As we know, every cycle has its challenges. And the challenges brought by this cycle are clear.
First, there was the COVID-19 pandemic, which required many adjustments to hotel operations. Now, we're in an era of higher interest rates, which affects operating costs, as well as the cost of debt.
During the pandemic, staffing, housekeeping, food and beverage, and most every aspect of operations came under the microscope. Those that did this review have found that they are better for it in today’s operating environment. Many insights learned out of necessity are now helping us operate more efficiently, save costs, and serve guests better. Similarly, while interest rates remain high compared to just a few years ago, they seem to have stabilized and we are learning, as best we can, to live with higher costs from recent unusual inflation. Gains in ADR continue to offset some of the cost increases. Overall, we must remain frugal without compromising brand standards or guest services; or the morale of our staff, which is often being asked to do more with less.
Moreover, hospitality remains an attractive real estate investment compared to many other commercial real estate sectors and other types of investments. Travel activity remains strong for both group and leisure guests and most markets have a reasonable balance of supply and demand. For now, over-capacity is not an industry issue, which helps operators.
However, many hotel operators and investors are now facing buy-sell decisions as debt maturities take place, as well as property improvement considerations, whether brand-mandated or driven by one’s internal asset management philosophy and planning.
Property-Specific Strategies
Regardless, property-improvement plans are significant aspects of any refinancing or buy-sell transaction at a time when there are pressures on the cost of debt. Each property will have a specific financial and operating history and be subject to its capital-expenditure reserves, where it sits in any given renovation cycle and the investment hold philosophy of ownership. In bold strokes, property improvements can be funded out of ongoing cash flow, CapEx reserves or new lending, whether through a discrete loan or refinancing of the entire property.
In some cases, hotel owner-operators will be able draw on reserves or ongoing cash flows, but overall we can expect stiffer interest rates and conditions for any new lending. Strong lending relationships and operating histories may temper possible sticker shock. Brand relationships also help; and a good strategy may be to get out in front of expected property improvements, carefully stage property improvements and negotiate “enthusiastically” with both brand partners and lenders.
Of course, refinance or sell decisions will further depend on future return potential, investment alternatives, property condition, investment history, a competitive market, local labor trends and overall community strength and appeal. If a property belongs to an investment fund or is cross-linked to other investments, additional considerations apply. This is a time to be strategic, to carefully evaluate each asset, to pay even closer attention to the community matrix that makes a market attractive to commerce, residence or recreation.
The current market fundamentals only serve to emphasize the importance of having conviction in one’s investment philosophies, as well as individual properties. Consider why you believe in a property; and the trust built over time with your strategic partners. What kind of deal-maker and operator have you been? Did you leave something on the table for all parties in previous transactions? It can be a difference-maker in times like these.
Overall, there are still many outstanding investment opportunities in hospitality, even if it will be more challenging to structure individual deals. Ultimately, it all goes back to controlling what we can to the best of one’s ability, as the next year will be a proving ground for both our investment and operating philosophies.
Rick Takach is chairman and CEO of Vesta Hospitality.
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