The Hotel Business Executive Roundtable, “Thinking Outside ‘The Box’: The Challenges and Rewards of a Diverse Portfolio,” held at La Quinta Inn & Suites Dallas North Central in Dallas, evaluated the opportunities available in the current landscape, as well as the role of branding.
Presented by Hotel Business, hosted by La Quinta Inns & Suites, and sponsored by Sonifi Solutions, BDNY and the International Hotel, Motel + Restaurant Show (IHMRS), the roundtable was moderated by Stefani C. O’Connor, Hotel Business executive news editor and managing editor, roundtables.
One topic the panelists discussed was where the opportunities are for hoteliers. “There are still two hotel businesses,” said Peter Connolly, EVP of operations & development, Hostmark Hospitality Group. “When we talk about 8-10% RevPAR, we’re really talking about the top 25 markets. But if you look at the greater America, and particularly focus on cities that have had substantial declines in air traffic—even places like Providence, RI, which used to have 25 flights a day and now has six— those cities have not recovered…so there is still quite a bit of distress out there. If there’s value add these days, it’s there; no one is doing a value-add deal in New York City.”
Steve Van, president and CEO, Prism Hotels & Resorts, agreed, noting that, in some cases, RevPAR hasn’t recovered enough to make up for the bad 10-year loans that were made from 2005 to 2007. “Those chickens are coming home to roost,” he said. “Most markets have not yet recovered the NOI they were producing in early 2008 adjusted for inflation. If they have recovered, so they’re producing the same NOI, the underwriting standards are so vastly different—they’re rational now and were irrational then.”
Van added that $18.5 billion of loans in the hotel sector are coming due in the next four years. “If you look at the loans that were underwritten, particularly in 2007, and what will happen in 2017, in 2007 hotel loans were made with the same risk profile as office buildings. The whole world changed since then, but those loans are still there. Our thinking is that there will be other opportunities for distressed asset acquisitions,” he said.
Edward Hoganson, EVP and CFO, Crestline Hotels & Resorts, noted that he’s not seeing that many distressed properties because the economy is improving, cap rates are dropping and cheap debt is available. “So, we’re not seeing as
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much of the distressed, especially with major brands,” he said. “But we are seeing a lot of assets coming to market because they have to put in a renovation or the term of their investment has expired. We’re seeing a lot more assets and portfolios coming to market, and the sellers are trying to take advantage of cap-rate compression and cheap debt.”
Raj Trivedi, EVP and chief development officer, La Quinta Inns & Suites, agreed that there’s less opportunity for distress. “What has happened is that, wherever you have opportunities for hotels at somewhat below replacement costs, you have the brand element that you have to do the upgrade and, all of a sudden, it’s taking you close to or about replacement cost,” he said. “So, the opportunities that used to exist three years ago are not there as much.”
“That’s why those things are working though,” said Connolly. “The deals that we’re working on now on the purchase side are predominantly in tertiary markets that have not done as well but are OK. They really are distressed deals in the sense that, when that loan comes due in three to four years, there’s no way on God’s green earth that the hotel will be worth what the loan is but, in the meantime, it’s worth enough. And it’s time for somebody to get out. If I can buy it at 30% less than replacement cost—setting aside our discussions about cap rates and what real value is—but if I can buy it for 30% less than replacement cost and if the PIP is only going to increase that to 20% less than replacement cost, then I’m in.”
Leo E. Spriggs, president and CEO, Hospitality Management Corp., noted, “There’s a lot of that product available in secondary and tertiary markets at 30% less than replacement costs.”
Peter Bheda, president and CEO, Frontera Hotel Group, added that, when it comes to properties and PIP requirements, brands would be taking more of a hard line. “I just met with IHG recently, and they basically in no uncertain terms told us, in 2015, they are going to be very careful in terms of who is going to stay, who is going to be the management company and who the owners are going to be,” he said.
Mary Beth Cutshall, SVP of acquisitions & business development, Hospitality Ventures Management Group, noted new construction is also affecting the ability to upgrade brands on an acquisition. “It’s becoming more difficult to convert to a brand because of the environment where new development is more plausible,” she said. “A lot of the brands are saying, ‘No. I have the opportunity for new construction, so I’m not going to allow that asset to convert.’”
“I agree with everything you just said with one exception: In secondary markets, especially in full-service, the brands are not holding out for a new-build,” said Spriggs.
“That’s the question that you have to ask in secondary and tertiary markets with a full-service hotel. It’s now obsolete,” said David Wilner, SVP of development, La Quinta Inns & Suites.
Van added that it’s the viewpoint of both institutional capital and the guest that select-service is a better model. “Another phenomenon I’ve seen led by select-service is institutions going into secondary and tertiary markets,” he said. “When you can package them up, they don’t care if it’s a town with 25,000 people.”
Wilner noted that brands need to be careful about rolling out new select-service brands. “The reason that select-service is there—not only comparatively lower operation and construction costs—is you’re giving guests everything they want for less: free WiFi, free breakfast. Certain companies are now increasing the amenity creep with the select-service, so it’s getting blurred. The margins for the owner have been compressing.”
Rick Frank, chief investment officer, Pillar Hotels & Resorts, stressed that the guest is driving this. “When I worked at Sheraton as a 45-year-old guy, we did all these surveys, and they found that whatever survey I filled out was the median. I’m now slightly older and I’m not the market, and most of us here aren’t the market,” he said. “My daughter is 23. Will she stay at a full-service Westin? No. She likes the Courtyard concept.”
“You’re right, we have to cater to what our guest expectations are,” said Connolly. “If you talk to the brands, a number of them believe that, for the next five years, we’re headed away from the commoditized, one-size-fits-all hotel. They’re looking for hotels with a sense of place. They’re looking for a food and beverage experience that has a real bar you can have a drink in and feel comfortable in after five at night. They’re looking at 180- to 200-room, full-service hotels that have a real restaurant and bar, and can be built for something that’s closer to the cost of a select-service property.”
“They’re looking for more of an experience,” said Raj Chudasama, managing partner, Kriya Hotels. “If I’m going to another city, I don’t really care what the brand is. I’m looking for who has a good experience, what will it be in the public spaces and the lobby.” He added that this is why his company is focused more on new-builds. “Because we can create that experience in the public areas and the location,” he explained.
The conversation turned to branding and the influx of new brands. “One of the most critical components of a brand parent is to protect the investment of the franchise partner,” said Trivedi. “Companies need to be really careful how and when they introduce brands. In my opinion, a single company can cannibalize within the family because you have a certain amount of travelers coming within a loyalty program and, if you’re dividing that share into eight hotels, it will become more challenging. That’s why brand selection is important and brand diversification is important. I don’t call two brands within the same company a diversification.”
Both Wilner and Spriggs noted that new brands in a brand family are also a way to get around an area of protection (AOP). “That’s why we’re doing multibranded hotels,” said Mike Hines, chairman and CEO, HP Hotel Management, Inc. “It’s in order to protect ourselves from our franchise companies letting another franchisee to come in and bastardize the reservation system.”
One thing the panelists agreed on was that business is driving finance and not the other way around. Bill DeForrest, president and CEO, Spire Hospitality, noted that the industry gets in trouble when finance drives the business. “The reality is that, today, the business is driving the finance,” he said. “The business is strong. Peter, you talked about the fact that 10% RevPAR is in mostly the major markets but, in our 22 markets, the market’s growing above 5% in every one of them but one, so it seems to be a pretty broad-based recovery. The business is driving the financing side, which is healthier for us.”
Jon S. Wright, president and CEO, Access Point Financial, noted that a good litmus test for the capital markets
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is that “we’ve made 220 loans since 2011 and 25% of those loans have already prepaid.” He added that the company is disciplined at underwriting and that “of those loans, with that percentage of takeout already, we’re seeing very good proceeds on the takeouts, proceeds amortization and the loss of the recourse component. That’s good.”
Bheda agreed with DeForrest, pointing to the Dallas market. “You’ve got new-builds; you’ve got brands now requiring them to upgrade facilities because of what they’ve seen in the RevPAR growth over the past few months in this particular market,” he said. “I agree that it’s the business driving the finance.”
Hoganson noted that it’s not just that there’s RevPAR growth, but that ADR is growing more than occupancy. “And we’re seeing more group business, which will also go to the bottom line. Those are very powerful drivers,” he said. Trivedi noted, in addition to that, it’s only the beginning of group business coming back.
“It really is just starting,” said DeForrest. “The other thing we’ll see is not just distressed stuff get dealt with. I think there are a lot of owners that got into the business and went through the really bad times, and they had no other option but to hold on. I think they’ll see the opportunity to exit and they’re going to take it.”
At the same time, there are new owners entering the market as well. “We’re working with Asian investors who bought five hotels we manage, and they’re looking at very specific, individual assets and are willing to pay premiums far above local buyers,” said Hoganson, noting that these owners are still doing their due diligence, but have different motivations. “There are different buyers valuing different things. I’ve seen declines in return expectations, so they don’t have to have the 20-plus levered IRRs. They can get lower expectations and lower returns, and they’re OK with that.”
“The cost of capital is remaining low. There is capital entering the market, like Asian capital, that has different motivations. It’s not, for them, necessarily about a 20-plus return; it’s about the opportunity to plant money in a place that’s more secure and perhaps even a visa,” said Connolly. “We’re either at a point where it’s either the perfect situation or the perfect storm.”