NEW YORK—The Blackstone Group’s appetite for hotel holdings hasn’t waned. The global investment and advisory firm is always on the lookout for more acquisitions—particularly those that meet its core philosophy of “buy it, fix it, sell it,” said Jonathan Gray, the company’s global head of real estate and chairman of Hilton Worldwide Holdings.
“Our North Star is trying to find hard assets you can buy at a discount,” he said Monday during the 36th annual New York University International Hospitality Industry Investment Conference.
That often means going against the grain to achieve success—something that’s not always easy during tough economic times, he said.
“At the bottom of the crisis it’s easy to lose your faith. You’re reading in the headlines that you’re not very smart with the capital you deployed; there’s a ton of uncertainty and your natural inclination is to sort of hide under the covers,” said Gray, who joined Blackstone in 1992. “We looked at it a little bit differently. We had the fundamental view that in the economic downturn that it was cyclical, not secular, in nature.”
He said the conclusion for company executives was to hold tightly to what they owned, buy debt on those assets at a discount and buy more assets at discounted pricing. The gamble paid off.
“We were able to buy hotels that cost $300,000 a key to build for $150,000 a key,” Gray said. “You don’t generate outside returns with consensus. You’ve got to go to London in the heart of the financial crisis when the money’s leaving. You’ve got to go to Europe two years ago when many people were saying Europe’s going to collapse.”
The European hotel industry’s recovery lags the comeback in the United States, according to Gray.
“That creates very interesting investment opportunities for us because of the distress,” he said.
There are other areas the Blackstone chief would like to add assets. He cited India, China and Colombia in particular.
“Emerging markets may grow more slowly; they may have challenges, but there is still going to be higher growth in those places than there has been historically,” Gray said.
Blackstone’s US preferences
In the U.S., Blackstone prefers assets in markets with high occupancy and low supply growth, such as San Francisco, Las Vegas and Oahu, Hawaii.
“We (like) select-service hotels because of their cash-flow-generating ability and low (capital expenditures) are very interesting. With today’s low debt cost, you can generate high rates of return,” Gray said.
Gray’s advice to those buying hotels was succinct.
“I would focus on the net cash flow,” he said. “I would look at the bottom line these assets produce, the margins—that’s one of the reasons we like select-service hotels, much bigger margins—and the CapEx costs. One of the things we’ve underestimated as hotel owners and investors over time is how much CapEx, particularly in the full-service space, you need to spend.”
The company latest deal was its $1.73-billion acquisition of The Cosmopolitan of Las Vegas, which was announced 15 May.
“We were able to buy a world class asset—3,000 rooms, 150,000 square feet of meeting space at the very center of The Strip in Las Vegas—at a substantial discount-to-physical-replacement costs,” Gray said.
When asked by interviewer Rebecca Jarvis of ABC News if Blackstone could succeed where previous owner Deutsche Bank couldn’t, Gray reminded the audience that Deutsche was a reluctant owner at best because it was a lender that assumed ownership of a distressed property during the depths of the recession.
Gray said Blackstone is betting on Las Vegas in many ways—through the ownership of single-family homes, office complexes, manufacturing space and hotels. Competition from regional gambling markets shouldn’t greatly affect Sin City.
“What Las Vegas is about is a total entertainment experience,” he said, citing the city’s retail, restaurants, live shows and meeting space capabilities as huge drivers of its success. “The Cosmopolitan is at the heart of that. We think Las Vegas will surprise people to the upside in the next couple of years.”
He said the gaming capital’s limited new supply growth should result in good cash flow growth for existing hotels.
Staying the course
Staying the course is one of Gray’s fundamental business strategies—something he said he was pleased to see Hilton CEO Chris Nassetta do during the downturn.
“When we bought the company back in ’07, we had simple formula: We could take the Hilton family of brands and grow them aggressively around the world,” Gray said. “So what happened in the downturn is we were growing.”
One of Blackstone’s latest reclamation projects involves the Motel 6 and Studio 6 brands, which it acquired in October 2012 for $1.9 billion.
“We bought Motel 6 about 18 months ago, which is a brand that had fallen on hard times,” Gray said. “This is a terrific company; it’s just got a few basic things wrong with it. We could (reinvest) in existing properties that had been unloved from a (CapEx) perspective; we sell off some its very bottom properties, and we could aggressively grow its franchise business. …
“It’s like showing up at a garage sale, finding something a little beat up and saying, ‘Wow, this has more potential than other people really realize,’” he added.
Of course, not all strategies work. Gray said buying resort hotels in the Caribbean and Florida before the downturn was something he would do differently.
“We probably took too much risk, believed too much and as a result it turned out to be a very poor investment,” he said. “Losing investments you agonize over; you beat yourself up and say, ‘I don’t want to make this same mistake again.’ That was a very valuable lesson.”
Brand proliferation
Gray said he expects the number of hotel brands around the globe will continue to grow as the industry becomes more embedded in the world’s psyche. Larger chains will lead that charge.
For instance, Hilton Worldwide Holdings globally represents approximately 4.5% of all open hotel rooms that exist today but close to 20% of the rooms in the construction pipeline.
“Big hotel companies will continue to gain more share, but they will probably do it with a greater number of brands,” he said. “Overall travel will be a growing force for a ways to come, and the number of branded hotel companies is quite limited. To create the kind of systems (Marriott International), (Hilton), (Starwood Hotels & Resorts Worldwide), (InterContinental Hotels Group) (and Hyatt Hotels Corporation) have around the globe—frequency programs and all of that—it’s really, really hard to replicate. There just aren’t that many brands available that can deliver revenue and the consumers are comfortable with.”
Gray’s bullish approach is in some part due to a strong economy that has buoyed the hotel industry for the past three years.
“It’s a pretty good environment economically that’s getting better,” he said. “The (hotel) supply side, that’s where things are generally pretty positive. In almost every market around the world, demand for hotels rooms is growing faster than supply. That’s pretty true in most classes of real estate as well. What that’s going to lead to is better performance.”