LOS ANGELES—Renovations might not yield as much increased performance as many hoteliers think, but they are important in keeping up with a competitive set that’s out to gain market share at your expense.
According to panelists who participated in the “The 3 R’s—Creating value by renovating, reflagging & repositioning” session at the Americas Lodging Investment Summit, the renovation aspect of the hotel equation is a big topic of discussion among owners, operators and lenders.
“It’s on everybody’s front of mind,” said Andrew Wharton, managing director for REH Capital Partners and the panel’s moderator.
Margaret McMahon, SVP and managing director for Wimberly Interiors, said conference organizers could easily have added a fourth R to the session’s title—resale—because of the demand for up-to-date properties in the industry.
Capital-expenditure projects will top $6.4 billion in 2016—which is more than 135% higher than the industry’s lowest point in 2010, according to Wharton. Deferred renovations and appealing to millennials are the biggest reasons for owners to pump large amounts of money into their properties.
Mark Gerstein, chief capital markets officer of the Americas for InterContinental Hotels Group, said most deferred capital expenditures have been deployed, so the renovations being done now are driven by transactions.
Nowhere is that more abundantly clear than New York City, according to the panelists. The city’s hotels are trying to keep up with the explosive supply growth, and STR—Hotel News Now’s parent company—lists more than 13,000 hotel rooms in the market’s pipeline.
“We’re finding in New York there’s a significant number of older hotels that are struggling with their economic viability,” said Lawrence B. Wolfe, senior managing director of Eastdil Secured. “Refurbishments will help, but sometimes it goes deeper than that.”
According to Wolfe, the biggest questions include:
- Is the hotel the best use for the assets?
- Is the configuration relevant?
- Is the land value greater than the current business value?
Regardless of the market, renovations don’t always mean instant revenue bumps, panelists said.
Gary Lake, EVP of asset management for Gencom Group, said revenue per available room is driven by the market, not renovations.
“Clients say most of renovations do not increase RevPAR,” McMahon added.
Therefore, the need to keep up with competitors—newly opened hotels and recently renovated properties—is essential in an environment that features many hotels being sold. That means operators must be shrewd when it comes to earmarking funds for renovations.
Gerstein said the typical 4% to 6% capital-expenditure reserve is meant to keep a hotel competitive—additional money needs to be set aside for investment improvements.
Pressure mounts during the process
The financial aspect of the industry puts pressure on the renovation process, panelists said.
“When you’re dealing with private equity the mentality is ‘let’s get in, get our biggest bang for our buck as possible, then flip it,’” McMahon said, adding that with real estate investment trusts there’s a “bigger story, a deeper dive.”
It gets more stressful for either type of owner the deeper and longer a renovation lasts, sources said.
“Renovations—I compare them to working on a fine Swiss watch—they’re so much harder than new construction,” McMahon said. “We have to make sure the owner is aware of all those hidden raps that are behind those walls in a renovation. It takes a lot of horsepower to do a renovation.”
“Owners might not know the complete history of the property. As the renovation unfolds there are lots of traps to deal with, and it could take a lot longer than originally planned,” Wharton said.
Panelists said the biggest challenge comes when a property is closed completely for a renovation.
“That was the most stressful thing in my life,” McMahon said.
“Shutting down a hotel can accelerate the time frame for a renovation, but you’ve got other problems,” Lake said. “You have to take employees into consideration—when you open again are they all going to be there?”
However, potential guest complaints and negative feedback on social media channels could be enough of a reason to close the property entirely, Wharton said.
But lenders aren’t so keen on that idea, according to the panelists.
“The debt holders want to see some capital flow,” Gerstein said.
“That’s the biggest stress I had—no revenue coming in and the stakes were so high in us meeting that (completion) date,” McMahon said.
Gerstein said owners must look at all options to make the renovation a success, but above all else they need to make sure they’re following the wishes of their lender—whether it’s a local bank, national lender or a private equity fund.
“Some require you to stay open during the renovation,” Gerstein said.
Reflagging, repositioning help capital flow
While increased capital flow is a goal of renovations, it is the major reason for repositioning or reflagging a hotel, according to panelists.
“Hotel capital is looking for a big return,” Wolfe said. “If you’re no longer at 6, 7, 8% RevPAR growth, you have to create value in other ways.”
Wolfe said repositioning isn’t always a quick decision. He cited Hilton Worldwide Holdings’ decision to sell the Waldorf Astoria New York in late 2014 as a prime example of that.
“I spent about two years with Hilton helping them assess what they wanted the Waldorf to be,” Wolfe said. “We spent a lot of time looking at various use options.”
That assessment, which included determining that residential units were the best option for 20 floors, helped the company sell the property for approximately $2 billion.
That deal helped reset the bar for all of New York, according to McMahon.
“People coming to us are sitting up straight because there’s a new game in town,” she said. “In New York City people are thinking what the Waldorf is going to become and how that will shift the paradigm.”
Repositioning is about changing the experience and changing the guest profile, Lake said.
“If you’re reflagging from one 4-star (brand) to another 4-star (brand), you’re not really changing the experience, you’re changing the reservation system,” he said. “There’s a way you can reposition without spending a lot of money.”
The important thing for owners—especially inexperienced ones—is to understand the entire process and ensure they have the right resources in place to handle any issues that arise.
“Perceptions are a lot stronger with an inexperienced owner,” McMahon said. “Their perception is (repositioning) can be done really quickly, that design ideas are just falling out of the sky. Our biggest challenge is telling them all the different stages that they haven’t considered.”