One size doesn’t fit all when it comes to investing in the right type of lodging asset.
My, have times changed. There’s no question that the lodging investor of today is far more business savvy than 10 or even five years ago. While there are certainly a few individuals who are simply in the “game” to own that trophy property in a luxurious location around the globe, many investors today are looking for a specific return on their particular lodging investment. They ask sophisticated and intelligent questions to ensure that the investment is worth their while and that the ROI is going to be there.
We are finding that the lodging investor today is one of several sources of capital: There are the U.S. real estate investment trusts, of course, as well as the private equity investor. There are also the high-net-worth individuals or families; the pension fund; the insurance company; and the European institution. So with different folks, we must have different strokes and find the right fit for those seeking to add assets to their portfolios. What do some of these entities look for and why?
U.S. REITs generate revenue primarily through the rents collected on the properties that they own. As a result, REITs can be very specific about the assets in which they invest. These stakeholders take into consideration quality level, service and amenities. Opportunities that service a wide spectrum of customers are of interest to these investors.
The private equity (PE) investor uses factors such as leveraged buyouts, venture capital and growth capital to make decisions regarding investments. This investor is attracted to properties that have a strong market position and sustainable competitive advantages. This includes businesses with high barriers to entry, high switching costs and strong customer relationships. Other requirements include multiple avenues of growth—balanced and diverse growth strategies through innovation, geographic expansion and upselling. Usually, the properties that are chosen for investment are well positioned to attract industry trends, resulting in above market growth and strong equity return. PE investors are also attracted to stable, recurring cash flows, allowing debt requirements to be serviced easily.
High net worth (HNW) families and individuals invest based on their priorities and outlooks. These factors include health, family and financial security. Now more than ever, these investment opportunities are influenced by the switch from HNW traditional needs to new preferences regarding style, fees, legal support and reporting. These investors are reassessing traditional private equity funds and are more attracted to larger co-investments or even participation on a deal-by-deal basis. HNW stakeholders tend to make their decisions based on transparency levels, detailed legal advice and consolidated reports. In particular, this group seeks a multi-family office model, which helps firms engage in fewer, deeper and more lasting relationships with affluent clients. It is based on customized solutions, specialized expertise and responsive service.
The pension fund seeks projects which will ultimately put people to work and therefore those investors desire construction projects which can include new builds or renovations. They may also desire unions to handle the construction projects and management of the asset. Additionally, in searching for a tax write-off, the pension funds want to enter into an arrangement that requires little to no leverage. Unlike the pension fund investments of the 1980s, which had no controls, today’s pension funds bring experts on board to ensure that all the nuances and logistics of the deal are on the up and up. The return may be slower than that of private equity, but pension funds today require checks and balances to create an alignment with their capital and the goals of that capital.
Insurance companies which possess lodging assets in their portfolios are at times looking to determine the best use of that “white elephant” trophy. Through their own internal or external underwriters, insurance firms are somewhat active today, thought a bit quieted down from years past in their acquisition activity. So their hot button truly, is “what is the best use of this asset? What guidance can one provide to extract the best ROI for this grandfathered or legacy investment?”
The hot buttons today for European institutional capital are the U.S. lease structure as well as CapEx. The sale leaseback structure is not as prevalent in the U.S. as it is in Europe, but the advantage that European capital seeks is the ability to enter into a lease agreement with the developer. The operator has to secure credit for certainty of payment for a period of time, to cover the basis of the lease payments.
So what do all these interests mean in today’s world as we continue to ride the positive side of the cycle? Investors in general seem to have redefined returns expectations downwards or gone into tertiary markets and with more aggressive returns-driven investors even into the “expeditionary” markets.
Tom Engel is principal of Boston-based T.R. ENGEL Group (TRE), LLC, a hospitality management firm operating on a global basis. TRE specializes in advisory, project management, asset management and transaction services for hotels, convention centers and mixed-use commercial real estate. As investment advisors, TRE advises its clients on the acquisition, operations and sale of hotels in North America, Europe and the Middle East. Engel can be contacted at firstname.lastname@example.org.
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