Depth Perception

Word-of-mouth probably does investment company HEI Hospitality particular good when it comes to recruitment. No need for monster.com or traditional employment classifieds at this privately held hospitality management company. It seems the philosophy governing Norwalk, CT-based HEI would make it attractive to the best and the brightest in the hotel business, especially those craving upward mobility in the upscale and upper-upscale segments that are HEI's specialty. That's because HEI managers Gary Mendell, chairman and chief executive officer; Gary's brother, Steve, executive vice president of acquisitions and development; and Ted Darnall, the chief operating officer, are all on the same page.

HEI is all about alignment — and the long term. HEI Hospitality is the investment arm of HEI Hotels and Resorts, the umbrella name for HEI Hospitality and its former management branch, Merritt Hospitality. But really, HEI is all you need to know.

By the end of 2007, HEI plans to spend $500 million to $1 billion on hotel real estate, focusing on the upscale and upper-upscale. That's part of an ambitious plan to increase the size of the company rationally and deliberately, building on a base of some 25 properties by adding five to six per year. In the past four years, HEI has acquired more than $2 billion in hotel-related real estate. The idea is that by combining an acquisition company — HEI Hospitality — with an operating company (the former Merritt Hospitality) under the new HEI Hotels and Resorts name, HEI will be able to better capitalize on its privately held owner/operator model.

Another underlying drive, all three executives stress, is to accumulate value over a period far greater than the typical two to three years a public company puts into its properties. But it's not about holding onto properties forever.

“Ultimately, we sell,” says Steve Mendell during an interview at HEI headquarters. But, notes Gary, HEI holds onto hotels for eight to 10 years, rather than “flipping” them every two or three. That hold adds to the stability that's one of the key qualities of HEI. “That allows us to create what we believe will be the best-ever operating company the industry has ever seen,” Gary says. “You can't create a great operating culture when you're buying or selling every two or three years.”

In addition to creating the best operating company in lodging, long holds also will “lead to creation of the best real-estate value,” says Darnall, who joined the Mendells last October after four years as head of Starwood's Real Estate Group (Darnall and Gary Mendell worked together at Starwood in the late ‘90s). “The other thing that advantages us is that our funds are exclusively dedicated to upscale and upper-upscale real estate, though we'll probably do some select-serve. Our investors are committed to the hospitality segment with us; the investment they're making with us is in upper-upscale and upscale — and in this industry.”

OPPORTUNISTIC BUT CAREFUL

Early this spring, HEI acquired the 179-room Equinox Resort and Spa in Manchester Village, an upscale vacation area in southwestern Vermont. The Equinox is a historic landmark and features the second-longest operating hotel in the United States. It sits on a parcel of nearly 1,300 acres, a site that also includes one of the top 50 golf courses in the country. It's a trophy property, for sure. And, Darnall indicates circumspectly, it's tired.

“We think we could reposition that hotel to make it more attractive to an upscale, urban buyer,” he says. “It doesn't really represent physically the expectations of the upscale customer.” HEI aims to recast the Equinox to make “it more aligned with the lifestyle of the urban professional today,” he says. “It's a great hotel, but it needs to be reinvented. That's the advantage we have because of our long-term renovation process.”

Before HEI acquired the Equinox package, which also includes a spa, restaurant and inn, from Olympus Real Estate Partners, it conducted due diligence not only on the Equinox but also on other hotels in the Northeast. “This opportunity felt really good,” Darnall says. “From my perspective, what's exciting about the structure of this company is that it gives us the ability to take advantage of the expertise that's in shop.” The acquisitions and development team numbers 14. “I don't know of any other company that's close to that,” says Gary, citing the team's depth and collective wisdom.

In addition, “not one of our competitors has the quality of full-service, upper and upscale, that we do,” he says.

According to Steve, acquisitions and development spends “a lot of time on the asset itself,” trying to gauge demand generators, the proximity of convention centers, the presence of office buildings, “everybody who makes sense for that particular investment, everybody who drives demand.” The strategy for acquisition and repositioning is developed up-front, he says, because “we're not looking to go outside to a third-party operator.”

Because HEI is geared toward creating long-term value, strategy is even more critical to it than to more opportunistic companies pursuing shorter-term goals. It might involve taking on prime contract business. It might involve shifting market strategy to change the customer base, something likely in the Equinox case.

IT'S THE ALIGNMENT, STUPID

The Mendells and Darnall use the words “alignment” and “legacy” frequently, suggesting a forward-looking, seamless HEI culture.

“There's no misalignment here,” says Darnall. “There's nobody sitting on the backside of the owner structure to create earnings at the sacrifice of our associate development environment or guest service environment.” At the same time, associates are incentivized to “improve efficiencies at the hotel and to deliver customer service in a more efficient manner.

“Our model of success is driven by meeting and exceeding customer expectations, attracting and developing talent within our own organization and utilizing that talent to be innovative in continuing to improve the efficiency with which we deliver service.”

What helps HEI is that it's a private company, these executives assert. In 2006, less than a quarter of the 73 percent of hotel acquisitions made by public companies or private equity derived from private equity long-term holders, according to Steve Mendell. And even in private equity, he adds, 90 percent of investors are focused on short-term gains. “The other 10 percent — a very small amount — are focused on long-term value creation, which is where we fit in.”

HEI's investors include many of the top 20 universities in the country, says Gary, keeping identification confidential. “Nobody else has this in this industry,” adds Darnall.

And no other company focuses so on upper and upscale or on long-term investment, even though there are other firms in the field that run on the owner-operator model, such as Noble Investment, White Lodging Services, Davidson Hotel Company and Sage Hospitality Resources.

“We're all upper-upscale,” Gary emphasizes. “We have it all. There's a slogan around here that the way we view the world is that we're heading toward being the best owner-operator that ever existed. And if we don't get there, shame on us.”

When the market is as robust as today's, the HEI model works fine, as expected. But it may work even better when the market is down, Steve suggests.

“That's a very good time for us to grow,” he says. “As the market turns sometime over the next three or four years, that's when our best buying opportunities will be, because values will be down. That's when we'll be buying.”

When the availability of capital shrinks, “that actually gives guys who really know the markets better opportunities because there's less capital chasing deals.”

“One advantage we have is that we're based on cumulative return and cumulative performance,” Darnall says. “That creates an environment where, I think, the ability to take a little bit more calculated risk — and push the envelope more — is much more encouraged.”

Because managers at HEI hotels are encouraged to take risks in running the room mix, pricing various customer segments and setting internal revenue goals, there's a far greater likelihood that they will outperform their competitors, Darnall says.

“You're a 30-year-old director of food and beverage and you want to be a general manager, but your investors are buying and selling hotels every two or three years, and you'll be out of a job,” Gary says. “Who do you want to work for? Us. Or would you rather work for one of the major branded companies, which has great stability and great opportunities and hotels all over the country, but the growth isn't there. You literally have to wait for somebody above you to retire to be promoted, in most circumstances. And if you're a short-term-value creator, you're on a new job every two to three years.”

There's no discrepancy between HEI's culture of stability and its deep-seated encouragement of risk-taking, these executives suggest. If anything, HEI's stable footing allows its executives to take those risks.

Adding to the stability and building a foundation for the legacy: development of a $150,000 database so people can apply to all of HEI's hotels — including many Marriotts and Hiltons, along with trophy independents such as New York's storied Algonquin — online. “[Executives at] every hotel in HEI's portfolio will be able to see someone apply, from anywhere,” Gary says. “The owner is us. You're looking at the owners right here.” Which means that the owners and the investors are aligned not only philosophically but also operationally.

That seamlessness makes for a creative culture, suggests Darnall. “The majority of opportunities in big brands have to do with your ability to comply, where in the independent world you're encouraged and stimulated to utilize your creativity and innovation to create new approaches to the business, to reinvent the business,” he says.

People who come to work for HEI like its flexibility and relatively small scale, Darnall adds. “Until now, independents were either third-party managers, which meant a lot of instability and ownership change, or they were these operating partnership models, where again you have a lack of alignment.”

“Our platform is the best of all possible worlds,” says Gary.

“A culture is like a jacket,” Darnall says. “It fits you or it doesn't. We have a culture that's more appealing to an individual who wants to be more entrepreneurial, who can be more innovative, and who likes to be clearly recognized as a winner.”

And, adds Gary, “I would probably add the word ‘stimulated.’”


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