Cost concerns weigh heavy on hotel deals
A panel of executives speaking at the NYU International Hospitality Industry Investment Conference said worries about costs are having a demonstrable effect on the transactions environment.
NEW YORK—Increasing costs are defining the outlook for hotel investors more and more, said a panel of experts speaking during the recent NYU International Hospitality Industry Investment Conference.
During the “Leaders perspective: Current cycle realities: Transactions and money” panel, Michael Medzigian, chairman and managing partner of Watermark Capital Partners, said his firm has cut down significantly due to rising costs and slowing revenue growth.
“We’ve slowed our pace of investing,” he said. “We were buying at $1 billion a year or a little more. We’re probably at half that today, and that’s the result of flattish (revenue per available room). … It’s hard to underwrite when the top line is moving at a pace below labor-costs growth.”
He noted his company remains an active buyer, but is focusing more closely on properties in markets with “real barriers to entry” and those with “hyper growth” like Nashville, Tennessee; Austin, Texas; and Denver.
But Medzigian noted the current environment has completely changed the nature of how people discuss the hotel industry.
“A few years ago, we would’ve been talking about interest rates, the economy, consumers, (revenue per available room),” he said. “I think the majority of our discussions now are around other things, like costs. It’s all costs.”
Mit Shah, CEO of Noble Investment Group, said there’s a lot to like in the hotel industry right now, including a prolonged period of “unprecedented demand,” but the cost issues are making it more difficult to get to a point where the bottom line gets better.
“We never expected 2.5% RevPAR growth to turn into flat (earnings before interest, taxes, depreciation and amortization),” he said, noting investors will keep a close eye on second-quarter numbers in determining their outlook for the hotel industry.
Gilda Perez-Alvarado, CEO of JLL’s Americas Hotels & Hospitality group, said real estate investors continue to be drawn hotels because of their high yields.
“To people looking for that above-inflationary type of return, hotels are an amazing asset class,” she said.
But Kevin Jacobs, CFO for Hilton, and Leeny Oberg, EVP and CFO for Marriott International, said the outlook remains strong for their businesses and other asset-light hotel brands. Both noted their companies have been focusing on share buybacks of late.
“Buybacks are always in play. … We’re a simplified fee business model,” Jacobs said. “We generate a lot of free cash flow that doesn’t require a lot of capital.”
“We’re very cash-rich,” she said. “We have arguably three times what we need to invest in growth, so the rest we return to shareholders.”
Jacobs said he sees bid-ask spreads widening in hotel deals as more companies “want to chase deals but it’s getting harder to underwrite.”
Oberg said when developing in higher-cost markets and in the luxury space, pairing hotels with a residential components is “still key to getting a deal done,” but financing is still strong even late in the cycle. On the select-service side, she said dual-brand projects are more and more en vogue to counteract increasing construction costs.
Medzigian said historically the biggest competition for the high-end properties Watermarkbuys have been publicly traded real estate investment trusts and foreign capital, but those two groups have been moving in different directions in the past couple of years.
While there is still foreign capital active in U.S. deals, he noted it’s “not as active” or aggressive in the deals he’s chasing. Conversely, REITs seem to have had new life breathed into them of late.
“A couple years ago, they were not as active,” he said. “Now they’re more active, and most have capital.”
He said private equity groups seem to have “a ton of dry powder out there, but they’re not buying the kind of assets we buy,” and there has been a relative explosion in non-traded REITs after Blackstone started one.
“There was just us for a while, then Blackstone; now there are a few,” he said.
Shah said state public pension funds have been particularly active investors of late with a “veracious desire to put direct dollars” into the business.
Perez-Alvarado noted the overall trend in foreign investment is positive, and even though outflowing capital from China took a hit, there are many other source markets for capital.
“We’re now seeing new types of European and Latin American investors coming to the U.S., and that capital is a little more entrepreneurial,” she said.