Insider's view: JLL hotel executive talks business-travel recovery, threat of distress heading into 2022

Chicago Business Journal

By:  Ashley Fahey

Nearly two full years after the Covid-19 pandemic began to impact the U.S. economy, some aspects of the hotel market have yet to come back.

With the Omicron variant now sweeping the globe, it's thrown yet another wrench in the ongoing recovery for the hospitality sector, although several U.S. markets ended 2021 stronger than even pre-pandemic 2019. Others reliant on business and group travel continued to struggle.

Kevin Davis, before the end of 2021, was appointed Americas CEO of Jones Lang Lasalle Inc.'s (NYSE: JLL) hotels and hospitality division, a group that's completed $83 billion in transactions in the past five years globally. Davis was previously a senior managing director at JLL, leading the firm's hotel investment banking group.

"We believe that 2022 will be incredibly strong from a transaction perspective, Omicron notwithstanding," Davis said. "Worst case, we think that pushes things back a couple of months. But as we look at our pipeline, we have an unprecedented pipeline of deals that we're taking out, including several transactions that are in excess of $1 billion."

The Business Journals caught up with Davis to talk about the hotel market recovery and what's on tap for 2022. The following excerpts have been edited for brevity and clarity.

Did we end 2021 with the kind of recovery that was hoped for?

I would say the one word that defines the year last year is bifurcated. It's really a tale of two cities in terms of how the recovery has played out in hospitality. On the one hand, you've had drive-to leisure resorts and hotels that cater to leisure travelers, as well as hotels in a number of the Sun Belt states that have generally remained open throughout Covid. Those assets performed exceptionally well and, in many cases, have outperformed 2019, which is the pre-Covid benchmark that investors are typically using when they evaluate a purchase or investment opportunity.

And then, on the other side of the ledger, are assets that are generally in urban markets like New York, San Francisco, Chicago, Boston … frequently, they’re union markets, so you have a pretty entrenched labor-cost structure. Many of those markets have had the most stringent Covid requirements, and those markets are frequented by business travelers. In the absence of a return of business travel, and a reduction in leisure travel to some of the urban markets, which were heavily affected by a reduction in international travel, some of those bigger markets have really struggled to recover. And, on top of that, (for) the hotels that generally cater to group meetings, we've not seen the group sector recover yet. Assets, both urban as well as outside of urban centers, that, again, are generally 500-plus keys or greater, unless they're in these resort markets, a lot have struggled to recover because there's not yet been a return of group travel.

As we look ahead, we know remote work and virtual meetings are going to become more commonplace. Will there be a lot of permanent changes that will permanently affect how successful hotels reliant on that type of travel are? 

From a group perspective, we actually think the work-from-home, or the hybrid work, phenomenon will actually benefit group travel because people may not be in the office as much, they may not be traveling to see clients as much. Maybe you don't have as many large meetings, as there once were, but we think there will be more frequent smaller meetings.

It's not clear that you will see a full return of business transient as we knew it. However, I think it's important to note that the nature of travel will be changing. In a work-from-home or hybrid scenario ... there's literally nothing stopping me from going to Miami and doing client meetings and working from our Miami office for a week whereas, in the past, I would have gone for a day or two days, met with clients, came home. Now, there's less pressure for me to be in an office on 42nd and Madison. Instead of being in Miami for two days, I can actually spend a week in Miami: two days meeting with clients and the remaining three days working from our Miami office — again, because I have a lot more flexibility for work.

The fundamental thesis for me is that work-from-home, or hybrid work, creates mobility workers, and, by definition, greater mobility is good for travel and is good for hospitality. When people are not required to be chained to a desk in a specific location and have the flexibility to work from anywhere, that's ultimately good for travel. More people will move around, more people will stay in hotels. When I say I'm optimistic about the future, it’s because I think that there will be greater demand. The demand may not fit into the old categories that they used to fit into. But there will ultimately be greater demand for room nights and hotels.

How does all of this affect what investors are targeting?

You've obviously had a lot of capital flow to the drive-to leisure resorts, and you had significant transactions where those types of assets are seeing record valuations. If you look historically, there have been seven $2 million-plus per-key transactions that have ever been done. Three of those got done post-Covid, just to give you some perspective of the frothiness, and those have generally been drive-to leisure, resort, coastal assets. There's been less focus on urban assets and group-oriented assets.

We've seen smaller markets that historically have been less of a target for institutional capital become in favor. We ran an asset sale in Portland, Maine, where we had incredibly strong bidding. And I would submit to you that, if this were 2019, the pool of liquidity would have been much shallower and the pricing would have been meaningfully lower. But it's a market that is a drive-to leisure market that people are attracted to. We also traded a portfolio of assets in Cape Cod, (Massachusetts), your classic drive-to leisure, family-owned — again, incredible reception from the market, tremendous amount of liquidity, tremendously strong pricing. They're the types of assets which, pre-Covid, would have received a lot less interest from the market, particularly because they're not your traditional institutional type of assets. But because they appeal to drive-to leisure travelers, institutional investors are strongly attracted to those types of assets.

Do you expect a certain category of hotel property will disproportionately struggle or face distress?

I would say generic assets in urban markets, particularly that have union labor, and particularly if there are significant ground rent payments associated with the assets. I would say that is the category of the greatest level of distress. This cycle has been categorized by a lack of distress. If I had to label what I think will happen in 2022, I would call it distressed light. And maybe it's distressed very light. There will be situations where you have owners that are forced to sell if, for no other reason, now that we're three years into Covid, they can't make the debt-service payments or they won't make the debt-service payments any longer, and they're tired of funding operating losses. Similarly, some of their lenders will force the investors’ hand: either force a sale or the lenders may look to sell the loans to buyers that may be less than friendly and look to foreclose owners out.

These are assets that have heavy operating costs and, in markets that have not yet recovered, I think that's where you will see a little bit of action.

If you look back at the financial crisis, there was an 18-month lag between the collapse of Lehman Brothers, the stock market meltdown and the legislative response. Post-Covid, we were 30, 45 days in, and we had a strong response from Congress as well as the Fed. You had both the fiscal response and the monetary policy response, which provided significant amounts of liquidity, which has helped limit the amount of distress. But, again, with hotel assets that are capital intensive, the passage of time and the lack of operating performance is what will force some of these owners and some of these lenders to finally have to deal with the problem. I think 2022 is the year that you start to see that. 

Are debt and equity sources feeling comfortable about financing new hotel development, particularly in those leisure-driven or Sun Belt markets, the ones recovering fastest?

We've got a number of hotel construction deals that we’re in the market with that we're getting strong reception from lenders with. We have been selective in terms of the types of deals that we've taken off, so to the earlier point, it's generally in drive-to leisure markets or markets that have strong underlying job growth and strong underlying fundamentals. The other driver is, we're betting on sponsors that have a long track record of developing hotel properties, and also in incredibly high barrier-to-entry markets. I'm a firm believer that there's no substitute for irreplaceable real estate. So good market, bad market — irreplaceable real estate with strong experience sponsorship, those are deals that get done. Those are the types of deals where you see sponsors having access to capital for new construction.