Boston-based H.N. Gorin Co. and Masterworks Development received approval in 2023 for a 300-room hotel at 39 Stanhope St. in Back Bay. Image courtesy of Group One Partners

Despite improving fundamentals, hotel transactions in Boston were subdued during the first half of 2024.

The same macroeconomic headwinds that hampered transaction volume nationally last year, along with a substantial increase in the cost of capital driven by the Federal Reserve’s interest rate strategy, has created a bid/ask spread that has left buyers and sellers 100 to 200 basis points wide of one another on capitalization rates.

On the bid side of the equation, the expansion in capitalization rate requirements for buyers is generally driven by the inability of investors to step into “negative leverage” situations in which the cost of debt capital is greater than the acquisition capitalization rate.

With the base Secured Overnight Financing Rate (SOFR) at 5.3 percent as of mid-May and spreads above SOFR ranging anywhere from 400 to 600 basis points depending on deal and cash flow profiles, all-in interest rates of more than 9 percent are not conducive to sales, especially in a market that historically traded in a capitalization rate range of 6 to 8 percent.

Until there is either capitulation by sellers on value or an improvement in the broader capital markets environment such as an interest rate cut, CBRE believes the hotel transaction market is likely to remain in a state of stalemate.

Robert Webster

Fundamentals, Market Sentiment Disconnected

Despite strong industry fundamentals, the hotel transaction capital markets have been in a “risk-off” position – which refers to the current sentiment of investors relative to their appetite for risk – for the better part of two years.

This decoupling between capital market sentiment and fundamentals will not last forever and we suspect that a transition to “risk-on” investor sentiment will occur sooner rather than later, especially in a quality market like Boston.

While it is unclear whether or not the stalemate will be broken in the second half of 2024, CBRE is bullish on the Boston-Cambridge hotel market during the next economic cycle given the severe supply-demand imbalance in and around the city.

Joe Cookson

Most notably, and against one of the most diverse bases of hotel demand in the country, CBRE anticipates that the supply of hotel rooms in Boston will grow at rates well below long-term historic averages as high construction and borrowing costs put stress on developers’ underwriting models.

The average hotel in the city of Boston does approximately $25,000 per key in net operating income.

If we assume construction costs are currently $600,000 to $700,000 per room and with construction debt well north of 10 percent, you have to make some incredibly aggressive assumptions for development underwriting to yield an attractive return.

We are hopeful that this structural barrier on the supply side will lead to strong growth rates for both cash flows and net asset values.

Despite strong industry fundamentals, the hotel transaction capital markets have been in a risk-off position for the better part of two years. This decoupling between capital market sentiment and fundamentals will not last forever however and we suspect that a transition to risk-on investor sentiment will occur sooner rather than later, especially in a quality market like Boston.

The average hotel in the city of Boston does approximately $25,000 per key in net operating income. If we assume construction costs are currently $600,000 – $700,000 per room and with construction debt well north of 10 percent, you have to make some incredibly aggressive assumptions for development underwriting to pencil with an attractive return. We are hopeful that this structural barrier on the supply side will lead to strong growth rates for both cash flows and net asset values.

Robert Webster is vice chairman and Joe Cookson is a senior vice president at CBRE Hotels Institutional Group.

Interest Rates Depress Hotel Capital Markets Activity

by Banker & Tradesman time to read: 2 min
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