Slippery Situation: Oil’s Potential Impact on Real Estate

While it’s certainly good news for the majority of consumers, the sliding cost of oil and gas could gum up the works for some real estate owners and investors.

With crude oil prices hovering around $50 a barrel since the beginning of the year, industry watchdogs are voicing concerns about the threats to particular real estate markets and CMBS transactions.

Oversupply and weak demand have pushed crude oil down more than 55 percent from its recent peak of $107 a barrel in June 2014. For the regions and commercial assets that are fueled by the petroleum industry—including parts of Texas, Colorado and North Dakota—sustained low oil prices could lead to vacancies and reduced property incomes, several real estate observers cautioned.

That, in turn, could bring on a new wave of delinquencies on highly leveraged properties, as well as increased volatility in high-yield bonds, some said.

“What people are most worried about is exposure to real estate markets with a lot of oil-services tenants,” Trepp Senior Managing Director Manus Clancy told Mortgage Observer in mid-January, noting that so far the impacts are largely theoretical.

“Upon re-leasing, the office tenants in those spaces would look to either give up space or spend less money,” he said. “Houston seems to be ground zero for that concern.”

Mr. Clancy said the submarkets at greatest risk are the oilfield “man camps” in West and South Texas and North Dakota’s Bakken shale region, where oil workers drill for fresh supply.

“These are places where there may be a couple of limited-service hotels and multifamily properties and everyone is there just to drill,” he said. “Those will be the first places to close up and die if oil remains in the $40 to $50 range.”

Jana Partners, an activist hedge fund that once held a major investment in the recently spun-off oilfield lodgings company Civeo Corp. sold its entire $51 million stake in the Houston-based firm on Dec. 30, 2014, regulatory filings show.

The New York-based fund dumped its 12 million shares after Civeo announced plans to severely cut its 2015 spending to between $75 million and $85 million, from $260 million and $280 million in 2014, as previously reported. Civeo plans to close sites and further reduce its North American workforce.

Civeo’s stock closed at $3.14 a share on Jan. 21, down from about $25 a share in October 2014. Representatives for Jana and Civeo declined to comment.

Several other Houston-based companies that specialize in oil and oil services, including Baker Hughes and Schlumberger, have announced budget cuts and layoffs. Overall, oil company analysts have said they expect 500 to 800 U.S. drilling rigs to come out of service in 2015, the Houston Chronicle reported in late December.

Likewise, CMBS deals backed by properties with heavy oil-related tenant bases could also take a hit if oil prices remain at a sustained low for several months or more, according to Trepp and other industry sources.

“For the Houston market, the concern is that if you just took out a $100 million loan on an office property where you have three big energy tenants, your grade-A tenants may start to look like grade-B tenants,” Mr. Clancy said. “If oil prices remain low, the securitizer may wonder, ‘Will they shrink their square footage? Will they go out of business?’ he added. “Nobody can say for sure what will happen to these guys, so that’s where all eyes will be.”

One prominent B-piece buyer who spoke at CRE Financial Council’s January 2015 conference in Miami Beach said that some recently issued securitizations for non-prime Texas developments are in jeopardy with oil and gas prices down. That buyer, who could not be named due to a strict conference policy on attribution, said those CMBS loans had been originated with high loan-to-value ratios and that the properties’ projected revenue streams relied on continued oil sector growth.

Now that that growth has been stymied, the panelist said he fears the loans may be headed to special servicing in the near future. That speaker and other industry representatives at CREFC declined to go on the record with their comments.

To be sure, others see the drop in oil prices as a minor concern in the context of a stable economy and rejuvenated real estate industry.

“The geographic diversity of other assets in multi-borrower deals will mitigate oil price exposure for CMBS,” Mary MacNeill, managing director of U.S. CMBS at Fitch Ratings, told Mortgage Observer.

There are no records of a single-asset securitized loan on a property in Texas, according to Fitch. However, the loan could still bring down the cash flow of securitizations that hold other mortgages.

“Vacancies in certain markets will rise over time if oil prices stay low for a more protracted period,” said Ms. MacNeill. “Particularly for office properties in Houston or other oil-dependent markets.”

The city of 2.1 million people, which is commonly referred to as the “energy capital of the world,” houses more than 5,000 energy-related firms, according to city government data.

Among several buildings in Houston that could be exposed are two office properties: Two Westlake Park at 580 Westlake Park Boulevard, owned by Houston-based Hicks Ventures, and Two Allen Center at 1200 Smith Street, owned by Brookfield Office Properties, loan documents provided by Trepp show.

Two Westlake Park is 80 percent leased to ConocoPhillips and BP, while Two Allen Center is 52 percent leased to U.S.-based natural gas and oil producer Devon Energy Corporation. Civeo is based in nearby Three Allen Center at 333 Clay Street, also owned by Brookfield.

The Devon Energy lease does not expire until 2020, which gives the space “minimal near-term exposure,” according to a Brookfield spokesperson.

“While Houston is considered a resource market, its economy is clearly more diversified now than it was during the ’80s and ’90s,” said Paul Frazier, head of the real estate giant’s Houston region. “Furthermore, the mid-stream and down-stream sectors of the energy space are also prominent in our economy, which gives us a hedge against lower commodity prices.”

Tom Fish, co-head of real estate investment banking in JLL’s capital markets group, also said that Houston’s economy and real estate market are adaptable enough to handle a shock to the oil industry.

“I don’t expect developers and projects to be going bankrupt or for there to be a string of foreclosures because of over-leveraged debt,” said Mr. Fish, who is based in Texas’ most populous city. “The capital markets for new development are efficient enough to withstand distress in the market,” he said. “I was here during the oil downturn of the ’80s and I don’t think we’re there again.”

Still, Mr. Fish said that there are concerns about the future of office and high-end multifamily properties in Houston with crude oil prices at such a low.

“Those have been the two most active sectors of construction in our city for the past few years,” he said. “If oil prices were to stay below $50 a barrel for several years, it would take its toll, but we are a long way from reaching a point where we see a lot of defaults.”

For the time being, low oil prices create a boon for retail companies, medical facilities, technology firms, and low- to moderate-income residences, Mr. Fish said.

“We’re a consumer-driven economy,” he told Mortgage Observer. “There’s no better way to turbocharge that than to put money back into consumers’ pockets.”

North American Hotel Investment Conference

The 2014 North America Hotel Investment Conference (NATHIC), held November 19 through 21 in Chicago, brought together a strong showing of hotel owners, investors, brokers, consultants, franchisors, brand representatives, and students from Michigan State University, New York University, and DePaul University. Top U.S. hospitality executives served on panel discussions that addressed an array of topics related to hotel ownership, development, and management, as well as the recent proliferation of new hotel brands and the catalyzing impact of Millennials or “Generation C” on the industry. A sense of optimism echoed throughout the conference, supported by reports of continued hotel performance improvements in markets nationwide. Read on for some of highlights from NATHIC 2014.


New Brands
Established brands are plentiful in the current pipeline of new hotel supply, while new brands and brand concepts continue to emerge and gain traction. Many industry insiders—including keynote speaker Jack DeBoer, who originally conceived the Residence Inn, Summerfield Suites, Candlewood Suites, and Value Place lines of hotels and, most recently, the WaterWalk Apartments—believe that the limited availability of established brands brings about the creation of new ones. Some speakers, however, emphasized the connection between new brands and the focus on Millennials (the generation of people born in the 1980s or 1990s), particularly as these travelers tend to be aligned with brand concepts such as health and wellness and lifestyle hotels.

The “soft brand” concept, currently represented by Marriott’s Autograph Collection and the Curio – A Collection by Hilton, among others, will soon include a new competitor. Michael Palmeri, Senior Vice President of Acquisition and Development for Loews Hotels & Resorts, announced the company will be rolling out a new soft brand in the first quarter of 2015. These “soft brands” or collections of hotels offer travelers looking for cultural experiences in unique destinations the security of basic brand standards; they also offer owners the benefits of brand affiliation, especially distribution and reservation channels. Other supply trends noted at NATHIC included the growth of ground-up developments versus conversions and the increasing development of urban extended-stay properties.

Although new brands, independent hotels, lifestyle concepts, and softbranded hotels tend to target customers from specific segments, the number of emerging brands and concepts was on the minds of many attendees. During the panel on extended-stay hotels, Diane Mayer, Vice President & Global Brand Manager with Marriott International, stated that “as [the number of] brands proliferate, they get harder and harder to differentiate.” Hence, while many new brands are emerging in the market, the lack of brand recognition can hinder their acceptance by customers, especially as, from the perspective of guests, discernible differences or advantages among the newer concepts are less evident when compared with those among existing brands.

Millennials and the Content Generation
The shear size, youth, and technological savvy of the Millennial generation makes it a key target demographic in today’s hospitality market. Many NATHIC attendees and speakers recognized that no one brand is likely to corner the market on Millennials, which are composed of a great many physiographic segments. Still, even if brands targeting Millennials capture only a small, like-minded portion of the approximately 80 million members of the generation, this still presents a very substantial potential customer base.

Millennials represent a sort of paradox when it comes to what they want in a hotel. They have high expectations when it comes to lodging, but look for sleekness and simplicity in the experience as well. Millennials also favor innovative design at every price point, and they’re tech-savvy yet value driven. The term Generation C (or the “Content Generation”) was also used to capture the physiographic of customers at all ages who create and share content through YouTube, blogs, and other online avenues; the members of Generation C, which may extend even more widely than the Millennial generation, hone in intensely on hotel options that allow them to access and share content during their stay. No matter the term, the importance of offering exactly what the customer wants, without all the extras they don’t want to pay for, is key.


Higher Spends, Longer Stays, and Limited New Supply Boost Optimism

Hotel performance so far into 2014 has exceeded expectations and will likely end on a high note, with all segments anticipated to exceed RevPAR levels in 2007 (the pre-recession peak) and 2013. Overall, occupancy for 2014 is projected to reach 64.6% and to surpass 65% in 2015; STR Analytics noted occupancy hasn’t been so high since the 1990s. Average rates in 2015 are expected to experience all-time highs as well.

Increased consumer confidence, longer stays with higher spending per stay, and limited new supply have all contributed to increasing occupancy and strong average rate. As the Great Recession becomes a thing of the past, consumers are willing to pay a premium for additional amenities and convenience. There was also discussion of the linkage between these trends and the aforementioned tendencies among Millennials and Generation C. Many spoke to how today’s consumers are extending their travel periods, most notably through an added Thursday or Sunday night to create an extended weekend. These longer traveling periods are becoming more prevalent in today’s hotel industry, and it was also recognized that many customers are willing to spend more on each day of their trip.

Lodging Econometrics reported that the U.S. hotel industry entered the expansion phase of the lodging real estate cycle in 2014. However, supply growth is expected to be approximately 1.3% and 1.6% in 2014 and 2015, respectively, which is notably below the 20-year average of roughly 2.0%. Conversely, the exit of hotel rooms is also below the industry average, according to Lodging Econometrics. Year-to-date through October of 2014, approximately 19,500 rooms have left the supply report, with approximately 4,000 of those located in Atlantic City. The industry average of hotel rooms leaving the system is approximately 35,000 per year.


Outlook
NATHIC 2014 made it clear that the optimistic outlook for the next several years, especially 2015, is well deserved. The potential impact of new legislature, such as the Living Wage Law, along with the influx of new brands, is important to consider going forward. Overall, however, the fulcrum of the hospitality industry is on the upswing.