New York—HEI Hotels & Resorts plays it safe when it comes to investing in hotels. Its investment approach is conservative regardless of the economic conditions, and that strategy will be the backbone of its latest investment vehicle, HEI Hospitality Fund III.
“Because we’re a long-term investor, we take more of a methodical approach,” said Steve Mendell, HEI’s executive VP-acquisition and development, during a break a the recent 30th Anniversary NYU International Hospitality Industry Investment Conference.
The $500-million fund will allow HEI to acquire or develop between $1.5 billion and $2 billion in lodging properties during the next three years. Its targets include branded full-service, upper-upscale and luxury hotels and premium select-service properties and resorts. HEI will focus its efforts on the U.S., Canada and the Caribbean. However, Mendell said the company won’t rule out independent properties in the upper-upscale and resort categories in strong markets.
One thing is certain: HEI will be fiscally conservative in any transaction.
“When you’re investing at a time when the cycle is moving down, to excessively lever would be a very risky strategy,” Mendell said. “If the market dips further than you thought it would, you are more likely to lose your equity position. It’s a safe, more conservative strategy in a down market to keep your leverage low.”
Mendell said HEI likes to keep its debt in the 65-percent range in this type of economic climate. During stronger cycles, it will elevate that to 70 percent or even 75 percent. The rest of the deal is financed with cash, as HEI doesn’t use mezzanine financing.
“During the last uptick, most people were financing 80 to 85 percent [of the total value of an acquisition] and it was driving up values. Those are going away today,” he said.
Investors apparently like what HEI is doing. Eighty percent of the investment in Fund III came from investors in the company’s first two funds.
“Our strategy of investing low leverage today, coupled with the fact that we are long-term investors, indicates that we have a very conservative investment strategy, which is an important reason why we’re able to attract investment capital in today’s market,” Mendell said. “This is a continuation of the growth we’ve experienced over the last few years. We believe in buying throughout the cycles as opposed to buying at certain times.”
HEI owns and operates 30 hotels that were purchased during the past five years, and estimates is portfolio value at north of $2.4 billion.
Mendell said the company’s acquisition profile includes single assets ranging in price from $40 million to $250 million and portfolios in excess of $1 billion.
The company also manages the hotels.
“Being an owner-operator puts our operations people in house side by side our acquisitions and development people. We never get a surprise at the end,” Mendell said. “Because we hold hotels 10 to 12 years, it’s a big benefit to the operations people within our company. They know if we buy a hotel we’re going to keep that hotel.”
Acquisitions of existing properties will comprise about 80 percent of the new fund, according to Mendell. Five percent of the fund will be for reserves, and the final 15 percent is a combination of development and take-outs, which are opportunities to acquire hotels from developers upon completion of construction
Mendell said acquisition opportunities will present themselves over time, but the current environment is one in which sellers are expecting higher bids than potential buyers want to offer.
“The difference between buy and sell is enough where very few deals will likely get done in the short-term,” Mendell said. “In bids, we end up 5 to 10 below what a seller’s expectation is at this point in the cycle.
“It’s not a big disconnect, and the gap will close,” he said. “As yesteryear’s pricing becomes less prominent in seller’s minds, more deals will get done.”
Mendell said HEI’s management believes the gap “will settle itself down in six to 12 months.”