On a panel at the Americas Lodging Investment Summit, members of the Industry Real Estate Financing Advisory Council addressed topics such as interest rates, property management models, M&A and private equity.
LOS ANGELES—The hotel industry will likely see 2019 shake out to be similar to 2018, according to members of the Industry Real Estate Financing Advisory Council who spoke on a panel at the 2019 Americas Lodging Investment Summit.
By the end of the year, hoteliers will say it wasn’t as bad as they thought it would be, despite external forces such as the partial shutdown of the U.S. government, said Mit Shah, CEO and senior managing principal at Noble Investment Group.
Wells Fargo Bank expects to be an active lender in 2019, which shouldn’t be materially different from 2018 unless there’s a shock of some sort, EVP Christopher Jordan said. There’s a lot of capital and the lending market is competitive, but his company’s deep relationships should provide an advantage, he said.
On how much further the U.S. economy can grow, Mark Elliott, president of Hodges Ward Elliott, said there’s no clock on when expansion expires. This is a strange time in the U.S., he said, as the highs aren’t that high, but the lows aren’t that low. It’s like there are guardrails on the economy, so there could be more of the same to come, he added.
Laurence Geller, co-moderator of the panel and chairman of Geller Capital Partners, asked IREFAC panelists whether the U.S. is transitioning from its peaks-and-valleys model to a more European cyclical wave model.
Referencing years of low interest rates, Tony Capuano, EVP and global chief development officer at Marriott International, said the protracted economic environment has softened the curve, which is why the U.S. is seeing more gentle waves. There was an unprecedented period of available and affordable debt, he said.
Brand-managed versus franchised
Wells Fargo works with both brand-managed and franchise hotels, and sees benefits to both, Jordan said. In situations in which it appears the operator is not the right one for the asset or has applied the wrong strategy, the owners tend to figure that out before his company does, he said.
“They take action before we have to take action,” he said.
Decades ago, the spread of the cap rate between a brand-managed hotel and a franchised hotel was about 100 basis points, favoring the franchised, Elliott said. Since then, the gap has narrowed, he said. Brands opened up and brought more franchisees into their business, adopting best practices from those operators and becoming better operators themselves, he said.
“It’s something that’s new to where today on a pure, straight up apples-to-apples basis, I don’t think there’s any differentiation in encumbered by brand-managed versus franchise in the cap rate,” he said.
A highly desirable asset for all brands and operators could be an exception, he said. If that property can be unencumbered by brand or franchisee within 10 years, it would probably see a cap rate premium.
Capuano said in the past, an appeal of brand-managed hotels has been a deeper labor pool when hiring GMs, who can be difficult to replace, and filling executive committees.
But Hersha Hospitality Trust has found a great ability to turn dials, create bigger shifts in strategy and be more of a local operator using an independent operator, co-moderator and President and COO Neil Shah said.
“You have a little more leverage as an owner on an operator reliant on your hotel for their income and growth than you often do with the big brands,” he said.
Mergers and acquisitions
Capuano predicted the value and necessity of technology and the amount of tech infrastructure investment necessary for brands to stay competitive will become a tougher burden to bear by smaller brands, which could lead to more small or single brand companies selling to larger companies.
He said he also expects to see more bolt-on acquisitions, similar to how Marriott acquired brands such as Protea, AC and Gaylord.
By virtue of its scale, Marriott has the ability to address cost issues and opportunities to capture a greater share of an incredible emerging middle market around the world, Mit Shah said.
Other companies are trying to capture that same effect, with brands such as Hyatt Hotels Corporation trying a different approach, focused on creating unique experiences for travelers, he said.
Capuano said the hotel industry is in a war for its life, and loyalty is the most powerful weapon in its arsenal.
“You will see the big brands, for a whole host of reasons beyond economics, try to drive scale perhaps through (mergers and acquisitions) to grow their footprint to in turn grow their loyalty to get their hooks deeper into the ownership of their customers,” he said.
Jordan said he’s skeptical there will be further M&A among the public real estate investment trusts. Pebblebrook Hotel Trust and LaSalle Hotel Properties had singular factors working in their favor, he said, and the industry shouldn’t extrapolate from that deal that more will come.
Elliott disagreed, saying there could be any number of combinations of REITs. “Anyone could be the acquirer or acquired based on certain circumstances,” he said.
There are large transactions costs in public company deals and questionable synergy values, Neil Shah said. He said he wonders how investors feel now about deals such as Pebblebrook-LaSalle, which has forced Pebblebrook to sell hotels to pay down leverage, perhaps reducing the upside of the merger.
“Mergers take so many years to prove out despite their growth, he said. “Look at their stock price. It takes a few years—even the Marriott/Starwood deal, which we all believe in. But it takes time for the value to come.”
Instead of REIT merger activity, Neil Shah said he thinks REIT privatization is more likely to occur. There was more of it during the last cycle, he said, but not as much this time round.
Integration is a big challenge, Elliott said. While the Marriott/Starwood integration went as well as it could, it required a lot of hard work, he said.
Private equity was well-represented at the conference, much of it in smaller aggregations of capital, Neil Shah said, which points to a changing dynamic.
In some U.S. cities, population in the urban core has tripled, forcing businesses to follow, but it’s expensive and competitive to build in these markets, Elliott said.
Last year, half of Hodges Ward Elliott’s new investments were in high-net worth, family offices or syndications of family offices—a volume he’s not seen before, he said. Deals ranged from super luxury redevelopment to suburban Marriotts for family offices looking for yield, he said.
There is a lot of appetite for deals from the private equity community, Jordan said. Everyone is familiar with Blackstone, he said, but Brookfield is of equal size and scale and is voracious. There is still a high level of confidence and comfort in real estate, because there isn’t egregious overbuilding, he added.
Japanese capital is definitely entering the U.S. for real estate, Elliott said. However, Japanese capital has mostly focused on non-hotel real estate and is only “nibbling” at hotels at the moment, he said.
“I think it will come,” he said. “Because they do have a long memory; they remember the ’80s. Japanese capital is wisely making sure it really understands the market.”