During a panel at the Hotel Data Conference, several experts discussed three major issues to consider when deciding whether to buy an existing hotel or build a new one.
NASHVILLE, Tennessee—Deciding whether to buy an existing hotel or develop a new one requires plenty of thought and sound strategy—and an eye toward the future.
Understanding changing demographics and trends and honing in on a specific timeframe to own an asset are key elements that go into the buy-or-build decision, according to panelists on the “Let’s make a deal: Buy vs. build” panel discussion held during last week’s 5th annual Hotel Data Conference, hosted by STR and Hotel News Now.
Michael Murphy, head of lodging and leisure capital markets at First Fidelity Mortgage Corporation, said the buy-or-build question in many ways comes down to a company’s hold strategy. Different thoughts are involved depending on if there’s a three-year hold strategy, a seven-year hold strategy or a 15-year hold strategy.
That also affects the lending strategy.
“Shorter-term guys want to have some floating rate that allows exit at a fairly reasonable cost,” Murphy said. “Long-term holds tend to do fixed (interest rates) because they know interest rates are going to go up.”
There’s a trillion dollars sitting out there waiting to be invested in hotels in one form or another, but acquisitions have their own hurdles to clear, said Biff Hawkey, senior VP of development for Hostmark Hospitality Group.
“Everyone is trying to get the impossible dream satisfied,” he said. “They want an 11 (capitalization rate) on trailing 12 (-month performance) on a 600-room Marriott in downtown Chicago with no renovation risk.”
Murphy said there were numerous capital funds formed in 2007 and 2008 to buy assets at deep discounts, but they never found a home because the huge distressed hotel selloff never occurred.
Deals have to traverse a challenging property-improvement-plan gauntlet supplied by the brands. The cost of those PIPs doesn’t always flow-through to the final acquisition price.
Hawkey said PIPs are such moving targets that many borrowers who acquire a hotel simply hope their conservative underwriting equation holds out.
“The sale cap rate is not reflective of the reality of the PIP environment,” Murphy said. “That’s what has changed a lot of people’s thinking about the buy-build equation right there.”
Murphy said because of that, many owners believe they might be better off buying a great piece of property and building on it, which ultimately puts another hotel that’s functionally obsolete out of business.
Competition for acquisitions
David Tarr, senior VP of real estate and development in the U.S. and Canada for Hyatt Hotels Corporation, said Hyatt almost always would rather buy an existing hotel rather than build one because there are far more moving parts in construction. But acquisitions are not easy because of the competition that surrounds quality assets when they hit the market.
“We fail more times than we succeed in trying to get hold of an asset,” Tarr said. “When something comes to market, it’s like a pancake-eating contest out there. There’s so much money chasing the deals that it drives down the cap rates.”
Hyatt’s philosophy was apparent in August when it acquired the Peabody Hotel in Orlando for $717 million. It will convert the 1,641-guestroom property to the Hyatt Regency Orlando Convention Center by October.
Hyatt isn’t the only company looking for transactions.
“We’re actively looking for acquisitions and have put out several (letters of intent), but we haven’t hit yet,” said Brooks Moore, CFO for Gulf Breeze, Florida-based Innisfree Hotels.
Many investors are choosing the acquisition route for one good reason: The return on investment can be immediate, according to Hawkey.
“You find the opportunity, find the right revenue manager and you can add five points to occupancy and $10 in rate,” he said.
The pipeline conversation
An increasing number of hoteliers are turning to developing hotels. Moderator Shawn Turner, finance editor for Hotel News Now, showed data from STR that revealed there are 100 more projects in the nationwide construction phase than there were just nine months ago (498 to 598).
Innisfree developed four hotels through local lenders during the past four years and has three more in the pipeline, Moore said. While it focuses on the Pensacola, Florida, area, it is open to expansion—particularly in New York—if the right opportunity comes along.
“We’re looking for any opportunity. It’s not necessarily a buy-versus-build situation,” he said. “Right now we’re seeing the opportunities in the build side of the column.”
That trend will continue, Murphy said.
“I predict we’ll have the mother of all overbuilding in the future,” he said. “There are a number of architects scribbling out plans, and at some point all the money will become available and they will get built.”
Murphy said many projects will get finished because investors don’t want to bail out on fees in which they’ve already invested.
“There are a lot of hotels built because they have $125,000 in architectural fees already into it,” Murphy said.
But the big “O”—as in overbuilding—isn’t going to happen overnight, panelists said.
“We’ve got four or five years. I don’t think you can get overbuilt much quicker than that,” Murphy said. “The perfect time to build was three years ago when there was no money (available). The perfect time for banks to lend was three years ago.”
The capital plan
Buying or building requires capital, and there is plenty of that available for the right borrower. Murphy said it’s much easier to raise capital for deals in gateway cities than it is for secondary and tertiary markets.
“But there are lenders willing to go into those (secondary and tertiary) markets. It just takes time to educate them,” Murphy said.
The type of property hoteliers are targeting varies. Tarr said full-service hotels, which have evolved to meet the demands of consumers, are sought-after assets.
“We’re seeing an interesting inflection. … The industry is more often building larger select-service hotels and smaller full-service hotels,” Tarr said. “Those two spaces are getting closer together than they have ever been.”
So, what will happen to the many suburban large-box hotels built with a lot of meeting and retail space? Hawkey said some entrepreneur will develop a plan that utilizes that space better to meet consumers’ needs.
Social, military, education, religious and fraternal business is there for full-service hotels, Hawkey said.