The coronavirus pandemic upended the U.S. lodging sector this past year, and S&P Global Ratings doesn't think a recovery will take hold in earnest until there's a widely disseminated medical solution--likely in the second half of 2021. Since April, we lowered the ratings on roughly 75% of all rated U.S. lodging companies, with only the cruise, theme parks, and fitness subsectors experiencing higher downgrade rates in the Leisure space as a percent of total issuers (see chart 1). Large hotel owners and globally diversified managers and franchisors face greater "Fallen Angel" (going from investment grade to speculative) risk, with the four remaining investment-grade issuers rated 'BBB-', with a negative outlook--on the cusp of speculative grade. Moreover, all ratings in the lodging sector have negative outlooks or remain on CreditWatch with negative implications, reflecting the potential for more strain on credit quality if the recovery path deteriorates beyond current expectations (see chart 2).

Chart 1

Chart 2

Chart 2a

U.S. Lodging Demand Has Become Untethered From GDP

While U.S. lodging demand is typically tied to GDP, our sector forecast has become untethered from key macroeconomic indicators due to health and safety concerns. This is most evident in the unprecedented slump in revenue per available room (RevPAR) in the U.S., which was down 46% in the first nine months of this year. The components that contribute to the loss in RevPAR include hotel occupancy and average daily rates, which were down 33% and 20%, respectively, through the third quarter. While hotel indicators have improved since the severe plunge in April, occupancy rates remain depressed due to rising infection rates and a lack of a medical solution. For the week ended Oct. 24, occupancy rates were down by 23.9% year over year, reflecting a choppy recovery depending on both hotel type and location. For example, in the top 25 markets in the country, which are significantly weighted toward upper upscale and luxury properties that rely on business and group travel, RevPAR was down 55% compared to the 46% national average.

Given the hit to group and business travel, we currently expect U.S. RevPAR to fall about 50% in 2020, recovering in 2021, but remaining 20% to 30% below 2019 levels. This forecast assumes a medical solution to the COVID-19 virus by mid-2021, with wide dissemination over the remainder of the year. However, under this scenario, even if demand picks up in mid-2021, the sector will be very competitive, particularly in cities, causing average daily rates to remain depressed. As a result, assuming recovery and normalization continue in 2022, we don't think RevPAR fully recovers until 2023 at the earliest.

Chart 3

The Shape Of The Recovery And Outlook For Hotel Demand

Following an unprecedented blow to lodging from COVID-19-related health concerns and restrictions, we think the path to recovery in hotel demand will be slow and span multiple years. Currently, leisure travel is driving the recovery and will probably be a bigger mix of hotel demand for the next year or two. Business and group travel have yet to significantly recover and probably won't until, and if, there is a medical solution next year. Even then, we believe there will be some permanent reduction in this more profitable customer segment given a shift in corporate business models and behaviors toward a greater reliance on work-from-home and video conferencing. In terms of location, drive-to markets are recovering faster than destination markets, while lower-price hotels are recovering faster than higher-price hotels in urban cities. Interestingly, globally, the U.S. and China are primarily domestic drive-to markets and are recovering faster than heavy fly-to markets in Europe, Mexico, and the Caribbean.

In terms of more lasting effects, we also believe there will be more permanent high-end hotel closures in the top 20 U.S. markets. This will result in lower supply in cities and could ultimately benefit occupancy and rates for hotels that remain open, and possibly some of the larger, more liquid hotel REITs in terms of acquisition opportunities. New development starts have virtually ceased, and while development and land costs have likely dropped, we don't expect financing will be available for new developments until a more solid recovery takes hold. All these factors will reduce room supply in the U.S., which is typically good in a downturn, but will likely be overwhelmed by depressed hotel room demand for the next few years.

Recovery Assumptions For U.S. Lodging Issuers

We believe the recovery in credit measures in 2021 and beyond will depend largely on individual issuer's reliance on each travel subsector--leisure, business, and group. Additional factors will include the issuer's cost structure, asset quality, and brand strength. Furthermore, we believe that hotel franchisors will recover faster than hotel operators in 2021.

Overall, we've assumed harsher 2021 RevPAR forecasts for full-service hotel owners reliant on business and group travel, such as Ryman Hospitality Properties Inc., Host Hotels & Resorts Inc., and Park Hotels & Resorts Inc. (see chart 4). Conversely, we have made a less harsh assumption for some of the midscale and economy managers and franchisors, such as Choice Hotels International Inc., Extended Stay America Inc. and Wyndham Hotel Corp. There are several portfolios that have exposure to both full service and midscale to economy, and these issuers fall in the middle of the range in terms of our RevPAR assumptions. Despite significant uncertainty, we've attempted to incorporate how the geography and price segment of the room base affect our RevPAR forecast, as well as how the revenue model and cost differences influence the overall forecast for credit measures.

Chart 4

Investment-Grade Issuers On The Fallen Angel Cusp

On Oct. 1, we affirmed our 'BBB-' issuer credit rating on three investment grade lodging issuers: Marriott International Inc., Hyatt Hotels Corp., and Host Hotels & Resorts Inc. The affirmations reflected our expectation that these issuers would restore credit metrics in line with the rating in 2022, and that ratings were also supported by the businesses' strength, asset quality, and liquidity runways that provide flexibility to withstand a slow and choppy recovery over the next few years. However, despite the affirmations, we revised the outlooks to negative for all three issuers, reflecting the potential for downgrades at any time over the next few quarters if incremental risks begin to materialize.

Table 1

All remaining investment-grade lodging issuers have only a modest cushion against downgrade thresholds in 2022 (see table 1). We assign a tighter downgrade threshold at the 'BBB-' rating for Host because typically hotel owners experience greater earnings volatility compared to globally diversified managers and franchisors such as Marriott and Choice. While all investment-grade lodging issuers currently carry the same rating, we believe the risk of a further downgrade varies modestly among them. Choice Hotels' and Marriott's cash flows will likely benefit the most if recovery materializes because the franchising model delivers high-margin revenue under normal economic circumstances. By contrast, Host has a lower margin, and its ability to reduce leverage may also be limited by its REIT status once it returns to profitability, because it will be required to pay out 90% of taxable income in a common dividend. Although Host could pay a substantial portion of the dividend in stock, absent asset sales or equity raises, we believe Host has less cushion than peers against a further slowdown in recovery. Hyatt is a hybrid franchisor and owner of hotels and lies somewhere in the middle in terms of our downgrade threshold and underlying risks.

Lodging REITS Need To Address Highly Leveraged Capital Structures

Lodging REITs, unlike various traditional REITs covered by our real estate sector team, don't have long-term tenants and rents, and are therefore vulnerable to daily RevPAR variability. Furthermore, rated REITs such as Host Hotels, Ryman Hospitality Properties Inc., Park Hotels & Resorts Inc., and Xenia Hotels & Resorts Inc., are concentrated in the luxury and upper upscale segments and are significantly exposed to business transient and group travel. As a result, these companies may not be able to restore credit measures in line with their current ratings until 2022.

In the interim, the REITs have obtained covenant relief and extended their debt maturities to 2022 or beyond. We don't yet view their capital structures as unsustainable, partly because of their adequate liquidity runways and their asset quality. Our view of liquidity incorporates strong cash balances or revolver capacity, long covenant relief periods, and good asset coverage for the rated secured debt of 95% or higher on average, which may motivate lenders to continue to support these issuers. In addition, the REITs have the flexibility to monetize individual assets given their high quality.

Table 2

Still, while we haven't yet lowered ratings on these issuers to the 'CCC' category, we believe companies such as Park, Ryman, and Xenia may ultimately need to pursue long-term solutions for their capital structures, either through equity issuances or hotel sales even if the timing is unfavorable. To the extent that a REIT uses proceeds from asset sales for debt repayment, we would view this as positive for credit quality if the assets sell for a higher multiple than the REIT's adjusted leverage.

For now, the hotel transaction market remains slow, with few transactions, and wide bid-ask spreads. While there are reports that capital raises are beginning to occur, we believe this is only for deals at a discount of 20% to 30% compared to pre-COVID levels. Smaller hotels and extended-stay properties could likely trade and remain as hotels, but some larger luxury properties reliant on business and group travelers may need to convert to residential units. For example, Smith Travel Research, which provides market data on the hotel industry, has reported that cities such as New York may sustain a loss of 20% of hotel rooms. This has significant implications for local economies, but it ultimately may benefit some of the large hotel REITs by providing much needed liquidity until the recovery fully takes root.

Over the next few years, we assume that REITs will manage their costs to achieve hotel-level breakeven at lower occupancy rates, maybe at 35%-45% depending on average daily rates. The REITs have strong relationships with successful hotel brands, which should help to drive occupancy during a normal economy. Assuming these issuers can address their capital structures over the next few years, their focus on quality assets in desirable city-center locations could help push pricing higher longer term once business and group travel begin to recover.

Table 3