NEW YORK: Independent hotel operators and giant global chains are increasingly linking up in franchise agreements as high-interest rates have slammed the hospitality industry, slowing down new hotel construction.

For big chains, new franchise agreements from conversions keep investors happy by opening new hotels in the short term. Meanwhile, independent, unbranded hotels like switching to franchise agreements because it gives them greater access to potential bookings and cheaper financing from lenders.

“Historically, global conversions have been 10% to 20% of the rooms entering the system, today it is probably closer to 40%,” said Patrick Scholes, Truist equity analyst.

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For U.S.-based Marriott International, conversions in 2023 accounted for 40% of organic room signings, double the 20% rate a year earlier. Half of France-based Accor’s hotel openings last year were through conversions. That matches trends across the industry.

“In a climate where the debt markets for new construction are somewhat constricted, the importance of conversions is elevated,” Marriott’s CEO Anthony Capuano said on an earnings call earlier this year.

Hotel operators benefited from the surge in “revenge travel” as the pandemic receded. However, the economic rebound also brought higher interest rates - making life more difficult for smaller operators who rely on capital borrowing to fund their operations.

Roughly 1,980 hotels opened in 2023, down from 2,730 in 2019, according to hotel development intelligence firm Lodging Econometrics.

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“Access to hotel financing, especially in South America, is currently limited since many hotels faced difficulties in meeting their debts during the pandemic,” said Fernanda L’Hopital, South America director of consulting and valuation at hospitality consulting firm HVS.

A branded hotel may be more appealing to owners refinancing loans or facing a “wall of maturities” that were pushed back, said Robin Farley, UBS equity analyst.

Approximately $217 billion in hotel loans are slated to mature globally by 2025, said Zach Demuth, JLL global head of hotels and hospitality research.

Those loans are likely to be refinanced at higher interest rates. In the U.S., interest rates for new branded hotels are between 6.75% to 8.25%, up from 5-6% before the pandemic, said Shivan Perera, senior vice president of debts and participations at real estate lender Avana Capital. Un-branded operators generally have slightly higher rates between 7% and 9%.

Brand-affiliated hotels have a lower cash-flow risk than independent hotels, according to a 2022 Cornell University study based on 4,000 hotels over 20 years.

“Good brands, their loyalty program, their reservation system, typically will help a property perform better and so a lender will often have that as a requirement,” UBS’ Farley said.

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In Europe, real estate interest rates are trending at around 6% and 8%, up from 2.5% to 3% before the pandemic, said Tim Barbrook, head of debt advisory at HVS London. For branded hotels, rates are about 0.25% lower.

“Some people have had 13 years of extremely low-cost money, said Barbrook.

“They’re coming off fixed rate loans into this much-higher rate environment. Many of our clients wish they could simply extend the facilities that they already have.”

Large operators have launched “soft” and conversion brands aimed at picking up independents. Those brands help boost net unit growth, analysts said.Hilton’s franchise and licensing fee revenue rose 14.6% year-over-year in 2023 and 38.5% in 2022, while Marriott’s were up 13% in 2023 and 40% in 2022.

“Every couple 100 or 1,000 more rooms matter because there’s a franchise fee associated with it,” said Jan Freitag, director of U.S. hospitality at analytics firm CoStar.

One such brand is Hilton’s ‘Spark’ chain, announced in January 2023. For smaller operators, a conversion gives them access to guests who exclusively rely on the chains’ loyalty programs to book rooms.

“We would have never done [the conversion] if we couldn’t have done it with Hilton,” said Lou Carrier, chief executive of Distinctive Hospitality Group, a development firm that opened the first Spark Hotel in Connecticut.

“Within the first two months over 45% of that hotel’s guests were Hilton Honors members. That was remarkable to me.”