In March 2022, the Federal Reserve began aggressively raising interest rates as part of its strategy to combat inflation, a trend that continued into early 2024. At the September 2024 Federal Open Market Committee (FOMC) meeting, the Fed lowered interest rates by 50 basis points, easing monetary policy for the first time in four years since COVID-19. Then, in December, the Fed lowered its key interest rate by a quarter percentage point, its third consecutive reduction, to a target range of 4.25%-4.5%, which is back to the level where it was in December 2022 when rates were on the move higher.
This article explores the potential impacts of interest rate cuts on hotel transaction volume, portfolio sales, cap rates and development.
Transaction Volume
Between 2016 and 2019, total U.S. hotel transaction volume ranged from $24.5 billion to $34.2 billion. The COVID-19 pandemic caused a sharp decline in 2020, with volume plummeting to $8.1 billion, followed by a strong recovery to $39.6 billion in 2021. Despite a mid-year slowdown, 2022 finished strong at $42.5 billion, approaching the 2015 peak of $45.7 billion. However, elevated interest rates led to a significant decline in 2023, with volume dropping to $23.6 billion. As of Q3 2024, transaction volume has remained nearly flat, with JLL’s Hotels and Hospitality Group’s projections indicating a slight increase by year-end compared to 2023.
Lower interest rates make borrowing less expensive, which can stimulate hotel acquisitions. With Secured Overnight Financing Rate (SOFR) forecasted to fall to 3% during the 2025-2027 period, the expectations of more rate cuts will further bolster investor confidence. As a result, transaction volume should accelerate. The biggest opportunity will be in the $75 million to $200 million single-asset deal tranche, which has been basically negligible over the past 18-24 months, as this segment is most susceptible to high rates.
Portfolio Sales
Portfolio sales have significantly declined in recent years. From 2015 to 2019, they represented between 28.4% to 43.3% of total transaction U.S. volume. This trend continued into 2021 and 2022, with portfolio sales accounting for 41.9% and 32.7% of total volume, respectively.
A clear correlation emerges between low transaction volumes and reduced portfolio sales. In 2020 and 2024 (through Q3), the years with the lowest total volumes, portfolio sales dropped to just 22.6% and 8.3% of total volume, respectively. This decline is particularly striking in 2024, where portfolio sales have almost disappeared, making up only $1.25 billion of the $14.97 billion total volume.
The data suggest a cyclical nature to portfolio sales. As overall transaction volumes increase, portfolio sales will likely once again play a significant role in driving market activity, potentially returning to the higher proportions seen in more active market years.
Cap Rates
Historical data show cap rates generally move in the same direction as SOFR/LIBOR. Though interest rate reductions may lead to cap rate decreases, this relationship is not guaranteed or strictly proportional and cap rates do not always mirror interest rate fluctuations precisely.
The gap between SOFR/LIBOR and cap rates typically expands during low-interest periods and contracts when rates are higher. This occurs because hotel cap rates are influenced by various factors beyond interest rates, including market conditions, risk assessment, supply-demand balance and property-specific attributes.
While there is potential for cap rates to decrease when interest rates are cut, it is not advisable to forecast exact cap rate adjustments based solely on interest rate cuts. A comprehensive analysis of multiple factors is necessary for more accurate predictions in the hotel real estate market.
Development
New hotel construction is expected to remain constrained in the near future, with a significant increase in hotel supply unlikely until late 2027 or early 2028. Interest rate hikes have only been part of the reason that new development has been limited.
High construction costs have been equally, if not more, impactful. The Turner Building Cost Index saw an 8% increase in 2022, followed by a 6% increase in 2023. Construction costs maintained their upward trajectory in 2024, with the index showing a 4.10% year-over-year increase in the second quarter of 2024 compared to the same period in 2023. The persistent elevation in construction costs continues to act as an obstacle for new hotel development projects, with these challenges expected to persist for at least another 12 months.
Additionally, the average time from groundbreaking to opening for a new hotel is 18 to 24 months, with the time needed for planning and approvals extending the timeline even further. Consequently, considering the typical development timeline, a substantial impact on hotel supply growth is unlikely to materialize for approximately three years, placing us in the late 2027 to early 2028 timeframe for a potential uptick in new hotel openings.
Looking Ahead
The Fed’s recent interest rate cut, following years of aggressive rate hikes, marks a significant shift in monetary policy that is likely to have a positive impact on the hotel real estate market. As the hotel industry navigates this changing economic landscape, investors and developers must remain vigilant to market conditions, balancing the opportunities presented by lower interest rates against other economic factors. The coming years may see a gradual return to more robust transaction activity, but the full impact of these changes will likely unfold over an extended period.
This story was contributed by Charlotte Kang, Managing Director, National Practice Lead – Hotels & Hospitality, JLL Value & Risk Advisory.
