Positive Big Picture
It is obvious that hotel operating performance will be much better in 2021 than 2020. It is, perhaps, less obvious that hotel lending has already begun staging a comeback that will accelerate throughout the year while continuing to stay ahead of actual hotel performance.
Hotel CMBS Lending Rebounds Prior to Hotel Performance
Leverage for hotel CMBS loans is currently available in the 55% +/- LTV range as lenders are beginning to close hospitality loans prior to the full return of cash flow. They are using the same forward-looking underwriting tactics that were prevalent in The Great Recession recovery in 2010/2011. Given the low default rate (prior to Covid-19) on 2010/2011 vintage hotel loans, there is a successful precedent for the strategy and a consensus among lenders and rating agencies that most underwriting mistakes are made later in the business cycle as earnings peak and lender competition and new supply heat up.
Leverage will gradually increase to 65% by the end of the year as hotel cash flows begin to normalize on a current run rate basis and strong, identifiable, positive year-over-year RevPAR trends make it easier to underwrite partial pro forma loans with confidence.
All-in rates for 10-year hotel CMBS loans are currently in the mid- to high-4% range. With more favored asset classes like multi-family able to secure financing in the low-3% range, lenders are viewing hospitality loans with an opportunistic eye. As the year progresses and underwriting relies less on pro forma, and more on “actual” results, we expect rates to drop to the low 4% range along with the previously mentioned increase in leverage. Lower leverage requests later in the year will break below 4% once again.
Bridge Financing Fills Permanent Loan Gap
Hospitality bridge financing began its resurgence in Q4 2020 and volume will continue to accelerate throughout the year. For hotel owners unwilling or unable to secure the lower leverage permanent financing currently offered, bridge financing is a good interim solution while waiting for a complete return to normalcy.
Current rates vary based on loan size, leverage and sponsorship, but generally range from 5.5% for large loan size (>$50 million), low leverage and excellent sponsorship to 8.5% for small loan size (<$5 million), higher leverage and average sponsorship.
We expect spreads will drop by 50-200 basis points by the end of the year, with the largest declines on the higher leverage/smaller loan size side of the spectrum.
Risk-Free Rates Go Up, Loan Rates Go Down
The 10-year Treasury yield is above 1% for the first time since March 2020 and the latest Bloomberg survey suggest it will end the year at 1.15%. We expect the 10-year will end 2021 at approximately 1.30% and will trade in a tight range throughout the year.
1-month LIBOR has been stuck below 20 basis points since May 2020. Based on the forward curve, it appears likely to remain there for the remainder of 2021. LIBOR tends to take cues from the Fed Funds rate, which has been telegraphed by the Federal Reserve to remain low the foreseeable future.
SOFR (Secured Overnight Financing Rate) is expected to replace LIBOR by the end of 2021. SOFR has thus far stayed just below 1-month LIBOR and the forward curve shows that it will likely remain that way in 2021.
What does this all mean for loan rates? If the 10-year Treasury yield hits 1.30% by the end of the year, it likely means COVID-19 is finally under control which would cause a corresponding, and more meaningful, drop in credit spreads. Our prediction is that credit spreads will decline more than risk-free rates which will be a net positive for all-in loan rates. As mentioned above, we expect 10-year fixed-rate coupons to end the year 50-75 basis points lower than today, and short-term floating-rate bridge loan coupons will be lower by 50-200 basis points.
New Year, New Outlook, New Allocation
There was very little incentive for lenders to take risk lending on hotels in 2020. If you entered 2020 full on hotel loans, you spent the year asset managing, not originating.
2021 will be a good year for hotel owners and lenders alike. Hotel operations rebound faster than other commercial real estate asset classes given there relatively short booking windows and “overnight leases.” The same cannot be said of retail and office properties whose performance will remain an unknown in the near to intermediate future. This will lead to higher allocations for hotel loans and given where we are in the cycle and the incremental spread available on hotel loans versus other asset classes, it is “risk on” for 2021.