How the Pandemic Made This Investment Firm a Leading U.S. Hotel Player Overnight

Real estate investment firm Highgate earlier this fall scooped up the biggest known U.S. pandemic-induced distressed hotel deal to date. Highgate bought $2.8 billion in hotel assets from Colony Capital for nearly $68 million and took on $2.7 billion in debt obligations.

The Colony deal is likely just the beginning when it comes to pandemic fire sales within the hotel industry.

“The disruption caused by Covid is unprecedented, and, as a result, there will certainly be a wide swath of opportunities to provide fresh capital and a fresh take on business plans. We constantly push our team to find innovative solutions to reconstructing hotel business plans,” said Mahmood Khimji, co-founder and managing principal at Highgate. “The Colony investment also speaks to the fact that we remain resolutely bullish on the long-term prospects for hospitality and travel.”

The Colony deal, comprised of nearly 23,000 hotel rooms across 197 hotels, is slated to close early next year and would make Highgate one of the largest hotel owners in the U.S. Khimji co-founded the firm with his brother, Mehdi, 30 years ago.

Highgate — which owns and operates properties like the Huntington Hotel atop San Francisco’s Nob Hill and the Knickerbocker in Times Square — is already one of the largest hotel owners in gateway markets like New York City, Miami, and Boston.

Highgate’s acquisition of hotels was made possible after Colony defaulted on $3.2 billion of healthcare and hotel commercial-backed property loans in May. The deal with Highgate appears to be the largest and one of the earliest distressed hotel industry transactions sparked by the pandemic.

“Through this disruption [over the last seven months], I have frankly been overwhelmed by the dedication, composure, and ingenuity that the Highgate team have brought to bear in addressing these challenges,” Khimji said. “As a result, I have never been more confident in our team and have never been more excited about Highgate’s future prospects. That confidence is what allows us to take on opportunities such as the Colony transaction.”

Highgate also added 22 hotels to its portfolio through its Trust Hospitality acquisition in early October, boosting its presence in Latin America and the Caribbean as well as strengthening its U.S. holdings.

Deals to Be Made

The other notable U.S. hotel industry pandemic portfolio shift was less about ownership and more with brand affiliation. Boston-based Service Properties Trust, or SVC, cut ties with Marriott and IHG earlier this year over property guarantee payment defaults. The landlord has since announced plans to transfer flag affiliation of those roughly 200 hotels to Sonesta International Hotels Corp., a smaller hotel company in which SVC has an ownership stake.

“Relatively speaking, we are still in the early stages of this crisis,” Khimji said. “The level of distress is unprecedented, so it is difficult to generalize on how the lending community will respond in the aggregate as this crisis matures and the longer-term ramifications are felt for the [commercial mortgage-backed securities] market and hotel owners.”

General hotel industry expectation is that a wave of hotel loans will default, and investors are waiting in the wings to scoop up distressed assets at rock-bottom prices.

Hotels — at a nearly 24 percent delinquency rate at the end of the summer — are the biggest source of delinquent loans for commercial mortgage-backed securities, a group of mortgages pooled as one that hotel developers use to build new projects, according to data firm Trepp. Just over 1 percent of that type of hotel loan was in default at the end of 2019.

But there are also green shoots of hope for hotel owners with loans outside of the commercial-backed market.

Given the enormity of the pandemic’s economic impact, individual banks offered forbearance and payment flexibility in the early months of the pandemic. That, combined with government relief passed in March, pushed out the timeline of at least some of the projected wave of loan defaults.

“Each capital stack presents unique challenges and opportunities. Through the outset of the crisis, we have seen lenders act constructively to find solutions with borrowers and we expect that, on balance, we will continue to see lenders take a collaborative approach,” Khimji said. “The ultimate outcomes for each of these capital stacks will likely be a function of borrowers’ willingness to invest or source fresh capital, and whether business plans were sound coming into this crisis or fundamentally impaired prior to the crisis.”

Segment Agnostic

The pandemic sparked the worst year on record for the hotel industry, but there have been some relatively strong performing segments due to changing traveler demands.

Extended stay hotels were generally the best-performing assets during even the worst of the pandemic due to the segment’s appeal to essential workers in fields like construction and healthcare as well as residential uses. Extended Stay America, sparked by its performance in the early days of the pandemic, even picked up notable investments from Starwood Capital and Blackstone Group.

Resorts and hotels in drive-to locations are expected to continue to lead the recovery while business traveler and convention-geared hotels in urban markets are likely to lag. Wyndham, which largely operates in drive-to and leisure markets, attributed these trends to its small third quarter profit reported last week.

Highgate leaders see the trends but aren’t letting them dictate their investment strategy.

“Highgate has a long history of growing market share in challenging environments and in making contrarian investments through cycles,” Khimji said. “I believe this is largely a function of Highgate’s track record as being a reliable, highly-flexible, value-add collaborative partner.”

The company’s current portfolio spans from extended stay and suburban select-service products all the way up to the Newbury Boston, a luxury hotel slated to open in the next few months in the heart of Boston’s urban core.

“Historically we have been segment agnostic,” Khimji said. “Our guiding principle is to pursue opportunities where we have a unique ability to add value and where we are confident that we can deliver on our partners’ objectives.”