LOS ANGELES — Changing market conditions across the U.S. have opened and closed deal opportunities for hotel owners trying to take advantage of travel demand as costs continue to rise.

During an Americas Lodging Investment Summit general session on building, buying and selling hotels, hotel executives said that they’re still able to make deals, but it’s more difficult to make all the factors necessary align. As they continue to review new development projects and potential acquisitions, they’re also reconsidering their portfolio strategies for reinvestment or sales.

Over the last decade, Apple Hospitality REIT has identified some meaningful economic and demographic shifts through the U.S. that were accelerating even before the pandemic, President and CEO Justin Knight said. The trends were moving away from high-cost markets to lower-cost markets, such as tech companies expanding in Boise, Idaho; Salt Lake City, Utah; and Austin, Texas, outside of the Pacific Northwest.

“We’ve worked overtime to adjust our portfolio to benefit from those trends,” he said. “Certainly, part of the reason I think for the quick rebound of our portfolio was our heavy concentration in Sunbelt states, which has not been our exclusive focus but has been a meaningful focus.”

Throughout the pandemic, Apple REIT continues to further adjust and pursue hotels in markets with diverse demand generators and a good balance between great potential and likely cost structures, he said. It continues to focus on high-density suburban and smaller urban markets, but there may be an appropriate entry point into something larger that has historically been more expensive to enter.

KHP Capital Partners started investing in drive-to leisure destinations starting back in 2015, co-founder and Managing Partner Ben Rowe said. The thesis behind it was the growing demand coming out of major cities as well as the constraints on supply growth in some of these destinations. The company still likes these investment opportunities, but they became more popular in the wider industry during the early days of the pandemic, and the competition for those properties drove up the pricing.

“We have struggled somewhat more recently to define opportunities that we think are compelling,” he said.

While drive-to leisure destinations still hold long-term investment opportunities, KHP is focusing again on some urban markets, Rowe said. Historically, the company has invested in properties experiencing some levels of distress.

“As we come out of COVID, now that’s compounded by pressures from the capital markets,” he said. “These assets can still be purchased at a significant discount to where they were valued pre-COVID, and, at the right circumstances, they are very compelling.”

Before the pandemic, Omni Hotels & Resorts decided to move its brand closer to the luxury segment after operating in the upper-upscale level, Chairman Peter Strebel said. The company is always on the hunt for trophy assets, but those are trading at prices that even during the pandemic were too high.

“We’ve taken the strategy of investing and building our own,” he said, adding the company’s last acquisition was about eight years ago in a deal for six resorts from KSL Capital Partners.

The strategy has allowed Omni to invest in its own real estate to grow and elevate its existing resorts and hotels, Strebel said. He cited the $140 million renovation and restoration project currently underway at the Omni Homestead Resort in Hot Springs, Virginia.

“We're really not out there growing as much, and [we’re] building our own and developing our own, but if there is a good deal out there … we'll be out there,” he said.

KHP isn’t focused on new development at the moment, Rowe said. With the escalation of construction costs and the other risks involved in new construction, the company feels there are better opportunities to acquire existing, undercapitalized hotels. Its strategy is to renovate them to a new standard while still being below the cost to build new.

“That said, we’re always looking at entitled land in really, really good locations where it’s hard to add supply,” he said.

Apple REIT measures new supply within a 5-mile radius of its hotels, Knight said. Prior to the pandemic, roughly 70% of its portfolio had exposure to comparable hotels under development. In the third quarter of 2022, that exposure was about 50%, likely due to the cost of new construction.

“Investors are looking at buying existing hotels where they can get into a property, including the renovation, below replacement costs for the asset,” he said.

Historically, the REIT has been able to secure or provide meaningful value to developers by providing them with a fixed takeout price upon completion of an asset, Knight said. That generally establishes it as a pipeline of assets that it can close in three to four years into the future. Currently, the company has one asset under construction through a third-party developer.

“Ideally we would have two to three to four hotels behind that so that we can accurately focus on existing assets and two to three to four years from now be closing on these assets as they come online,” he said.

Despite the cost of construction, Omni has been building its Omni PGA Frisco Resort in Texas, Strebel said. The project was stalled for about six to eight months earlier in the pandemic. All costs associated with the project increased more than expected, but it and other development projects are still on point for performance.

Leisure travel and group demand remain Omni’s focus, not business travel, he said. It doesn’t have the distribution or strength in the loyalty program. The brand performs well in major markets, such as New York, Chicago or San Francisco, but the company won’t buy or build a hotel in a corporate suburban market.

“We’re going to stick with city’s convention hotels, big boxes and resorts where they make sense,” he said.

Apple REIT’s executive team thought strategically about where to invest capital to yield the best returns for investors, Knight said. Early on, they decided instead to optimize a portion of its portfolio for sale.

As markets shift over time and properties’ relevancy changes due to these shifts, the company is constantly evaluating its portfolio around reinvestment points in the life cycle to see where it’s necessary and to maximize an exit strategy and redeploy those proceeds, he said.

“It’s true overall on average that real estate appreciates over time, but it’s not necessarily true for every specific asset,” Knight said. “For us, we’re looking at managing our portfolio and creating the mix of assets that will yield the best for our investors.”

Apple REIT will continue to be active when the market supports it both by selling assets nearly all the time in order to ensure the mix of assets is producing good performance, he said.

There are certain markets where Omni can’t compete in anymore from a brand perspective as well as a rate perspective, Strebel said. Those types of markets are saturated with limited-service or midscale hotels, pulling down the overall rate level.

Omni recently sold five assets in such markets because they no longer made sense for the portfolio, he said. They were good hotels generating good earnings before interest, taxes, depreciation and amortization, but they didn’t fit Omni’s profile.

“It didn’t really make sense for us to put in $20 million to $30 million per hotel, because there really wasn’t the upside on the rate,” Strebel said. “We still have a few hotels that we kind of scratch our head and say maybe it’s a good time to recycle those assets, but right now, we’re in a pretty good space where our hotels are in good shape.”

As a private equity firm, KHP is not a long-term holder, typically owning properties for five to six years on average, Rowe said. Its business plan is to stabilize a property and sell it when market conditions support it.

The company started looking at selling some of its leisure assets before the capital markets shift as they saw they were trading at premium pricing, he said. After the shift, however, the company hasn’t considered selling any additional properties. It likely won’t for the near future.

From a buying perspective, it’s more difficult to make these deals work now, Rowe said. The combination of lower leverage and higher interest rates against hotels makes them worth less.

“That’s particularly true across the board, but it’s particularly true for transitional assets where the debt market is thinnest and where spreads widen the most,” he said. “I don’t think seller expectations have necessarily fully adjusted to that.”

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