Archives for November 2022

After a surge of activity earlier in the year, many hotel investors are putting their wallets back in their pockets. The disruption has been caused by rising interest rates and the potential for a recession in 2023.

Some hotel properties are still trading hands. Some recent nine and 10 figure transactions have made headlines. But they’ve also distorted the data on transactions. As a result of these deals, average prices are still high and cap rates are still low. Sales of individual hotel properties may be a better indicator of the health of the market overall than those averages. And investors spent less to buy individual hotel properties in October 2022 than any month since 2020, according to MSCI. “The headline increase was a function of megadeal activity,” says Jim Costello, chief economist for MSCI.

For example, the 260-room Montage Laguna Beach, located on the rugged Southern California coastline between Los Angeles and San Diego, Calif., sold for an estimated $650 million, or $2.5 million per key, to Texas billionaire Tilman Fertitta. It’s just one of several deals to where luxury, resort hotels traded hands.

“There’s a perception that resorts are a bit more insulated from recessions,” says Jan Freitag, national director for hospitality market analytics at CoStar.

Investors are also still closing giant deals for portfolios of hotel properties. In a November deal valued at $1.1 billion, Flynn Properties and Värde Partners, a leading global alternative investment firm, bought an 80 percent ownership stake in a portfolio of 89 select service and extended stay hotels. The sellers, affiliates of Highgate and Cerberus Capital Management, retain 20 percent ownership of the portfolio and Highgate will continue to manage the properties.

The deal “speaks to resilience of the limited-service sector of the market as well,” says Freitag.

A few giant deals like these can mask the deepening weakness in the market for hotel properties. Investors spent $4.6 billion to buy hotel properties in October 2022, according to MSCI. That’s a 28 percent increase from October 2021—and 2021 had seemed very busy at the time. But nearly two-thirds of the money investors spent on hotel properties in October 2022 came from just one deal: Brookfield AM’s acquisition of Watermark Lodging Trust.

If you leave the deal for Watermark Lodging Trust out of the total and just count sales of single hotel assets, then investors spent less than $2 billion in October. That 50 percent less than they spent in October 2021.

Investors are also not bidding up prices for hotel as quickly as they did earlier in the recovery from the pandemic. Prices for hotel properties grew as an annualized pace of just 1.3 percent in October 2022, according to Moody’s Commercial Property Price Index. That’s better than the prices for most other types of commercial real estate, which shrank in October. But it’s a slower pace of growth than in previous months. The CPPI for hotels grew at an annualized pace of more than 10 percent throughout the first quarter of 2022.

Cap rates still averaged less than 8.4 percent in October, according to MSCI. That’s roughly the same as September. The average cap rate wobbled within a dozen basis points of 8.4 percent for most of 2022.

Strong demand for hotel rooms

The fundamental demand for hotel rooms has come a very long way since the depths of the coronavirus pandemic—and that is helping to support strong prices.

“Demand has basically recovered on a national level,” Freitag says.

The demand for hotel rooms is now roughly the same as it had been in 2019. It was slightly lower in October 2022 than October 2019. It had been slightly higher in September 2019 than September 2019. The strong recovery in demand has still left the occupancy rate for hotel rooms few percentage points lower than it was before the pandemic—64 percent in October 2022, compared to 67.6 percent in October 2019. That’s because developers have continued to open new hotel rooms.

“Because supply has grown over the last three years, occupancy is still lower than it was in 2019,” says Freitag.

However, the demand for hotel rooms is still strong enough to support higher nightly rates for hotel rooms, averaging $149.54 from January through October 2022. That up from $131.98 over the same period in 2019.

Source: “High Interest Rates and a Looming Recession Weigh on Hotel Investment Deals“

The past year has brought more cannabis legalization in the United States. But is legalization turning into greater real estate investment opportunities?

Two more states, Missouri and Maryland, voted in the November 8 election to make cannabis legal for adult use, making recreational marijuana use legal in 21 states, plus the District of Columbia and Guam. Adding states where medical marijuana is legal brings the total to 38.

As a result, the most recent Marijuana Business Factbook, published by Marijuana Business Daily, projected that sales for the legal U.S. cannabis industry could reach $30 billion in 2023, which is triple the amount of total pot revenue in 2018.

Yet despite expanding opportunities for investment in cannabis-related real estate, sentiment among investors remains unfavorable due to ongoing downward revisions to revenue and EBITDA (earnings before interest, taxes, depreciation and amortization, a formula used to approximate the value of a business) projections by many of the cannabis companies, says Matthew Karnes, CPA and founder of Greenwave Advisors, a New York-based cannabis research and advisory firm. This downward trend is attributed to both the economic headwinds of rising prices and strong illicit market that provides a less expensive alternative for consumers than legal cannabis sellers, he notes.

A recent report from Hoya Capital Income Builder Marketplace also cited stalled progress in federal legalization of cannabis, which has made a challenging fundraising environment even tougher; tighter monetary policy; and a 30 to 50 percent plunge in cannabis prices due to a flood of new entrants to the cannabis industry, as reported by Seeking Alpha.

Valuation of cannabis properties is complicated because a lot is contingent upon the timing of federal legalization, says Karnes. In general, both cannabis businesses and real estate are valued based upon projected cash flows, but the added nuance related to cannabis involves section 280e, or the higher taxes to which cannabis companies are subjected.

“The longer prohibition continues, the harder it will be for many cannabis companies to continue as a going concern due to the added costs of prohibition, most notably income tax,” Karnes says. Section 280e of the IRS code can have an effective tax rate as high as 70 percent, which has promped a surge in distressed asset sales, he notes.

A few cannabis operators have recently backed out of deals to purchase New York licenses, including Ascend – MedMen and Verano – Goodness Growth, because following deal announcements, they realized that cannabis prices had dropped significantly, Karnes adds.

REIT investment as an option

Cannabis REITs, on the other hand, are appealing to investors because they pay dividends and are listed on a major stock exchange, says Karnes, but most importantly, REITs are not subject to Section 280e.

Cannabis REITs, including five public and a handful of private ones, are a primary financing source for cannabis operators and have delivered significant outperformance compared to broad-based cannabis exchange-traded funds over most recent and long-term measurement periods.

REITs effectively serve as “non-bank” lenders to state-licensed cannabis cultivators, which do not have access to federally regulated banks. Therefore, many operators rely on REITs for funding. Equity REITs acquire cannabis properties through sale-leaseback deals typically structured as triple-net leases with terms of 15 to 20 years, while cannabis mortgage REITs usually originate five- to 10-year loans collateralized by the underlying real estate, which stays on the balance sheet of the borrower. In both cases, the capital provided enables operators to build-out new facilities or expand existing cultivation operations.

But even this part of the industry remains challenged, according to Karnes, as the ability for some cannabis tenants to make lease payments remains questionable, which has prompted some investors to remain on the sidelines. For example, cannabis REIT Innovative Industrial (IIPR) reported in July that Kings Garden, one of its largest tenants with six leased properties, had defaulted on its second quarter rent obligations for total base rent of $5.5 million.

“Valuations for the public cannabis REITs also have taken a beating over the last six months as larger economic concerns, such as inflation, have driven REIT investors to more conventional real estate property types and larger, more liquid names,” adds James Fitzpatrick, Orange County, Calif.-based president of Solutioneers, a consulting firm that provides compliance and land use services to cannabis firms.

As a result, access to and the cost of capital for these players has become more challenging and investment activity has cooled off somewhat, Fitzpatrick notes.

There are a few private cannabis REITs, such as Aventine Property Group, that have achieved scale and are making investments, he says, noting that these private REITs typically raise money from hedge funds and family offices, which take a longer view of the opportunity and can be patient through cycles. “As such, they may be able to continue to raise capital in spite of challenges with the public markets.”

The most desirable cannabis-related properties in today’s market provide the ability to scale and increase operating cash flow, according to Karnes. He also stresses that properties in states that adopt a limited-license model are the most popular among investors.

This framework, which effectively ties the license to the property, puts the real estate asset at the center of the business and grants the landlord significant protection from tenant non-payment, while also serving as a barrier-to-entry to new supply growth, according to a report from the Hoban Law Group.

Source: “Sales of Cannabis Real Estate Run into Some Challenges“

The past year has brought more cannabis legalization in the United States. But is legalization turning into greater real estate investment opportunities?

Two more states, Missouri and Maryland, voted in the November 8 election to make cannabis legal for adult use, making recreational marijuana use legal in 21 states, plus the District of Columbia and Guam. Adding states where medical marijuana is legal brings the total to 38.

As a result, the most recent Marijuana Business Factbook, published by Marijuana Business Daily, projected that sales for the legal U.S. cannabis industry could reach $30 billion in 2023, which is triple the amount of total pot revenue in 2018.

Yet despite expanding opportunities for investment in cannabis-related real estate, sentiment among investors remains unfavorable due to ongoing downward revisions to revenue and EBITDA (earnings before interest, taxes, depreciation and amortization, a formula used to approximate the value of a business) projections by many of the cannabis companies, says Matthew Karnes, CPA and founder of Greenwave Advisors, a New York-based cannabis research and advisory firm. This downward trend is attributed to both the economic headwinds of rising prices and strong illicit market that provides a less expensive alternative for consumers than legal cannabis sellers, he notes.

A recent report from Hoya Capital Income Builder Marketplace also cited stalled progress in federal legalization of cannabis, which has made a challenging fundraising environment even tougher; tighter monetary policy; and a 30 to 50 percent plunge in cannabis prices due to a flood of new entrants to the cannabis industry, as reported by Seeking Alpha.

Valuation of cannabis properties is complicated because a lot is contingent upon the timing of federal legalization, says Karnes. In general, both cannabis businesses and real estate are valued based upon projected cash flows, but the added nuance related to cannabis involves section 280e, or the higher taxes to which cannabis companies are subjected.

“The longer prohibition continues, the harder it will be for many cannabis companies to continue as a going concern due to the added costs of prohibition, most notably income tax,” Karnes says. Section 280e of the IRS code can have an effective tax rate as high as 70 percent, which has promped a surge in distressed asset sales, he notes.

A few cannabis operators have recently backed out of deals to purchase New York licenses, including Ascend – MedMen and Verano – Goodness Growth, because following deal announcements, they realized that cannabis prices had dropped significantly, Karnes adds.

REIT investment as an option

Cannabis REITs, on the other hand, are appealing to investors because they pay dividends and are listed on a major stock exchange, says Karnes, but most importantly, REITs are not subject to Section 280e.

Cannabis REITs, including five public and a handful of private ones, are a primary financing source for cannabis operators and have delivered significant outperformance compared to broad-based cannabis exchange-traded funds over most recent and long-term measurement periods.

REITs effectively serve as “non-bank” lenders to state-licensed cannabis cultivators, which do not have access to federally regulated banks. Therefore, many operators rely on REITs for funding. Equity REITs acquire cannabis properties through sale-leaseback deals typically structured as triple-net leases with terms of 15 to 20 years, while cannabis mortgage REITs usually originate five- to 10-year loans collateralized by the underlying real estate, which stays on the balance sheet of the borrower. In both cases, the capital provided enables operators to build-out new facilities or expand existing cultivation operations.

But even this part of the industry remains challenged, according to Karnes, as the ability for some cannabis tenants to make lease payments remains questionable, which has prompted some investors to remain on the sidelines. For example, cannabis REIT Innovative Industrial (IIPR) reported in July that Kings Garden, one of its largest tenants with six leased properties, had defaulted on its second quarter rent obligations for total base rent of $5.5 million.

“Valuations for the public cannabis REITs also have taken a beating over the last six months as larger economic concerns, such as inflation, have driven REIT investors to more conventional real estate property types and larger, more liquid names,” adds James Fitzpatrick, Orange County, Calif.-based president of Solutioneers, a consulting firm that provides compliance and land use services to cannabis firms.

As a result, access to and the cost of capital for these players has become more challenging and investment activity has cooled off somewhat, Fitzpatrick notes.

There are a few private cannabis REITs, such as Aventine Property Group, that have achieved scale and are making investments, he says, noting that these private REITs typically raise money from hedge funds and family offices, which take a longer view of the opportunity and can be patient through cycles. “As such, they may be able to continue to raise capital in spite of challenges with the public markets.”

The most desirable cannabis-related properties in today’s market provide the ability to scale and increase operating cash flow, according to Karnes. He also stresses that properties in states that adopt a limited-license model are the most popular among investors.

This framework, which effectively ties the license to the property, puts the real estate asset at the center of the business and grants the landlord significant protection from tenant non-payment, while also serving as a barrier-to-entry to new supply growth, according to a report from the Hoban Law Group.

Source: “Sales of Cannabis Real Estate Run into Some Challenges“

Another day, another set of companies interested in the potential that CRE distress might offer. Atlanta-based real estate investment platform CARROLL Credit is working with institutional partners to pull together $250 million for structured capital investments in multifamily primarily found in the Sun Belt.

That region as well as the West have been seen by the industry as fertile grounds for profits, given shifts in demographics and businesses moving to the areas. Those changes have directly and indirectly driven demand for housing. As is true elsewhere in the country, costs of buying a house, compounded by rising mortgage rates, have pushed many people firmly into the arms of rental living.

But it’s easy to misapprehend the situation. Talking of the Sun Belt market in particular, David Lynd, CEO of the Texas-based Lynd Group, who has acquired and developed real estate there for 40 years, previously told GlobeSt.com, “It’s divided into a lot of different submarkets like Arkansas, Oklahoma, Texas, Florida. It is not a one-size-fits-all solution. The bottom line is they’re having their ‘day in the sun.’ We love the Sun Belt, we love everything it represents, but this pandemic certainly threw gas on the fire and accelerated markets into a big population boom.”

“It’s harder to underwrite deals, even though the rent roles are coming,” Swapnil Agarwal, CEO of Nitya Capital, told GlobeSt.com. “A lot of people are betting on rent growth.” They justified low cap rates with the promise of future higher rents, but how long will renters have the same income multiples of rent that have been available?

Back to Carroll. As a PR rep for the firm wrote, “high cap rates caused by rising interest rates and other factors – affecting developers/owners who bought properties too high and at low cap rates” are a major reason Carroll expects distressed multifamily properties. Following that are frozen markets, where owners can’t get loans to complete deals, and maturing loans that might leave many unable or unwilling to refinance at higher rates.

The plan is for CARROLL Credit to leverage the parent company’s operational capabilities, as it currently has 32,000 multifamily units across nine states. According to the company, the choice of properties will be those that, if necessary, it would be comfortable taking over in case the owner can’t continue payments.

Carroll is not the only platform interested in the potential that current conditions might provide. Greystone Commercial Mortgage Capital, an affiliate of CRE finance firm Greystone, and Inlet Real Estate Capital formed a joint venture to provide short-term, floating-rate capital to troubled CRE property owners.

Source: “CARROLL Credit Gets Ready for Multifamily Distress in the Sunbelt“