Boston's hotel market is firing on all cylinders
Hotel investors worldwide consider Boston to be a top destination for hotel investment in the United States. Anchored by world-famous institutions in both higher education and healthcare, Boston is a diverse and thriving economy that is only getting better. New developments in the Seaport District, Downtown, North Station, Fenway, Back Bay and Cambridge will surely drive expansion and add to an already impressive lineup of notable Boston-area companies, including General Electric, Fidelity, John Hancock, LogMeIn and Wayfair. Furthermore, more than 18 million people visit the city annually to experience the abundant tourist attractions and to attend events at two world-class convention centers: The Boston Convention & Exhibition Center (BCEC) and the Hynes Convention Center.
Due to strong corporate, leisure and convention demand, Boston is one of the top-performing lodging markets in the country. Occupancies have hovered above 80 percent for five consecutive years, and the market-wide average daily rate was $258 as of year-end 2017, according to a survey conducted by Pinnacle Advisory Group.
Boston Hotel Investments: A Scarcity Premium
Despite unprecedented levels of interest in Boston hotel real estate, very few hotels have been marketed for sale over the past few years. Through the first five months of 2018 saw only two hotels transacted, while only three hotels transacted in downtown Boston and Cambridge in all of 2017. All of these trades represented historically high price per keys and low cap rates.
What is contributing to this highly competitive transaction environment? The answer is simple supply and demand dynamics. With strong hotel operating performance, Boston hotel owners are content with current cash flow, and many existing hotel owners in Boston are considered to be long-term owners of real estate. Those owners that have considered a sale are taking advantage of the lack of available opportunities by demanding attractive prices. Over the past few years, despite record levels of “dry powder” from private equity needing to place capital into real estate, these investors have remained disciplined. This discipline has led to a “bid-ask” spread phenomenon, meaning that there is a gap between seller expectations and what buyers can economically underwrite.
We expect that the collision course between the lack of available opportunities and a massive wall of private capital will result in the bid ask spread compressing to a level in which there will be meaningful transaction activity for the remainder of 2018 and through 2019.
Who are the Boston Hotel Buyers?
Nine years into a bull market, the days of the “value-add” hotel deal in Boston are more or less in the rearview mirror. As such, value-add/opportunistic capital (private equity firms with higher return profiles) have been priced out of the market. The most likely buyers for 2018 and beyond will be domestic high-net-worth family offices, public and private hotel REITs and global capital, all looking at a long-term hold period.
Since its founding in 1630, Boston has long been a gateway city with an international presence. Several recent acquisitions included capital from Canada, Europe, the Middle East and Asia. We expect this trend to continue with significant global capital investments in both acquisitions and development.
Furthermore, we view global capital as being increasingly more strategic. In the past year, we have witnessed an increasing demand from very well capitalized global capital sources that are aggressively working on expanding their global hotel brand distribution. Recent examples of new developments from international brands include Yotel (UK) and CitizenM (Netherlands).
Hotel Development Increasing but Measured
The lack of developable land, a lengthy permit process and the high costs of construction make Boston a challenging development landscape with very high barriers to entry. As such, Boston is generally considered an under-supplied hotel market.
With the transaction environment as competitive as it is, developers and private equity alike are finding value through new development. Today, nine hotels are under construction totaling 1,969 hotel rooms. While this represents a roughly nine percent increase over the existing supply of hotel rooms, the increase in hotel supply since the last recession has been modest comparative to other cities experiencing a tremendous growth in new hotel supply.
We expect a handful of these new hotel developments to deliver in 2018 and we expect that there will be an increasing focus on boutique hotels with unique design elements and an experiential lodging experience.