The average price of hotel property in the UK went up by 6.1% in 2007 according to brokers Christie & Co. This is less than half the rate of increase achieved in 2006 of 13.1%.
Christie & Co remain optimistic on current conditions. "Despite the credit crunch, high quality hotel assets are still in scarce supply with many deals continuing to take place", said the company in its annual Business Outlook publication.
There is much truth in what Christie & Co has to say. But the underlying reality is much grimmer than this panglossian world view.
Hotels are a tiny sub-sector of the wider commercial property market. While it is entirely possible that hotels will prove more resilient than some sectors, it is unrealistic to suppose they will survive the current meltdown unscathed.
Last week, the Investment Property Databank showed that UK commercial property suffered its worst month since the index began in 1986. Total returns were down 3.7% just for the month of December. In the final quarter of 2007, total returns were down 8.5%.
Hotels are not included in the index, but it encompasses £51bn of property across retail, offices and industrial. IPD said that the speed of the reversal in the index was "unprecedented".
A burgeoning field in property is derivatives contracts. These allow investors to put their cash explicitly where their predictions are. IPD said that the pricing on the derivatives based on its indices show another two years of negative returns.
The hotel deals that have been done since the credit crunch in the summer are either single assets or small portfolios. Those deals requiring syndicated debt have collapsed.
The market consensus is that even if the prevailing gloom surrounding the debt markets lifts soon, it will still take until the second half of this year for the backlog of deals to clear.
Some debt providers remain in the market, others are out. Some that claim to be in the market are unable to lend unless they can move on some of their existing portfolio. There is no point doing that unless better quality loans – ones that are less risky and are at a bigger margin – come along.
Given the prevailing market conditions, even those banks which are lending have tightened spreads as discussed last week (see Issue 2, 16-01-08).
Even if the Bank of England drops rates in line with the Fed (and the Bank has indicated it is in no hurry to do so), the cheaper interest rates will merely compensate for the higher margins on loans. In continental Europe, the situation appears even worse with the European Central Bank unlikely to move its rates anywhere near enough to compensate for the increased borrowing costs.
Established lenders prefer cashflow as the key measure, rather than loan to value. But just as LTVs have dropped from 90% to a maximum of 75%, debt service requirements have risen from as low as 1.0 times to a target of 1.4 times.
The huge spike in property values had been caused by an overabundance of both equity and debt. The equity remains available but the rapid tightening of debt means values are heading one way: down.