourth quarter with year-earlier results, then we'll have reached bottom.”

Morris Lasky, the CEO of Lodging Unlimited, who is raising a $350-million hotel acquisition fund, endorsed Hanley's notion that the bottom will be reached this fall. He said he's been in negotiations with lenders poised to foreclose on hotels in the fourth quarter, when a wave of asset takeovers is anticipated.

“Lenders have been holding off, hoping that industry conditions would get better. They haven't,” Lasky said. “We could see close to half the hotels in California go back to lenders. When the market gets that bad, then you can say that we're at the bottom. This foreclosure phenomenon is not a matter of if, only when. And the moment is getting closer.”

Bharat Patel was a little less cheery in his remarks during the event's opening general session. “We haven't hit bottom yet,” the chairman and CEO of the Sun Group of Companies flatly said. “The rate we gained in the last six to seven years, we lost in the last six months.”

Many other observers at the conference believe that the ultimate day of reckoning in hotels is more likely to fall later in 2010. “The industry still isn't feeling enough pain yet,” said Ted Mandigo, a hotel consultant based in Chicago. He believes the bottom will not come until “large numbers of banks with hotel loans have the keys handed back to them and are forced to start writing checks each week instead of receiving checks from the borrower.”

In a session on the acquisitions market, participants agreed that most dealmakers will remain on the sidelines until a signal that the current cycle has reached its nadir. A frustrated Michael Medzigian, chairman and managing partner of Watermark Capital Partners, said “as many hotel cycles as I've seen I've never seen one like this before. This is way worse than it ever was in the recession of the early 1990s, and I don't think the market has reached bottom yet. Investors in the meantime are asking, , ‘Why should I buy a hotel before I know what the future looks like?’”

Acquisition activity is bumping along at levels not seen for nearly a decade. Most conference attendees acknowledged that the market must decisively reach or pass bottom before dealmaking breaks out in earnest again. But most of 2010 could remain quiet, they said. “We could see good deal flow again in 2011,” predicted John Jameson, managing director of hotel brokerage Molinaro Koger.

THE MONEY SPIGOT

It's become a thorny issue of perception versus reality in the hotel financing world. Contrary to popular belief, lenders have not completely shut off the capital spigot, said Ravi Patel, vice president of finance and development for Hawkeye Hotels. “There is lending occurring. It's just much different than what we were accustomed to a few years ago.”

While the Mortgage Bankers Association reports that hotel loan originations plummeted 88 percent in the first quarter compared with the same period a year earlier, several industry experts said deals $20 million and under are still getting done.

But no one disagrees that it's a rocky terrain for borrowers. For example, lenders typically require Hawkeye Hotels to plunk down anywhere from 20 to 40 percent equity on new-construction projects before a loan is granted. The equity requirement is up sharply from a few years ago for the developer, which owns 40 hotels in secondary and tertiary markets in the Midwest.

Despite the tough financing climate, Hawkeye Hotels has closed on six loans during the past six months. “Construction loans are a little bit tougher to come by,” readily admitted Patel. “A lot of our refinancings I haven't had a problem with at all.” Patel also has been tapping every finance source possible, including the U.S. Department of Agriculture, which offers relatively low interest-rate loans for properties in rural areas.

Joe Epstein, president and founder of First American Realty Associates, a mortgage broker in Fairfield, N.J., said developers today want to be in markets that are “recession foolproof” — markets where there is strong demand for the product they're building in a particular segment.

Military training bases provide an excellent source of built-in demand for hotels, said Epstein. He recently arranged financing on two Candlewood Suites, one in Fayetteville, N.C., near Fort Bragg, and the other near Parris Island, SC. “If you build a new, wonderful product and you are closest to the base, it's very easy to convince local and regional lenders that there is categorically a demand and a need in that segment.”

For deals under $20 million, financing is available for smart and resourceful borrowers who are not overleveraged, emphasized Epstein “I've always maintained that no matter what the market is, if you have a good deal, one with a demand and need in the segment, with an owner and operator that has a track record, with somebody whose head is still above water, there is somebody out there under a certain set of givens that will do the deal.”

A breakout session on creative financing prompted panelist Rich Niedbala, senior vice president of the Midwest region for the Plasencia Group, to humorously question the word choice. “Unfortunately, the session is called ‘creative financing’ and that's what got us to where we're at right now,” said Niedbala, referring to the years of loose underwriting that is now manifesting itself in higher loan defaults and delinquencies.

For many borrowers, the more conservative lending climate remains a period of readjustment, says Niedbala. “There is still this cognitive dissonance going on between what people had been doing deals at and what you have to do a deal at today. It hasn't fully come to roost yet.”

RATE WARS

Speakers on the Monday morning opening panel started off in agreement that hotel companies have been helpful to owners with programs to reduce costs and delays in capital improvement projects, but things escalated when the topic turned to rates.

“Hold rates, hold rates, hold rates,” said Nancy Johnson, chief development officer for Carlson Hotels. “That message needs pounded again. A competitor just took down their rate X percent across the board. You can't drive occupancy to zero travelers. We need to suck it up, take care of our customers, hold rates and provide good service and we'll all be better in the long run.”

Walter Isenberg, president and CEO of Sage Hospitality Resources, agreed in theory, but said the reality wasn't as simple. “If we got all of my competitors at the same table and agreed to price fix — which would be totally illegal — the first guy to walk out of the room and get a call for 10,000 rooms for a $10 discount — he'd do that in a New York minute. The power is with the customer and that's reality.”

WHAT'S THE VALUE?

Not surprisingly, a panel of hotel valuation experts was unable to definitively answer the question embedded in the session's title: “What Is Your Hotel Worth Today?” It wasn't their individual or collective faults, however; the truth is that no one can say for sure what any particular hotel or portfolio of properties is worth today.

“It all depends on the deal at hand,” said Eric Belfrage, a Columbus, OH-based vice president of CB Richard Ellis Hotels. “Because so few hotel transactions are being consummated, the sales comparability approach to valuation has little credibility in this environment.”

Penn State Hospitality Professor and Lodging Hospitality Contributing Editor John O'Neill, was able to share some historical data on the severe drop in hotel values in the past year. According to the Penn State Index of U.S. Hotel Values, lodging values have dropped 17 percent this year, with properties at the top and bottom of the segment spectrum hit especially hard.

“Values should increase by .04 percent in 2010, but the gains will be uneven,” said O'Neill. “The increases won't start at the beginning of the year, and we're still forecasting decreases for the luxury segment.”

The panelists agreed the unavailability of debt is a significant factor in the uncertainty surrounding value. “At some point, buyers are going to start acquiring hotels,” said Dan Beider, senior managing director and chairman of Paramount Lodging Advisors. “And once they focus on a particular segment, values will become clearer and begin to rise.”

The panelists had a lively debate over the best valuation techniques to employ in this volatile market. According to O'Neill, “occupancy and rate, rather than net operating income, are better predictors of value; thus, a revenue multiplier is a useful tool in valuations.”

Suzanne Mellen, managing director of HVS San Francisco and Las Vegas, says it can be a mistake to rely on the rooms multiplier technique. She advocates using a discounted cash flow analysis that assumes the property will be refinanced in the future once credit markets return to normalcy.

Following the general session panel on valuation, Professor Ray Schmidgall of The School of Hospitality Business at Michigan State unveiled a new tool developers can use to gauge which markets are ripe for development. The Lodging Market Potential Index, which was developed at The School, uses a matrix of 10 data dimensions to determine the cities with the highest long-term potential for hotel investment. Three indices — hotel market performance, market performance growth and hotel supply and absorption rates — account for more than half of the Index. Other factors range from tourism trends to the performance of all commercial real estate.

A preliminary Index ranking of 16 markets released by Dr. Schmidgall shows New York City at the top, followed by San Francisco and Miami (tied) and then Houston and Orlando.

Four Midwest markets — Chicago, Minneapolis, St. Louis and Detroit — were among the bottom five.

The 2010 Midwest Lodging Investors Summit will be held July 11-13 at the Sheraton Chicago. Check the conference website www.midwestlodginginvestors.com, for more information.