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The Bay Area Real Estate Journal
Survival Strategies for Bay Area Hotel Owners
A San Francisco investment advisor’s guide for the Bay Area’s hotel sector.
By Mark H. McDermott
It’s time for some tough love in the hotel real estate market. The multi-year party that investors enjoyed through 2007 came to an abrupt end last year, and we are due for some even more serious realism this year. That said, in the Bay Area, there is a silver lining in the lurking dark clouds.
The hotel and resort sector will be affected deeply during this recession. We know that there is a high degree of positive correlation between lodging demand and GDP performance. And global economic changes are quickly felt at the hotel property level because hotels lease rooms often only for a single night, unlike the rest of the commercial sector, and hotel tenants can cancel with only a few hours’ notice. Complicating matters, travel of all types is down, and it’s happening at a time when the financial crisis is hitting harder than ever.
In spite of the global economic headwinds, it is important for regional hotel owners to remember that the Bay Area has strong real estate fundamentals. Our firm recently ranked San Francisco one of the best cities to buy and own hotels in the near term noting its high barriers-to-entry, relatively small increase in new supply and diverse demand base, among other factors.
Against this backdrop, Bay Area hotel owners should implement a survival strategy for the purpose of weathering the near-term gyrations until the region’s inevitable economic recovery takes hold. This task will challenge many who have enjoyed the recent years of relative prosperity, although there are some fairly easy tactical steps each hotel owner can take.
Become a data junkie, then act
Now more than ever is a time to collect—and more importantly, to use—the wealth of available industry data. Bay Area hoteliers know that there are distinct differences between the area’s major sub-markets (San Francisco, San Jose/Silicon Valley and Oakland/East Bay), but third-party data also allows owners to monitor a specific competitive group of hotels within each submarket.
Even more problematic is the possibility of reduced attendance at future conventions due to corporate restructuring and layoffs. By understanding these drivers, hoteliers should have well-conceived back-up sales tactics and be ready to implement immediate plans to combat the loss of room nights.
Today’s marketplace also creates longer-term opportunities to enhance asset value by re-branding. As the credit crisis postpones, if not purges, new projects that have not already begun construction, franchisors should be open to brand conversions to re-fill their growth pipeline. Repositioning your property to fit your marketplace better could yield long-term benefits as the market turns.
Get back to the basics: NOI will drive real estate value in the years to come
Current property net operating income will be the key metric for a sale or a loan in the immediate future. Gone are the days of transacting at low, single-digit cap rates by selling blue skies ahead and a value-added future plan.
For operators, this emphasis on present performance places a premium on the efficient execution of operating fundamentals in the form of sales, customer service and cost containment. Hotels that generate meaningful revenue from food and beverage services, spas, golf courses and even parking should focus on total revenue management and offer packages that bring guests into the hotel. On the cost side, owners that closely monitor demand trends (e.g., cancelled conventions) will also be able to minimize costs in the areas of labor, procurement, utilities and other operating expenses.
Owners not directly involved in day-to-day operations need to actively asset-manage their third-party hotel management companies. If you don’t use an experienced third-party firm, you should consider hiring one, especially if you are an accidental hotel owner such as a lender with a distressed asset or an investor that had originally planned an exit in 2008.
Revisit your capitalization
Most owners are probably aware of the significant capital challenges for hotel assets and all commercial real estate, for that matter. Few conventional lenders are in the market, and those that are lending are conservative. But even if you have no plans to sell or refinance, you should maintain flexibility. Markets like today’s can force an unexpected sale, for instance, if an equity partner needs liquidity. As a result, hotel owners need to be aware of their capital structure and keep their options open. What are your non-financial loan covenants and could they be breached if the economy continues to stagnate or decline? When does your loan mature? Are you aware of any equity partners that have, or could have, liquidity problems? Are you facing a brand-required renovation? It’s never too early to meet with your lender or financier to explore these questions and prepare strategies so you are not caught off guard.
Get deals done with forward thinking
Warren Buffett’s mantra is: Be greedy when others are fearful. Similarly, hotel investors should recognize that today’s tough environment should produce unique acquisition opportunities. Owners who acquired Bay Area assets during our last recession in the early part of the decade have for the most part achieved outstanding returns for their investors.
A buyer’s market implies it’s tremendously difficult to be a seller. But better deals for sellers can be facilitated with creative deal structures. For instance, today’s credit crisis represents a huge challenge for even the most qualified buyer. Therefore, seller financing can be offered, not only to facilitate a sale, but also to maximize the deal terms for the seller.
Sellers might also consider a lease-purchase option or sale of an equity stake. The former may benefit an owner who now prefers to be more passive while the latter may be a good option for an owner that faces major property renovation. Whatever the specific circumstances, creative thinking can get a deal done.
While the near-term economic climate is unquestionably challenging, investing in and owning a hotel in the Bay Area can be a profitable undertaking over the long term, provided that owners roll up their sleeves and take the many necessary steps to mitigate risk and maximize value.
Mark McDermott can be reached at 415.288.7815 or at mark.mcdermott@pkfc.com.
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