Branded hotels with a history of strong performance give investors and buyers confidence, but the growing demand for unique experiences and having the ability to change to market needs is making independents an increasingly attractive option.
REPORT FROM THE U.S.—While the U.S. hotel industry might be nearing the end of its cycle, guest demand for unique, authentic accommodations continues to grow.
That demand has helped buoy the value of independent hotels even as hotel transactions overall are no longer setting the records they did just years ago.
There’s general optimism for independent hotels long term, said Shawn Tuli, VP of acquisitions and development at Hersha Hospitality Management. His company’s portfolio has independent hotels in global markets with diversified demand, and he said independent properties have a lot of opportunities to customize themselves to meet the specific needs of their individual markets.
“That bodes well for valuation,” Tuli said.
The pool of institutional investors is not as interested in independents as it is in branded assets, but that should soon change, Tuli said. As more and more investors become more comfortable with independent properties, the pool will grow for independent real estate. He said such deals will be predicated on the right buyers who tend to be longtime holders.
It’s hard to predict the market for the next six to 12 months, Tuli said. There’s an argument for the security of a brand when the markets might be challenged, but investors looking for a long-term hold and not as much leverage can find the upside in independent opportunities.
Lending and financing are definitely harder for independent hotels, said Jim Merkel, CEO of Rockbridge. Properties in a major market with a historical cash flow can attract capital, he said, and on the opposite end, lenders are more conservative when developing properties because they have no track record.
“They’re going to be more conservative than lending on a branded property simply because there’s a heck of a lot more information available for a lender on a Marriott hotel and they probably already have experience with that,” Merkel said. “It’s easier for them to underwrite.”
The advantage of having options
What broadly makes independent properties appealing is the opportunity for customization and differentiation, Tuli said. Not every guest prioritizes something like roomservice of a three-meal restaurant or club lounge, he said. Independents can more easily reprioritize their offerings to fit the needs of its market, he said, and doing so can attract unique guests. Strong operators and owners with experience in this space can test and rethink what they provide.
“We see more upside opportunities through items we can control at an independent versus branded,” he said. “That’s not always the case. There’s just great opportunity.”
Independents that take advantage of their ability to customize their offerings and design can appeal to unique customers, which creates and drives value, Tuli said.
Rockbridge developed The Commons Hotel in 2011 to create an independent experience at the University of Minnesota because the university identified an unmet need and general dissatisfaction with the hotels in the market, Merkel said. The company created a successful product, he said, and later sold the property for an undisclosed sum to Adventurous Journeys Capital Partners to convert it into a Graduate Hotel.
“I think this is important in that an independent hotel, a successful hotel, is more valuable than a branded hotel if it’s in a market that is a viable market and a high-barrier-to-entry market,” Merkel said. “When we sell it, we have the opportunity to sell it to anybody unencumbered. The buyer pool can buy the pool and put a brand on it if they want to, and an independent can buy the hotel. That creates an opportunity to have a win-win on the exit.”
Different buying opportunities
The price of hotel acquisition remains high, said Matt Marquis, president and CEO of Pacifica Hotels, and cap rates are aggressive. The company is still looking at some independent properties, he said, but Pacifica is looking for underperforming independent properties to partner with rather than fully acquire them.
“We’ll provide capital or take money off the table for you, and you stay along for the ride,” Marquis said. “They’ll stay as the property gets repositioned. They’ll stay at almost the same cash flow as when the property was underperforming, and we are taking on the return on the capital.”
One thing in play in the independent segment is poor-performing brands, Marquis said. There’s opportunity for people to come in and reposition the property into a lifestyle independent, he said, which could improve the property’s average daily rate and revenue per available room. Some of these conversions even help with occupancy, he said, but it is difficult considering brands’ reservation and distribution systems.
The impact of soft brands
There are a lot of investors who aren’t necessarily comfortable with independents because they want a strong brand system in place during challenging periods, Tuli said, and soft brand collections are a good solution for that. The possibility of joining a soft brand can make independent properties more attractive to buyers, he said.
“Optionality helps drive value because it can have a wider investor pool,” he said. “There are some great independent assets brands think would be a great fit for soft-brand collections, which would be appealing to investors.”
Soft brands came about because big brands, with their significant customer loyalty and brand recognition, wanted to meet their guests’ demand for more independent experiences, Merkel said. Independents that join a soft brand benefit from the distribution channels and brand backing, he said, which can attract investment.
“We look at it as a good relationship,” Merkel said. “It doesn’t work in every case, but if you look at our independent hotels, we probably soft brand them half the time.”
Although the hotel is associated with a bigger brand, the independent hotel can still retain the individuality and freedom to do things brands would never allow at their own properties that attract guests in the first place, Marquis said.
“It’s smart to develop soft brands, but there’s always a place for true independent hotels,” he said. “It will be interesting to see how that goes over the next five to 10 years.”