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Risky Times Create Opportunities

MLIS Speakers, Attendees Stress Need to Take Chances

The most profound message at the recent Midwest Lodging Investors Summit came from the first speaker, the inimitable Laurence Geller. Geller, who heads Strategic Hotels & Resorts and was the keynoter speaker at the first MLIS in 2008, warned the crowd of hotel owners and operators to expect volatility as the new normal in the hotel industry.

“The next five years, and I’m serious about this,” said the often-joking CEO of the Chicago-based hotel REIT, will be “a sea change in our industry for the first time since maybe 1974-75. Cycles aren’t here anymore. What you see is what you’ve got: Volatility and bouncing around. Don’t look for cycles, manage for today and tomorrow.”

His words struck a tone that carried through many of the general session and breakout panels at the three-day event in Chicago. More than a few speakers talked about the need to take risks in this uncertain environment. Perhaps the most vocal was Bruce White, founder and CEO of White Lodging and recipient of Lodging Hospitality’s Game Changer Award.

“The reason we’ve been able to grow is because we’ve taken enormous risks,” White told Dr. Ron Cichy of The School of Hospitality Business at Michigan State University during a Q&A session following presentation of the award. In 2007, White took a risk and sold a portfolio of 100 hotels to RLJ for $1.7 billion. That well-timed move enabled the company to develop nearly a half-billion dollars of product each year since.

Other speakers reinforced White’s risk-taking philosophy, but with caveats. “We’ve got to be more data driven and find reasons not to make some of these deals,” said Bill DeForrest, president and CEO of Lane Hospitality on a panel discussing repositioning strategies. DeForrest admitted to blunders he and others made during the bull market days in the middle of the last decade.

“Remember, we were the smartest guys in the industry doing acquisitions in 2006 and 2007,” said Bill DeForrest, president and CEO of Lane Hospitality. ”We were really bright. I remember doing our models and saying ‘What if we have a downturn. Let’s model things down 7% to 10%. At 10%, the deal didn’t work. So we changed it to show only 7% to make it work. Then things dropped 28%.

Even Steve Van, also on the ‘Repositioning to Succeed’ panel, has changed his tune. Long the one calling for a tidal wave of distress right around the corner, the head of Prism Hotels & Resorts admitted, “I just don’t know.”

“It’s not a tsunami, but a fast-moving iceberg,” he said of the dearth of debt coming due. “The last three years, I’m always saying it’s about to happen. Not anymore. I can’t answer when and I’ve given up trying.”

During the ‘Who’s Got Money’ general session ending MLIS, Reginald Heard, the president and CEO of Bankers One Capital, said, “This is the new normal, with higher levels of unemployment. Companies have adjusted with fewer employees.”

Geller made the same point the day before, speaking about the hotel industry: “The operational savings we made are here to stay.” Geller, who candidly said “things suck now,” at the first MLIS in 2008, was far more optimistic this year. His takeaways: fuel prices will rise, it will never be cheaper to buy hotels than today, rates will go to new highs, and as a result of labor cuts, profits will remain strong.

The uncertainty he and others touched on—the upcoming election, unemployment, the capital markets and Europe, the fiscal cliff—didn’t dampen spirits. Even the repositioning panel, serious and somber for much of the session, all predicted national occupancies would reach 63% in two to four years, which would be a new high for the hotel industry.

The conference’s opening general session featured a panel of hotel company CEOs who pleaded with the industry to be more aggressive in boosting rates. Hotel demand and revenues are at all-time highs, so rates should follow, argued the six chief executives.

“The mantra around our shop is now is the time to be bold,” said Mark Laport, president and CEO of Concord Hospitality. “We’re seeing demand come back in all 83 of our hotels in 25 states so we don’t whisper [to our properties], we yell that if we don’t get rates soon we’ll miss the cycle. Our revenue managers are coaxed and mentored that now is the time to turn on the gas and take some risks in the marketplace.”

Laport’s philosophy has had impact at his firm, where RevPAR has risen 8.3% this year, half of which is attributable to rate gain. “If revenue managers are on their game, there are nickels and dimes to be found every day,” he said.

David Kong, president and CEO of Best Western International, believes there are several reasons why rate growth has been depressed, at least compared to the other positive industry indictors. He said while growth in hotel supply is currently muted (up 0.3% this year), the number of hotel rooms entering the market grew by 93% in the last 25 years.

“Demand has grown in that time but it hasn’t kept pac
e with the growth in supply,” said Kong. “Also, the transparency created by the Internet makes it very easy for operators to see what their competitors are charging. Another factor is the impact of the OTAs on rate growth. It’s the only channel of distribution that has seen a decline in average rates.”

Vantage Hospitality Group President & CEO Roger Bloss believes fear is another factor. “Many of our members are Mom and Pop owner/operators and they fear what effect raising rates may have on their occupancies and revenues. As a brand, it’s our obligation to give them the tools and confidence to do so.”

Wayne Goldberg, president and CEO of La Quinta Inns & Suites, also shared his frustration over the lack of pricing aggressiveness. Over the recent Memorial Day holiday weekend, Goldberg said the chain posted an 87%-plus occupancy and the highest RevPAR in 10 years, but only a “nominal rate increase compared to demand.”

“Pricing power has returned, it’s just not being leveraged. The challenge in ADR is largely self-inflicted,” lamented Goldberg.

Despite the frustration over rates, the CEOs were generally upbeat about the industry for the remainder of 2012 and beyond. But Jim Abrahamson, CEO of Interstate Hotels, thinks the jury is still out on the industry’s performance for 2012. “The story of 2012 will be what happens between Labor Day and Thanksgiving,” he said. “That’s when the year will be made or lost.”

A panel of lenders to the hospitality industry agreed there’s no shortage of financing for all kinds of hotel deals, including new construction. The trick for those looking for money is matching their acquisition, refinancing, repositioning or new development deal with the right source or sources of financing.

According to the lenders, the story of hotel financing today has at least two parts. On the debt side, said panelist Neil Freeman of Aries Capital, money is available at low interest rates for up to 65% to 70% of a hotel’s value on cash-flowing assets in major or secondary markets tagged with good brands.

“There’s plenty of capital for good operations, but when you veer away from solid brands and consistent cash flows, debt financing is much more opportunistic,” said Freeman, who’s chairman and CEO of Aries, which has financed nearly $1.5 billion in hotel deals in its nearly 30 years of business.

Yet, some lenders like deals that are under the radar and may seem dicier to other groups. Firms like RockBridge, which works on both the debt and equity sides of hotel capital formation, looks for what Managing Director Chris Diffley called “story deals.”

“In the top 10 markets especially, values are getting pushed to place where you’re not going to get paid appropriate to the risk in these deals,” said Diffley. “As a result, we look for opportunities on hotels that need turnaround or repositioning in order to get attractive returns.”

Veteran dealmaker Michael Medzigian of Watermark Capital Partners agreed: “There is a long cycle ahead of us, and there are a lot of deals out there, especially on those hotels that are broken and need recapitalization and new equity.”

As a new feature at this year’s MLIS, three panels explored the opportunities and challenges ahead in urban, suburban and interstate hotel markets. All three markets are showing signs of recovery, but not in the exact same way. Each still faces challenges.

Developments and transactions in urban markets generally draw the biggest headlines because of the larger price tags for the deals often done in areas with significant barriers to entry. After the recession, urban markets took a massive hit in revenue per available room (from $102.61 in 2007 to $84.63 in 2009, according to STR), but the biggest decline came in transaction numbers.

Lodging Econometrics reported 135 fourth-quarter deals in 2007, for an average sales price per key of $224,979. Two years later, the numbers were a dismal 21 deals at $100,442 per key. Last year there were 89 fourth-quarter deals, but the average sales price came all the way back to $231,542 per key. The frenzy driven by REITs in the first half of last year has cooled, mostly due to continued flux in the capital markets and other overriding concerns.

“We’re seeing slower, more stable growth now,” said Mike Cahill, CEO of HREC, during a breakout session discussing urban markets. “The concern is uncertainty, and a general sense of apprehensiveness over all our heads.”

Craig Mance, senior vice president of development, North America, Hilton Worldwide, said Hilton is like other hotel brand companies trying to help developers by offering key money to get projects off the ground. Cahill added acquisition debt is “still tough, but getting better and better every week.”

It all adds up to a strong future for urban markets. Doug Dreher, CEO of The Hotel Group, said the next two years would present good buying opportunities.

Suburban markets faced similar declines to their urban counterparts, but the recoveries have not been as strong. RevPAR was at $57.03 in 2007, but has only come back to $51.85 after falling to $45.56 in 2009. Fourth-quarter transactions went from 791 in 2007 to 173 in 2009 and 272 last year. Price per key nearly dropped in half from 2007 to 2011, and there were 73,356 rooms under construction in 2007, but only 15,583 last year.

Jason Cowan, regional VP of franchise sales & development for Choice Hotels, said oversupply—because of the massive surge in suburban development from 2005 through 2007—has slowed the market’s recovery.

And during that panel discussion, Vantage Hospitality’s Bill Hanley said from the audience that two key trends have challenged suburban markets compared to the faster recovering urban centers: Many from Generation X prefer living in and visiting urban areas, and suburban offices and regional centers were some of the first to close with the contracting of the corporate market during the recession.

Consultant Chuck Pinkowski said higher levels of unemployment would remain as companies who survived the downturn with less staff and creative cost control would continue like that. “They’re doing well now with lesser staff,” he said. “It will be a long, long time until they ever hire more. That’s our challenge.”

Interestingly, interstate markets increased in average daily rate from 2007 ($66.94) to 2009 (69.31) to last year ($71.65), but RevPAR still lags slightly from peak numbers because of declines in occupancy. Transactions and new construction are way down and fell from 2009 to 2011, unlike urban and suburban markets.

Teresa Matsui Sanders, who moderated the discussion of interstate markets, said the panel’s consensus was many interstate markets have a lot of outdated and no-longer competitive product that needed razed. Despite that, there were pockets of opportunity for new builds in underserved markets and opportunities to acquire and refresh, not necessarily reposition, assets.

Ravi Patel, an executive vice president of Hawkeye Hotels, said financing is available from local banks: “As their balance sheets have improved, they need to make loans, so in some cases they’re fighting over deals to do. A lot of the financing in this segment involves SBA or USDA participation.”

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