Investing in the Future: From capital markets to construction costs, how do owners value a deal & create a successful transaction?

COLUMBUS, OH—A variety of factors go into the financial wheeling and dealing of the hospitality sector, from finding the right partner—and the right property—to all of the issues affecting today’s hoteliers.

STANDING, LEFT TO RIGHT: Mark Elliott, Hodges Ward Elliott; Robert Cole, HVMG; Mike Deitemeyer, Interstate Hotels & Resorts; Jim Merkel, Rockbridge; Dave Johnson, Aimbridge Hospitality; Rick Takach, Vesta Hospitality SITTING, LEFT TO RIGHT: Chip Ohlsson, Wyndham Hotels & Resorts; Art Adler, JLL; Jennifer Dakin, Wells Fargo; Chris Diffley, Rockbridge

Held here last month at Eleven restaurant, in conjunction with Rockbridge RTRX, which has raised millions of dollars for cancer research, the Hotel Business Executive Roundtable “Investing in the Future: The Art of the Deal” provided a platform for 10 industry executives to share their varying opinions on the topic. The roundtable was hosted and sponsored by Rockbridge and moderated by Hotel Business Senior Editor CJ Arlotta.

Healthy partnerships
The participants all agreed that finding the right partner is key to making the deal work.

“It does help when you have a partner who understands an industry,” said Rick Takach, chairman/CEO of Vesta Hospitality. “It makes a big difference. I have had partners who really didn’t understand the industry and they really wanted to learn—it makes it very difficult. [You want] somebody who understands the industry, somebody who has integrity, somebody you can trust, somebody who is non-litigious because you really get to see what people are like when things get tight. So, you better have a good relationship.”

Jennifer Dakin, Wells Fargo

Jennifer Dakin, SVP at Wells Fargo’s Hospitality Finance Group, said that her company examines three factors when considering a partner. “Our motto is: ‘People, credit, real estate.’ You really want to do business with people who you can look across the table and strike a deal with and know that they are going to follow through on what they say they are going to do,” she said. “We also look at the credit quality of these people and make sure that they are adequately capitalized to handle whatever obligations they are entering into. Then, you are obviously looking at the quality of the real estate and making sure that it’s sustainable.”

For Jim Merkel, CEO of Rockbridge, knowing who your partners are and how they behave really matters during the tough times. “Put together the right team, the right partnership, where you can look each other in the eye—you don’t have to agree on everything, but agree that you are going to try to do the right thing, be transparent and have high integrity—because we are all trying to do good business for our investors,” he said. We all have investors in our companies… We are trying to create sustainability. You have to consistently do good deals in order to grow and build your company. Looking around the table, everyone here has done that very successfully over the long term, and I think that’s in large part because they care about who they do business with and what they do when they sign their name onto it.”

With the “right” partners being so important, it is no surprise that many in the industry try and use the same ones as much as possible. “Using the same partners as much as you can is really helpful because with most capital partner investors, their asset management has gotten so sophisticated and so hands-on and so engaged, you want to do business with the same folks; you already have the system down, you have the process down, you have the communications,” said Robert Cole, president/CEO of HVMG. “Lenders and investors have just really stepped up their asset management game.”

Using the same partner offers a sense of security. “Everyone wants a good partner,” said Chip Ohlsson, EVP/chief development officer with Wyndham Hotels & Resorts. “I don’t care if I am sitting across the table from a buyer or a seller, or I am sitting across the table signing a franchise agreement, or if I am sitting across the table looking for a lender, you want somebody you can trust and you want a good partner—which means there is a win-win. You can’t go in looking to screw somebody you are doing business with; that is the problem with an unknown partner—sometimes you have that… You don’t know if the deal is really going to happen or they are just beating you up for other reasons.”

For Art Adler, chairman, Americas, hotels & hospitality group, Jones Lang LaSalle (JLL), the best deals are the ones that are a win for both sides, and the best partners are the ones who know that. “What makes a successful transaction is one where both the buyer and the seller win,” he said. “It doesn’t have to be a win-lose or a lose-win. We have a client who thinks the buyer has to lose for them to win. That is probably not a good relationship. The way we look at the business is we have a client and we want to sell the asset for the highest price we can for that client with the best financing in place. But on the other side, you have a buyer, and that buyer is either currently or will also be our client at some point. We have to look at the deal and say, ‘How can we do a great deal for our client, but make sure that that buyer is also going to do extremely well with that asset? What’s the value-add? What can they do with the asset? How can we ensure that they make money? Our underwriting the deal is very, very important, so that it is a win-win.”

Brand vs. independent
When its comes to the financing of deals, Arlotta asked if lenders favor deals where the hotel property is branded.

Takach thinks that is the case. “I have a few independent properties, and I will say that when you go out, you find that there are fewer lenders that are interested in non-branded properties,” he said, adding that it’s not impossible.

For Dakin of Wells Fargo, it is not all about the brand. “With the right sponsor, we would look at an independent brand. We have looked at several and we have financed several. It is really based on location, location, location,” she said.

The panelists enjoyed a lively conversation.

There are pros and cons of having a brand, according to Adler. “If it is brand-managed and fully encumbered, the exit cap is higher,” he said. “If the lender has a problem, there is less room to maneuver from a brand and management perspective. If it is franchised with third-party management, then you can move some things around on the management side.”

He continued, “We will arrange probably $5 billion in debt this year, and we have for the last few. We do a lot of independent hotels, and it really depends on who the owner is, who the operator is, what the location is and what the track record of that operator is with regard to managing these types of properties. To some extent, given social media, the internet, etc., OTAs, you can drive business to independent hotels depending on where the location is and maybe save that brand cost—or hybrid a little bit and go with the soft brand.”

Labor shortage
Labor shortage was also on the minds of the participants—something they see as affecting deals.

“I would say that the No. 1 issue for our economy right now—everybody talks about interest rates and GDP, and we are right in the thick of it—is worker shortage,” said Dave Johnson, chairman/CEO of Aimbridge Hospitality. “We can’t find anybody. Manufacturing is getting hurt. I think the only thing that can derail this economy is shortage of workers. How many of us can’t hire people? Everybody is outsourcing laundry. We never outsourced laundry.”

He continued, “We used to do a job fair for a new hotel opening six to eight years ago and we had 400 people show up. Now, you are lucky to get 40.”

In addition to the difficulty finding employees, finding those who are at the top of their game is becoming problematic, affecting service. “I am having a really hard time finding good people who will do a good job,” said Takach. “I have seen service levels drop off at a lot of our hotels. It is driving me crazy. No matter how much time or effort or money and training you spend on it, the service levels have dipped. I have seen it everywhere.”

LEFT TO RIGHT: Chris Diffley, Rockbridge; Chip Ohlsson, Wyndham Hotels & Resorts; Mike Deitemeyer, Interstate Hotels & Resorts; Mark Elliott, Hodges Ward Elliott; and Gregg Wallis, Hotel Business

The shortage of employees means that employees who may not be qualified are filling jobs that may require a stronger set of skills, like speaking English. “I know a lot of us in here sit on various brand committees,” said Cole. “I think there is a lot of research pointing to the language barrier creating service score declines… A lot of the folks don’t speak English, and if they do, it is very limited. There is a direct correlation to the labor shortage where service scores are declining because of that language barrier. Sometimes you have no choice, you have to go with the folks who want those jobs. It is a big issue.”

Takach tells his GMs to search for employees from his competitors. “[I tell them] to find the best labor [our competitors]have, and I will do whatever I need to get them,” he said. “Unfortunately, you are not finding new labor outside the industry, you are poaching sometimes.”

Johnson said his company is stepping up recruiting at hospitality schools. “We have always recruited at colleges and hotel schools, but we are gearing up a big plan for this next year,” he said. “We want to hire 250 people out of the hotel schools.”

Mike Deitemeyer, president/CEO of Interstate Hotels & Resorts, has changed what his company looks for when hiring employees. “In certain markets, we are targeting nontraditional hires and just really going attitudinal, trying to find those people who have that passion for hospitality,” he said. “It is an investment right now, but from our perspective, we certainly see that changing how we are working.”

While Johnson said his company no longer has this problem, it is hard for smaller companies to attract and retain talent. “I think it is harder for smaller companies because when I was small, you would hire a kid out of school, they would do a great job, and you promoted them up to a GM of a hotel. Then, they said they love the company, but they want to run a bigger hotel and want to make more money. I had to say I couldn’t give it to them. It is hard,” he said. “The biggest advantage of being a larger company is talent. If they like your company, they can stay with you because they can make a career out of it.”

Full-service vs. select-service
The labor shortage has led to the popularity for buyers toward purchasing select-service hotels, and away from those offering full-service. “I meet a lot of our people who say they don’t want to buy a full-service hotel because of this labor issue; they are only going select-service,” said Deitemeyer.

He said that the full-service hotels have attracted overseas buyers. “What we’ve seen is a shift to South American and Asian buyers,” he noted. “We have had a lot of success with Chinese with money already outside of China.”

Adler added that he has seen that be true with hotels like suburban, full-service 350- to 400-room Marriotts, Hiltons and Hyatts in some cases, but not all. “They trade at higher going cap rates because they are generally 1980s/1990s vintage,” he said. “I wouldn’t say it is necessarily offshore buyers for some of them. There are the syndicators of Chinese capital that will buy those types of properties because they have higher yields, but you also have owner/operators with smaller private equity firms liking that kind of property because they get most of their return during the hold period. If they are buying at an 8.5 or a 9, then their delivered cash-on-cash return is already low teens. They are getting a much larger share return during the hold period, which in theory de-risks the investment because they have to rely less on appreciation or cap-rate impression to get to their returns. Some investors like those deals but they are under it a little bit.”

Construction costs
Rising construction costs are also affecting what types of properties are invested in. “Construction costs are up 25% in the past 18 months to two years,” said Ohlsson. “We are not seeing a slowdown in it. Lumber is going up, steel is going up.”

These rising costs make renovating properties a much smarter move than new-builds. “Buying them and improving them is a much better economic model because your price per key is significantly lower, buying for $100,000 and putting in $50,000 versus spending $250,000 on construction,” said Adler.

“It is hard to see new supply outpacing demand in this environment because it is so expensive to build it; you can go buy it in suburbia and renovate it way below replacement cost,” said Chris Diffley, managing director, investment group with Rockbridge.

With the construction costs, Ohlsson said that Wyndham is now reviewing all of its prototypes. “We are not saying, ‘You have to build it, you’ll drive rate.’ We’re saying, ‘Okay, we’ve got to value-engineer this.’ That’s what we’ve got to do,” he said. “There are ways to do it without compromising the brand, which is the important piece of it. But you have got to have a plan, because if you don’t have a plan to value-engineer it this time, you are going to be dead in the water.”

The investor
Mark Elliott, president of Hodges Ward Elliott, said that he has seen a change in the type of investors who are out there for hotels. “The most significant change in the investor profile is the entrance of the high-net-worth investor. This is across the spectrum. Last year, we probably did a half-dozen deals to that profile buyer,” he said. “This year, it is probably going to be a dozen. It is across the spectrum from $40-million deals to $1-billion deals. Some of them are by themselves, some of them are being syndicated. We have a bid currently this week, and two of the top three bidders are high-net-worth families; they have made a lot of money, and they are looking and are saying lodging provides a whole lot of yield compared to multifamily or industrial.”

In addition to the type of investors who are now in the market, Adler said hotels are now a more popular investment. “Hotels have become a core institutional investment. Twenty years ago, they weren’t. Hotels were an alternative investment,” he said. “Hotels have become a core part of any private equity or institutional portfolio. They are trading now like any other type of real estate. If there wasn’t something there for the buyer and the seller, then they would never trade. If the buyer didn’t see something there and there wasn’t a motivation for a seller to sell, they wouldn’t trade. That is what the beauty of the industry is now. They are assets that trade every four or five years.” HB

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