"Extend and Pretend"—Just as Hamlet famously questioned, "To be or not to be," we are also on the brink of a crucial revelation. Are we facing a seismic shift with sustained higher interest rates, a largely overlooked issue? How will this shift affect commercial real estate and other asset classes in both the short and long term? Are the public and private sectors ready for what appears to be the inevitable? Today, we face more questions than answers, and indecision is no longer viable in a higher interest rate environment.

Unlike in the past few downturns, such as COVID, the Global Financial Crisis and the dotcom bust, the Fed significantly reduced interest rates, enabling owners of commercial real estate and lenders to easily engage in "Extend and Pretend," even when cash flows were negative or razor-thin, thanks to the exceptionally low interest costs.

Today, we are in a commercial real estate recession showing no signs of abating. The economy boasts considerable strength, driven by a strong job market, and record liquidity is on the sidelines. I do not see the necessary catalysts to revert interest rates to levels seen in previous cycles. Therefore, I don't see “Extend and Pretend” to be an effective strategy and would prepare for more bankruptcies, foreclosures and forced sales as reality sets in that we are in a new rate paradigm or maybe just a return to normalcy that, unfortunately, will be destructive to values, especially to the lower cap rate assets. Ultimately, amidst any market disruption, there will be pivotal opportunities for those with the decisiveness and the liquidity to seize them at the right moment.

This commentary originally appeared on Greg Friedman's LinkedIn page in response to a Wall Street Journal article titled: Even If the Fed Cuts, the Days of ultralow Rates are Over.

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The hotel industry has had a remarkable recovery in the post-COVID era, marked by strong fundamentals, limited supply and increased capital inflows, making it an attractive investment option.

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Peachtree Group CEO Greg Friedman sat down with Bryan Younge, executive vice president at Newmark to discuss this remarkable recover and where the market is today. Bryan heads the hospitality practice group at Newmark and is a leading commercial real estate advisor. Below is a recap of his expert analysis and insights.

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Listen to Peachtree's discussion with Bryan Younge, EVP Newmark here.

Hotel Industry Comeback

‍The industry witnessed an unprecedented come back after the pandemic. 

Limited New Hotel Supply: Limited new hotel supply coinciding with high travel demand creates a favorable scenario for the existing hotel inventory to capitalize on the surging interest.

Investment Attractiveness: The hotel sector's resilience has increased its appeal as an investment vehicle, offering substantial returns. This is reflected in the significant capital and dry powder ready for investment in this sector.

Macro Challenges: Despite its success, the industry faces challenges like staffing shortages, wage growth and inflation.

Hotel Performance – Segment: Closely examined the performance across various segments of the hotel industry, including commercial, group, leisure, and extended stay, as well as different distribution channels. These channels are crucial for predicting occupancy trends and Average Daily Rate (ADR), especially in the current volatile inflationary environment.

Key observations include:

• The group segment, crucial for hotel revenue, experienced a significant decline during the pandemic but has recently fully recovered.
• Other segments, like online travel agents (OTAs) and FIT (Foreign Independent Travel) and wholesale channel, outperformed group and global distribution     systems (GDS) in terms of recovery.
• The FIT and wholesale channel had a substantial initial setback but rebounded strongly in spring 2022, reaching levels 70% higher than in 2019.
• Seasonality patterns, resembling a heartbeat monitor, show three demand spikes in mid-spring, summer, and October, indicating a return to normalcy and     balanced pricing strategies.
• Overall, the analysis suggests that while larger hotels faced challenges during the pandemic, smaller hotels remained more resilient due to less reliance on group bookings and other factors. 
• The current trends indicate a recovery and adaptation in the hotel industry's various segments.

Predictive Analysis: Discussed methods for predicting future pricing trends in the hotel industry, including analyzing room rates and booking adjustments, the personal savings rate and its impact on the travel sector, and the performance of different hotel market segments and their recovery post-pandemic.

Transaction Market: An equilibrium is emerging in the transaction market, with buyers and sellers reaching common ground and avoiding distressed pricing. This indicates a healthy market with growth potential and abundant opportunities. 

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Investing in a franchise hotel can be a good way to diversify your portfolio and to achieve solid returns over an extended period of time. Finding the right hotel financing options can make this acquisition even more profitable. Comfort letters are designed to provide a legal framework for lenders and franchisors to handle situations in which the hotel purchaser defaults on the loan. Here are some facts ever investor should know about comfort letters.

What are Comfort Letters?

Comfort letters are documents that allow lenders to assume franchise rights if the original franchisee defaults on the loan. These letters include provisions that ensure that lenders can continue to operate the hotel in the event of default or foreclosure on franchise hotel loans.

Benefits of Comfort Letters

Comfort letters offer several benefits for all parties involved in the transaction, including the following:

• Borrowers are more likely to find the most attractive hotel lending arrangements if the lenders have greater certainty that they will be able to recoup their investment even if the borrower defaults. This can improve the terms of these loans and can make it easier to obtain the financing needed to acquire franchise properties.
• Lenders can more effectively collateralize their loans by ensuring the ability to maintain the profitability of the properties they finance.
• Franchise companies can protect their brand name by continuing operations and maintain a presence even when franchisees fail to meet their financial obligations and go into default on their hotel loans.

Many lenders require comfort letters before they will finalize loans for franchise hotel properties.

Crafted by the Franchise Company

In most cases, the comfort letter is drawn up by the franchise company as part of the franchising process. These legal documents may follow a standardized template or may be customized to suit the needs of the borrower and the lender. The contents of the letter may include some or all of the following provisions:

• A provision that ensures the ability of the lender to appoint a receiver to operate the hotel for a short period of time during foreclosure proceedings.
• A clause that allows the lender to cure any default of the franchise agreement before it is terminated.
• A provision that allows for the resale of the property and the transfer of the franchise agreement to a third party if the hotel goes into default.

These provisions are designed to protect the lender if the hotel financing loan goes into default.

About Peachtree Group

Peachtree Group is a direct lender with a specialty in hospitality lending. Our originators work with investors across the US to provide the most practical hotel financing arrangements for their specific needs. Contact us today to discuss your financial needs with one of our expert loan originators. We work with you to provide the best options for your hotel financing requirements.