Several top hotel executives recently spoke about key issues facing the hotel industry, including the uneasy nature of the financing landscape and the escalating costs associated with operating a hotel.
MEMPHIS, Tennessee—The ebbs and flows of the hotel industry’s financial and operating landscapes are top of mind for hotel executives looking to extend the current economic cycle.
At the recent 19th annual Memphis Lodging Industry Update held at The Guest House at Graceland, a group of hoteliers identified unclear lending parameters and rising operational costs as issues that could lead to insomnia if they persist. The financial landscape took center stage during the event.
Fixated on financing
Led by Warren Fields, principal and chief investment officer for Boston-based Pyramid Hotel Group, the group’s word of the day regarding the financing environment was “choppy.”
“Twenty-four months ago you probably got eight to 10 term sheets (from potential lenders)—today you might get four or five,” said Fields, who added that Pyramid is buying and building hotels in the current environment. “You can still (get) deals done but it’s not as fluid as it had been.”
Fields said he expects interest rates to rise, but for now they stand at between 7% and 8% for new-construction projects and between 4% and 5% for acquisition loans.
“You can always find debt, the challenge is deciding if it makes sense,” he said.
Other executives agreed.
“’Choppy’ is probably pretty accurate,” said Nagib Lakhani, principal at RevMax Hospitality Services. “That’s a gaining issue for our group. That drives a lot of our decisions. There are options available. For the right reasons banks are much more conservative.”
“Warren had the term of the night—‘choppy’ is really the right adjective to use for what’s going on in the financing market,” added John Sonnier, SVP at Hodges Ward Elliott. “There’s money out there … it’s becoming more particular in what kind of projects it backs. For the construction guys, it’s going to become a little more difficult.”
Phil McNeill, CEO of Germantown, Tennessee-based McNeill Hotel Company, said financing issues are becoming more evident in the new-construction sector. His company is building a Homewood Suites property in downtown Athens, Georgia, and a Hampton Inn in Germantown.
“The problem we’ve had lately is several banks have been precluded from making construction financing by the (federal regulators),” said McNeill, who added that his company puts in 30% to 40% equity in every deal. “They can make an existing hotel loan but not construction … It’s almost as cheap to buy something today as it is to build it.”
Sonnier said unpredictability is finding its way into the financing process as well.
“In 2016 we saw a lot of financing terms change at the very last minute,” he said. “That was the first time we saw that since just after the recession.”
The bottom line for borrowers is getting returns on their investments—regardless of where the cycle stands.
“Return on equity is how we look at it,” McNeill said. “If we don’t get 12% to 15% back we don’t do it.”
“How do you protect that investment while at the same time making sure you get the type of returns you want?” Lakhani added. “We’re more willing to go in with a little more capital and not leverage as much to protect (those returns). The downturn is going to come. When that hits, it’s going to be very painful.”
Financing isn’t the only challenge for developers, according to Ron Lustig, principal and senior designer of Nashville-based Earl Swensson Associates.
“There’s starting to be an escalation in labor and a real escalation in materials that’s having an impact,” Lustig said. “You can see it where developers are looking to hold.”
All of this, however, hasn’t slowed hotel construction. STR, the parent company of Hotel News New, indicates there are approximately 187,000 rooms under construction in the United States and projects at least 2% supply growth in both 2017 and 2018. The activity hasn’t gone unnoticed.
“I would say it’s somewhat crazy right now,” said Bryan Nearn, president of Memphis-based Mountaintop Management. “With all the building that’s going on, somebody’s going to get hurt badly.
“When I look around at some of these locations … there’s so much under construction—it’s incredible to see all the construction going on in the major brands,” he added.
All of this puts pressure on developers, owners and managers to make 100% correct decisions. Calculating the right financial stress point a property can handle becomes more important as the cycle slows, according to Lakhani.
“We have to be mindful that you should be prepared for a significant change in the market,” Lakhani said.
The other recurring topic was the industry’s escalating operating expenses.
“(The biggest issue for hotels) is the overall cost of operating hotels,” said Don Howard, president of Lexington, Kentucky-based H&W Management.
Howard said revenue growth flattened industrywide in 2016, but operating costs continued to rise.
“Everyone thought they were great revenue managers and great cost-control managers, but that combination had it tough in 2016,” Howard said. “Maintenance, upkeep and (property improvement plans) on your property are a huge issue, and so are (brand) standards overall.
“Costs have been going up, but we’ve been outrunning it with revenue,” he added. “If you slip on the revenue side you’ll get run over by the cost side.”
John Pharr, president of Myrtle Beach, South Carolina-based Strand Hospitality Services, said the market-specific locations of his company’s 35 hotels dictate their performances.
“It’s a mixed bag—some are doing well, some have hit the peak and some going down the other side,” Pharr said. “Cost control is going to be one of the bigger items on our agenda.”
Pharr and Fields said hotel general managers tend to get somewhat complacent when times are good, and it’s hard to teach them how to survive an economic downturn if they’ve never experienced one.
“You’ve got to be able to do something better than just the market,” Pharr said. “We look at flow through every month, we bonus our management people heavily on flow through.”
Fields said owners and management companies have to keep an eye on managers if the economy slows.
“Having a bunch of young managers who haven’t been through a bad cycle is something to prepare for,” Fields said. “It’s going to happen at some point.”
Climbing operating costs include the expanding requirements of technology, said Keith Hess, VP and managing director of the 450-room Guest House at Graceland.
“Where it’s going and how everything correlates and works with all of our systems in our hotel,” he said, adding that his new property has 25 different IT-related systems that have to work together. “If one of those systems doesn’t work properly, it’s a real challenge.”
Hess said the importance of paying attention to details in the IT department can’t be overestimated.
“We rely so heavily on IT,” Hess said, explaining that in the early days of the hotel opening employees discovered one wrong number in the credit card batch system and its revenue ended up going to a company in Phoenix. That caused issues elsewhere because of the interaction of the systems.
Meanwhile, Don Houseworth, the owner of four hotels in Blytheville, Arkansas, said he is looking forward to seeing how the new government changes health care. He said the introduction of the Affordable Care Act cost his company $300,000 a year for its 200 employees.
“I’m hoping the new administration gives some relief on that,” Houseworth said. “I don’t expect it to be total relief.”
Lakhani said the reality of the industry is that owners, managers and developers have to be prepared to slog through any downturn.
“If you’re in this business for the longer haul, you can’t be the one that says when times gone bad I’ve got to cut,” Lakhani said. “It doesn’t work that way.”
But the influx of new owners and developers into the industry as the current economic cycle reaches its crescendo is worrisome, said Micajah Sturdivant, president of MMI Hotel Group, based in Flowood, Mississippi.
“What concerns me more than GMs who have not been through a downturn is the developers who have not been through a downturn,” Sturdivant said. “There’s this second generation (of developers) who find the hotel business is not about people but how many licenses they can sign … they’re going to learn a lot when the downturn comes. … There’s a new crop out there that has no clue what they’ve gotten themselves into.”
Even with all of the issues surfacing and putting pressure on hotels, it’s a good time to be in the industry, Fields said.
“For what we do as a manager I kind of like it when things are in turmoil,” he said. “Turmoil creates opportunities, and where there are opportunities you can find some really good things.”