• Debt markets stir but values are under pressure

The credit crunch has slowed portfolio transactions to almost a standstill over the summer but there are signs that the debt markets are coming back, albeit in a more chastened form.

Sinem Erol-Aziz, a director at Deutsche Bank’s European Commercial Real Estate Group, believes that in the US, commercial mortgage backed securities are already on the way back.

Speaking at Henry Stewart’s Hotel Funding conference held in London last week, she admitted, however, that the highest loan-to-values being offered were now 75% rather than the previous 85%.

The loan departments at investment banks were still open for business but they were being forced to keep the debt on their own balance sheets rather than farming it out within three months as is normally the case.

This has inevitably brought more caution to the type of deals being done. The sub prime problems in the US have led to distrust of the rating agencies and negative investor reaction to all types of asset backed paper.

There is a liquidity crisis and the widening, unstable spreads means it is hard to price loans for a CMBS exit in the next three to six months.

Bill Waite, senior manager at AIB Capital Markets, agreed that banks have a problem with syndication. Thanks to both rising base rates and the increase in spread between base rates and LIBOR, interest rates in the UK had soared by over 40% since March 2005 (although LIBOR has come down in the past few weeks moderating this increase slightly).

Waite pointed out that if private equity buyers wanted to generate returns comparable to the recent past (teens to early twenties) then hotel capital values would need to rise by double digit numbers.

But expectations for capital values are, if anything, bearish. Philip Johnston, head of hotels at Savills, said at the same conference that the potential was there for yields to begin rising. He quipped: “Is 7% the new 5%?”

While there remained a weight of money in the market much more equity participation was now needed. There was now the potential for operators to make a u-turn and begin buying back product that they have sold-off at premium rates in the last few years, said Johnston.

A key positive at present, however, was robust trading performance. Jonathan Langston, managing director at TRI Hospitality Consulting, said that revpar growth continued to outstrip forecasts, particularly in London which was currently at 8.4% growth year-to-date, well above the TRI full-year forecast of 5.6%.

HA Perspective: There is no question that the debt markets are currently choked but it is false to believe that all lending has stopped. Smaller deals that balance sheet lenders are comfortable with have continued to be put away over the summer and will continue, albeit with tighter conditions.

The biggest lump of debt waiting for a home is the $20bn that the investment banks underwriting Blackstone’s Hilton buy want to unload. The most bearish commentators have suggested that this might lead to this deal being unwound but that is very hard to see happening.

In fact, Blackstone still seems to be in acquisitive mood and is tipped as the buyer of the 46 hotels in the Alliance Hospitality portfolio being sold by Westmont and Goldman Sachs. Some reports have mooted a price as high as Eu1bn, although that would be toppy even without current market conditions.

Across the Atlantic, it emerged late yesterday that Fairmont has unloaded Delta Hotels, the manager of 40 properties based out of Toronto. The acquisition, by pension fund BC

Investment Management, is a further sign of normalcy returning. Two months ago the same pension fund paid $1.2bn to buy Canadian Hotel Income Properties REIT which has a number of hotels under the Delta brand.

The full picture of the credit market turmoil will take months to become clear. But an increase in the overall cost of capital seems unavoidable. Even if base rates decline, falling LTV ratios mean more equity or higher cost mezzanine will be needed.

With hotel trading performance beginning to decelerate, the combined effects must translate to pressure on hotel values as yields seem more likely to increase rather than decline further.

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