LIIC talks CapEx, select service, supply
06 FEBRUARY 2015 7:36 AM
The window for taking advantage of renovations during this cycle might be closing, according to speakers at Lodging Industry Investment Council meetings.
LOS ANGELES—Hoteliers with properties needing capital improvements might be too late to the party to reap the full benefits of aggressive renovations—but that doesn’t mean they should forego the process, according to members of the Lodging Industry Investment Council.
“The time for CapEx is not now; it was three years ago,” said Steve Kisielica, principal and chief investment officer for Lodging Capital Partners. “You have to take rooms out of service for CapEx programs. (Guest) displacement costs are double what they were two or three years ago. Everyone underestimates that.”
Kisielica said a recent project that involved replacing bathtubs with showers at one of the company’s luxury hotels resulted in $1.5 million in guest displacement costs alone.
LIIC met during the Americas Lodging Investment Summit. Click here for full conference coverage, including more from LIIC.
Doug Dreher, president and CEO of The Hotel Group, concurred, calling the process “very disruptive, very complicated.”
“You are supposed to do the heavy lifting during the recession,” added Adam Valente, managing director for Columbus, Ohio-based Rockbridge.
But regardless of the potential rewards or if the peak time to engage in CapEx has passed, hoteliers who have not jumped on the bandwagon should do so, said Abid Gilani, senior VP, hospitality finance group at Wells Fargo.
“Things have been held off; the debt providers have capital financing, so why wait?” Gilani said. “This is the time to take advantage of it.”
There’s also pressure to upgrade the asset from brands, he said.
“The brands are now saying ‘do it.’ … They have the detractor list and are pushing,” Gilani said. “It’s the confluence of pressure.”
Valente said that as Rockbridge becomes a more active buyer of hotel assets, it is finding brands more stringent in their approach to renovations surrounding property improvement plans—but even that often doesn’t go far enough to place a hotel on sound footing for years to come.
“The approach we’re taking is fixing it head to toe,” Valente said. “Make that asset institutional-quality now, and three to five years from now there is no maintenance.
“The PIP alone doesn’t get it done; sometimes that’s only 50% of what it takes of what it really needs to get it done right,” he added.
The driver of such expenditures is easy to figure out, according to the LIIC members.
“The guest doesn’t care about the cycle—it comes down to the product,” Dreher said. “The guest is really determining … what the needs are.”
“Doesn’t it boil down to (return on investment)?” asked Russ Urban, executive VP of business development and acquisitions for Destination Hotels & Resorts. “If you believe the guests are going to pay more, you should invest now. In some markets you can justify it; in other markets you just can’t.”
Click here for more coverage on CapEx from ALIS.
The increasing select-service factor
Mike Cahill, one of LIIC’s co-chairmen and the CEO and founder of Hospitality Real Estate Counselors, said boundaries are increasingly becoming broader regarding when a hotel needs to upgrade its presence to protect its market share.
“New always wins, especially in select service,” Cahill said.
Even that isn’t so cut-and-dried anymore. Gilani said the convergence between select service and full service is blurring the line of determining a true competitive set.
“You have the convergence of brands and style so much that the new select-service stuff has a feel of nearly full service,” Gilani said. “It goes back to maintaining, preserving your competitive share and your market share.”
Gilani and Kate Henriksen, senior VP of investment and portfolio analysis at RLJ Lodging Trust, were decidedly pro-select service.
“You see all the new supply charts … (select service) is coming because that’s what guests want,” Henriksen said. “It’s supply and demand. I wouldn’t want to own too many suburban full-service hotels now.”
“Pure full service? I’d be watchful,” Gilani said.
“The successful select-service hotel put on the market may sell above replacement costs—if the cash flow is there, it’s justified,” Cahill said.
Cahill said there are still some suburban full-service hotels available for acquisition for as little as $50,000 per key.
The key driver: industry performance
The renovation and select-service discussions are made possible by the continuation of strong industry fundamentals, according to speakers at the LIIC meetings.
Only 6% of hotels in the United States experienced declines in occupancy and average daily rate during 2014, according to Jan Freitag, senior VP of strategic development at STR (the parent company of Hotel News Now). Meanwhile, the pipeline is accelerating but still well below the peak.
“It seems like usually at this point in the cycle demand is slowing down,” Cahill said. “It seems too good to be true that we just keep cranking along like this.”
Freitag said two-thirds of the pipeline falls in the upscale and upper-midscale segments—the so-called select-service hotels—and questioned whether the additional supply will have a psychological impact on the industry.
“Psychologically, I wonder if GMs are pricing the 13,000 rooms in New York that are coming (rather than the current supply),” Freitag said when asked why New York City’s ADR has been stagnant as opposed to San Francisco, which has a muted pipeline.
Henriksen said San Francisco still has a number of compression roomnights available, while New York City has many fewer nights available to push rates.
David Loeb, senior research analyst for Baird, said the transaction environment is strong, but real estate investment trusts have yet to satisfy their appetite because they’re not finding enough high-quality product to acquire.
In addition, Loeb said it’s difficult to imagine 10-year treasuries dropping any lower than current levels.
“We’re getting closer to a time when lending standards are getting really, really loose,” he said. “Lenders have not forgotten how bad things really got (during the downturn), but developers have.”
Gilani said Wells Fargo has done some selective new-construction financing.
“We are forecasting to do a similar amount of new underwritings in ’15,” Gilani said. “Underwriting is still pretty strict.”