WASHINGTON, D.C.—It might be easier to underwrite a select-service hotel, but that’s not to say investors should avoid their full-service counterparts, said a panel of investors Wednesday during the Bisnow Lodging Investment Summit.
“There’s a lot less brain damage when you’re underwriting and buying a select-service hotel,” said Tom Naughton, chief investment officer of Clearview Hotel Capital LLC. “It runs itself pretty much.”
And yet Clearview tends to focus more on larger, full-service hotels. Why? As an asset manager, Naughton and his team have more opportunities to extract value from an inefficiently run big box, he said.
“It’s got a lot more levers to pull and tweak to create value,” he said.
Neil Shah, president and COO of Hersha Hospitality Trust, agreed that full-service assets sometimes allow for more upside when acquired at the right point of the cycle.
“That said, we do believe a lot in the select-service business model,” he said. “Not only is it very profitable, but what we’re finding is there’s a secular shift in consumers. Their tastes and preferences are moving to a select-service hotel as well.”
And when all things are created equal, select-service hotels are simply more profitable, he added.
“The business model of select-service hotels allows a higher profit margin for every given dollar of revenue,” Shah said.
Dealing with debt
No matter what type of asset is purchased, debt is cheaper than ever before, panelists agreed.
Tom Corcoran, founder and chairman of FelCor Lodging Trust, said rates are similar to what was being offered during the 1950s.
“We’re absolutely in the sweet spot for the entire industry just in general from a debt standpoint,” he said.
Total debt available on a per-deal basis, on the other hand, is not as robust.
“In terms of just the amount of debt you can get on an asset, that’s still less than what it might have been in a different time in history or last cycle. But on a low leverage balance sheet (less than 50% leverage on corporate side), if you’re willing to stay in those types of leverage areas, you can get very attractive terms and rates,” Shah said.
For example, Hersha recently refinanced its unsecured credit line at approximately 3%. To maintain that rate, however, the real estate investment trust must maintain a fairly unlevered balance sheet. That means more equity has to go into each deal, so the costs are still there—although they come out of a different pocket, Shah explained.
Also reining in the investor enthusiasm are the terms being offered, Corcoran said. Long-term money is very attractive, which might dissuade some investors looking for a quick turnaround.
Holding an asset for 10 or 20 years has its advantages though, FelCor’s founder said.
“If you put in long-term money today at a good interest rate, you can ride through the cycle versus always have the refinancing issue every three to five years,” he said.
Besides, the window for those quick turnarounds is quickly shutting, said Janet Brashear, lodging principal at Edgewood Investors.
“The back half of the cycle is great for operators—it’s rate growth, it’s very profitable. But when you look at the deals cycle, we’re more than halfway through the cycle,” she said.
Eyeing EBITDA
When asked how far along the hotel industry was in its current cycle, Corcoran pointed to FelCor’s 6.9% growth in earnings before interest, taxes depreciation and amortization during 2012.
“I think we’ve got a lot of runway left to go,” he said.
EBITDA is the most important metric for investors, Corcoran continued. Revenue-per-available-room index, which occupies the attention of many of his counterparts, is somewhat an overinflated measure of performance.
“I think our industry needs a complete rethinking and a refocus. It is about EBITDA per room and making more money,” Corcoran said.
“That’s the key metric to determine quality to a certain degree,” Shah agreed, adding the sweet spot for Hersha is $20,000 per room across any segment.
Enter the funds
Somewhat new to the investment pool during this up cycle are the hotel funds, Brashear said. “They’re not your typical investors.”
They operate on a short-term basis, aiming to be in and out of a deal within five years. They like value-add scenarios, usually with a big property improvement plan, so they can extract maximum value from each investment, she said.
They’re led by small teams who can turn on a deal “immediately”—sometimes as quickly as under a week, Brashear said.
And returns? “They’re looking for 20%,” she said.
“It is expensive capital from a hotel investor standpoint, but they’re pretty smart and a lot of them make a lot of money,” Naughton said of the funds, with whom Clearview has partnered with frequently during the past few years.