COVID-19 is causing tangible disruption throughout the hotel industry. Daily decreases in travel and cancellations of meetings lead to quick drops in occupancy, followed by hotel pricing decreases (often irrational) that further exacerbate market jitters. A hotel market rate and occupancy shopping app, MSight, estimated downtown Los Angeles hotels had a year-over-year market decrease of 4.7 percent in RevPAR for March 3rd, mostly driven by occupancy. Similar stories can be found in Manhattan, Miami Beach and San Francisco.
On February 20th, IATA issued a report that projects a potential 13 percent loss in full-year passenger demand for Asia pacific carriers. On March 3rd, the Board of Governors of the Federal Reserve made a decision to lower the federal funding rate by 0.5 percent, or 50 basis points. While the jury is out on the validity of the Fed’s use of economic stimulus to “combat” the current worldwide health crisis, such action sends a strong message to the market that we are in combat mode. Waking up in the morning to hope for quick virus containment is no longer an option, and decisive actions by hotel owners and lenders could have definitive and measurable results. While an immediate plan should be implemented to safeguard the well-being of employees and guests, this article focuses on the financial health of the asset.
Hotel operators
Operators know the drill. What is the contingency plan for a downturn in business of 5 percent, 10 percent, 20 percent or even more? Here some short highlights to consider:
- Staffing: Many hotels implement a hiring freeze and prefer to offer overtime where needed, as it often makes more economic sense than adding another FTE (full time equivalent) and keeps employees motivated. In addition, while March is not the typical employee vacation time, there might now be additional flexibility for PTO (paid time off) or unpaid time off.
- Rebidding contracts: The purchasing manager might be busy trying to source items that are now hard to find, but it is during slower times that harder to tackle expenses can be analyzed. This might include the outstanding workers compensation case resolutions, review of old POTS phone lines that are no longer active, the frequency of trash pickup, OTA cancellation penalty audits, or the elevator maintenance agreement.
- On a positive note: Hotels that typically run high occupancies (especially airport locations) can jump on/accelerate a deep clean and maintenance program to guest and employee areas (often referred to as room PM). Any such efforts should also include a critical look at storage facilities and the building’s external envelope.
- The three-month dust layer on marketing and sales plans should be removed to review second quarter efforts, including a hands-on session with the electronic marketing agency to derive a short term plan.
- On the food and beverage front: Does a breakfast only banquet for a small group actually make money or should that group be relocated to a dedicated space in the restaurant? Smart owners and operators keep a keen eye on group and catering booking pace to make wise decisions about banquet area activation as it often takes an army to open, maintain, serve, clean and close that space.
Hotel owners and lenders
A productive discussion can be held about the most recent hotel appraisal and/or PCR (Property Condition Report), as well as any pending brand PIPs. Details in such reports might include necessary capital improvements that are quick and easy to implement and can be done as a “one off”. This might include a mandatory replacement of parts of the fire life safety system (such as sprinkler heads), lock system upgrades, grease trap exchanges, roof repair, etc. Based on collaboration (and careful examination of USALI rules) in-house labor that is dedicated to a large enough capital project may be allocated to a job and funded by the reserve. In addition, smart financial controllers ensure that larger purchases of operating supplies such as linen are expensed over the projected period of consumption, or simply do not go into circulation until absolutely needed—at which point they are expensed over the projected useful life.
The reality is that the Covid-19 impact may cause hotels that are already struggling to default on certain terms of their loan agreements. The most notable covenant to be affected is the Debt (Service) Coverage Ratio or DCR, which requires available cashflow to be a certain percentage amount above the calculated mortgage payments. Floating rate mortgages might see a slight decrease in debt load, given the Fed’s recent actions, but it is unlikely that this will be sufficient to counter the potential decrease in projected revenue.
Lenders should be able to run historic DCRs extrapolated against market trends and identify potentially troubled assets. Perhaps more expedient, a simple call from the lender’s loan officer to the borrower, or preferably vice versa from the borrower to the lender (pending legal counsel approval), could set the stage to have an honest conversation about the coming months and mitigate potential complications. Loan officers are tasked with supporting and managing their debt portfolio, and they are also expected to be knowledgeable and proactive where possible. They might respond positively to a borrower who has a tangible plan and exhibits fiduciary ethics, but is simply impacted by market demand, and (often pending bank approval) offer certain flexibilities to avoid complications (if given proper notice). Unannounced shortfalls in payments to special account escrows that are used to pay insurance, real estate taxes, and CAM fees, as well as simply not paying the mortgage on time (or in full), often forces the loan officer to follow the bank SOP. Such protocols may include forwarding the account to the “Special Situations” or “Workout Team,” at best followed by legal notice with a timeline; at worst initiating a “hard lockbox” that traps all revenues until bank fees escrows and resulting legal fees are covered, thus significantly decreasing the available level of working capital to cover ongoing operations.
Gil Keinan serves as principal with HObsequio LLC, which specializes in hotel accounting, reporting, compliance and asset management.