The Hawaii hotel market, long characterized by scarcity of available properties, is now facing a different challenge: a pricing gap. According to recent analysis, while several hotels in Waikiki are available, buyers are hesitant to accept the initial returns offered, creating a standoff between buyers and sellers.
The market is currently underwriting returns at around seven percent, but sellers are holding out for closer to five percent. This two-point difference has led to a slowdown in transactions, but not distress. The activity that remains is concentrated at the two ends of the spectrum: independent investors and family offices are moving in, while institutional capital, particularly publicly traded REITs, has stepped back. This shift is partly due to the performance of REIT stocks, which have seen significant declines, making hotel investments less attractive compared to other options like tech stocks.
Mark D. Bratton, CCIM, of The Bratton Team at Colliers International Hawaii, explains that owner-operators underwrite hotels differently than stock investors, focusing on the business potential rather than portfolio diversification. Recent transactions illustrate this range: PACIFIC 19 Kona was acquired by Nine Brains, a family office-backed firm, while Host Hotels acquired Turtle Bay Resort and rebranded it under Ritz-Carlton.
The pricing gap is not irrational; it reflects the cost of debt. With borrowing costs around 6.5 percent, a seven percent return offers a modest spread, but a five percent return results in negative leverage. Buyers are declining to invest in properties that would lose money on debt. However, many acquisitions are underwritten on future repositioning rather than day-one leverage, allowing buyers to accept lower initial returns if they have a plan to improve the asset.
Equity requirements in Hawaii are notably higher than the conventional 20-30 percent. The practical floor is 30 percent, with 30-50 percent being common. A higher equity contribution can lead to better debt terms, as lenders face less risk. Additionally, the timeline for deals is longer in Hawaii, with supply visible years in advance and transactions moving slowly. Buyers often accept a full price in exchange for a plan to improve operations and achieve positive leverage over time.
Hotels are unique in real estate, described by Bratton as "a business inside of a piece of real estate." Operating experience is crucial, and labor structure is a key surprise for mainland buyers. Two major unions represent Hawaii hotel workers, with renegotiations every three to four years. About half of the state's hotels are non-union, with larger properties more likely to be organized. Investors either underwrite union properties or avoid them entirely, but discovering the labor situation after closing can be costly.
Another consideration is leasehold versus fee simple ownership. Much of Waikiki sits on leased land, making fee simple beachfront properties rare. Buyers seeking fee simple ownership face a very limited pool.
To bridge the pricing gap, some transactions use structures that give buyers control before title. For example, Nine Brains took a leasehold position with the right to buy the fee at a stepped-up price, spent $10 million on improvements, and closed the fee purchase at $23 million after six years. This approach has been applied to other assets, allowing sellers to achieve better prices over time.
Looking ahead, the market is quiet but stable. Debt levels are conservative, and owners are absorbing lower distributions rather than facing forced sales. The market is waiting for a catalyst, such as a shift in debt costs, to close the pricing gap and spur activity.
