There are two good reasons why the public loves shows like “Extreme Makeover: Home Edition” and HGTV programming: They love to see an ordinary or worn-down dwelling lovingly transformed into something inspirational and aspirational. Now imagine this on a much larger scale in the hospitality industry, where independent and corporate hoteliers see great potential in properties that have seen better days. They don’t just see a building, they see the future taking shape once they’ve purchased it.
At the Meet the Money: National Hotel Finance and Investment Conference held May 6-8 in Los Angeles, moderator Mike Cahill, a founder and CEO of HREC Investment Advisors, asked, “What will drive acquisitions in today’s market?” Panel members largely approached the topic informed by the region of the country in which they are doing business. The consensus is that patience and creativity go hand in hand, and that due diligence is required to ensure that the reality of the final product will live up to expectations and pay off. The strength of the 2024 market reflects this.
Taking the Risks
Adam Marquis, president of Invest West Financial and Pacifica Hotels in Orange County, Ca., said that his firm has redeveloped and repositioned nearly 40 small hotels and lodges (mostly lining the California coast and Hawaii) as upscale properties—a significant accomplishment with California markets, particularly in Los Angeles and San Francisco, which are regarded as weak at the current time. Pacifica manages about 80 percent of its portfolio and is looking into other markets in Portland and Seattle that other investors may not see as viable ... yet.
“We looked at the Pacific Northwest and found two Kimpton properties in Seattle and Portland that we determined were below replacement costs,” Marquis said, reflecting on the company’s recent acquisitions. “Kimpton was a great brand, and while the Seattle market has been recovering nicely, Portland has been a challenge. These are some of the calculated risks, and when looking into newer markets, [my partners and I] have to weigh whether [we] want to wait out this thing over the next two to three years, build an interest reserve, and then see where things go. However, when you are buying a beautiful, historic hotel for $300,000 out the door and similar properties are going for more than $450,000, it makes sense to take this risk.”
Overall, Marquis observes there is significant uncertainty and disruption in today’s market, though not a mini recession like in earlier cycles. He cautioned that the current economic climate within the hospitality industry suggests there’s a big spread between the bids of prospective buyers and the fact that operating costs can run high, especially with labor laws in some states. When certain properties go to market, he added, a disconnect can exist between seller and buyer. While some sellers are working things out with their lenders right now, some of his broker colleagues who went through the process and provided a Broker Opinion of Value to buyers and sellers reported that even completed transactions don’t always pan out.
Re-investing in NYC
As somebody heavily focused on New York City, and one who has acquired, developed and operated many hotels in New York City over the years, Will Obeid, who founded Arcade Capital in 2014, said there are several great dynamics at play that makes now a good time to re-invest in New York City hotels. He reflected on one potential acquisition—an independent limited-service hotel that was in receivership when it went to market. It began as an independently owned select-service product. The firm put out an all-cash offer at an eight and a half cap rate, which was determined based on the property’s limited growth potential, the small size of the rooms, and a below-market rent on the retail that was a long-term lease.
In all, there were 10 competitive offers, and Arcade did not have the winning bid. However, Obeid says that more opportunities have since streamed in steadily, including some off-market deals.
“Even with hotel ‘supply’ going down somewhat between Airbnbs being outlawed (under Local Law 18), 140 hotels converted into shelters, and massive properties like the 2,000-room Hotel Pennsylvania not coming back after the pandemic, the average cost per key in New York is approaching $800,000, and investors can buy hotels in New York right now for way below replacement cost,” he explained.
Getting Creative
“We invest all over the United States and its territories, and we have hotels in North Carolina, Texas, Arizona [and] Puerto Rico,” said Mack Watson, associate general counsel for Driftwood Capital, a Miami-based hotel sponsor that acquires, develops and finances hotels. “When I think about the last few deals we've done, we've had the most success with unbrokered or pre-market deals. We like deals where we can get creative. However, it is hard for us to [finalize the deal] unless we can see a value-add component where we can leverage our construction team and our development team to reposition the hotel.”
Watson added that Driftwood’s past few deals have been closed in that same vein. He cited an acquisition in North Carolina just before the conference. The seller had purchased the asset in question out of receivership, but realized it needed lot of work. “We were able to come in, pre-market process and acquire it,” Watson detailed. “I think it was at a nine cap, as we are going to have to do some really heavy renovation to it. However, these are the kinds of deals that we like, and [it works, as] it is a combination of participating in broker processes as well as being creative with off-market deals where people can't take them to the market for whatever reason. And there's always a lot of reasons for that. I've been successful in acquiring off-market deals in the past, and I find it always just takes creativity, thoughtfulness, and it is a way of getting them done.”
The Price is Right
From a broker’s perspective, Patrick Deming, managing director for Los Angeles-based advisory and global real estate investment bank Eastdil Secured, observed that the 2024 market is markedly better than it was in 2023, but serious parties on both sides need to be active to continue the momentum into the future.
“We’re seeing a lot of activity, and a lot of large players in our sectors complete a lot of deals within the past 30 to 40 days,” he said, pointing to recent high-profile deals in Nashville, Washington D.C., San Antonio, San Diego and Florida that prove his point of the high volume of business being done in the past month compared to the entirety of 2023.
While there's a little more liquidity in the current market, and Deming has a vested interest in protecting his brokers, he put earlier conditions into context. In the past, he noted, there was less visibility (what is disclosed on paper in deals) in the market, and brokers were guessing on prices and values when competing on deals. Today, more details and price points are spelled out and brokers understand how to price things better, as they don't get paid until a deal is successfully completed on behalf the clients.
“We're all trying to be smarter on picking our clients and giving them the right advice on ‘if you really want to transact, here's what it's going to take,’” said Deming. “It's up to us to run very competitive processes where we can show our clients that the market bids reflect the current debt in the market. I don’t think [sellers] take assets to market hoping they fail, so we're trying to be a little bit pickier about what we're taking on to make sure that we can meet the seller's expectations. There's a little bit of flexibility on both sides required to get things done in that gap.”
Bill Reynolds, senior managing director at MCS Capital and Marcus Corporation MCS Capital in Milwaukee and Main Street Hospitality in New England, said that he would advise buyers in the current climate to take a closer look at properties to see which ones make the best canvas.
“Look for ones where you can change the fundamental nature of the property so that you can create better [and] see value where others do not. You have to get creative and strategic with which markets you want to be in, and ready to understand what the upsides are in those markets Maybe value-adds going to come back stronger because construction prices will fall. You have to plan your game that way.”