AY: Canadians are on the move, enjoying hotels and resorts

It’s safe to say that hotel stays and travel have blissfully returned across Canada, but the same cannot be said for transaction volume for hotels as an asset class.

Canada’s average daily rate (ADR) for a hotel room stay rebounded dramatically since the nadir of the pandemic and has continued to edge up in 2024.

Across Canada’s top 10 hotel markets, occupancy remains just shy of pre-pandemic levels, at 64.5 per cent, according to Canadian Tourism Data Collective. Vancouver saw the highest occupancy (83.8 per cent), while Prince Edward Island saw the lowest, at 54.5 per cent, according to CoStar data.

However, the rebound captured in these occupancy and room rate statistics belies the fact that Canada’s hotel investment sales market is buffeted by local and global trends sharply different from pre-pandemic realities. The result? Lower transaction volume for hotel assets.

Pandora’s box of WFH

The rise of remote and hybrid work has permanently reduced the need for in-person meetings globally. Corporate leaders are unlikely to splash out of junkets and get-togethers, as many companies are currently implementing cost-cutting measures.

Canada’s unemployment rate edged up to 6.6 per cent in August and was the highest since May 2017, outside of 2020 and 2021, during the pandemic, according to Canada’s statistics office.

In contrast, Canada’s luxury and resort hotels have outperformed other hotel categories, as pent-up, post-pandemic leisure demand is still playing out. Furthermore, traditionally seasonal destinations, like ski resorts, are seeing more year-round demand, as are destinations for other activities like mountain biking, hiking, swimming, tennis, and golf.

Another driver boosting hotel occupancy is the Canadian government. As it looks to house refugees and asylum seekers, government agencies have been leasing and acquiring hotels, effectively taking those assets off the market.

Bid-ask spread

Even as Canada’s tourism industry has largely recovered from the pandemic, few hotels are currently trading hands. In recent transactions, buyers have tended to be domestic, given the currency risk and other challenges associated with cross-border transactions.

The bid-ask spread remains challenging to bridge, and the interest rate cuts delivered by the Bank of Canada earlier this year have not been sufficient to stimulate demand. Because hospitality assets are performing well, investors have not been pushed to sell by distress-type situations. Transactional fluidity is more likely in 2025 when two more central bank rate cuts are expected.

Meanwhile, the Canadian government’s move to increase the capital gains tax rate earlier in 2024 complicated matters, making sellers of hotel assets even more reluctant to close deals. The tax law change put additional onus on sellers to acquire equivalent assets within a certain period to avoid the higher tax.

While capital gains-driven transactions on some other types of commercial real estate assets - namely the ones that require simple and straightforward underwriting – were able to close, few hotel transactions did.

A new wave of hotel development?

As ground-up development deals for office and residential sites fail to materialize, more land sellers and developers are making inquiries about pivoting to hotel projects instead, as the arithmetic of hotel development is looking more appealing over the long term.

While the operating costs of running a hotel and the financing cost to build one remain high, the dearth of supply is making hotel development more appealing. In addition to landowners and developers, hotel brands are also exploring the option of building new developments and ground-up projects.

Income is high on hotel assets, which has led to their valuations going up, but this has led the bid-ask spread to widen further. It has been more challenging for transactions to close as investors do not feel pressure to sell, given that their properties and portfolios are performing well.

The Canadian central bank has reduced interest rates by 75 basis points, but so far, the reduction has not moved the needle in terms of stimulating transaction volume. We believe further reduction in interest rates may give both buyers and sellers the confidence to transact by giving them the certainty that interest rates are on a more solid downward trajectory.