228: Should you Invest in Hotels?

Buck: Welcome back to the show everyone. Today my guest on Wealth Formula Podcast is Steve Usher. Steve is a founder of the pasadena-based Titan Hospitality Group which was founded in 1999. Titan Hospitality focuses on hotel brokerage assignments located throughout California since its founding has closed upwards of about two billion dollars in total hotel sales and prior to a founding Titan, Steve also worked with Cushman and Wakefield in San Francisco. Steve welcome to Wealth Formula Podcast.

Steve: Great thanks. Nice to meet you Buck.

Buck: So yeah Steve let’s just kind of start out. Tell us a little bit about your background. What got you involved specifically in this space of you know of hotels which is a little unique niche within our real estate world.

Steve: Sure yeah I’m actually originally from San Francisco Bay Area and I started working with Cushman and Wakefield in their downtown San Francisco office in the early 90s and their focus was really high-rise office building sales, union square retail building sales and I noticed early on that when a hotel deal would come in the door nobody knew what to do with it because it’s a totally different animal it’s not like any other kind of commercial real estate real estate. So I thought well this is really my opportunity to get up you know the curve very quickly so I said I’m going to be the hotel expert. So that was in the early 90s. And then after about five years of that I’d say by 96 I really kind of established myself and then moved down to LA in 96 because it’s just a much, much bigger market and so that’s where I’ve been for about the last 20-25 years.

Buck: So you know it’s interesting because you talk about how hotels are such a different animal. Talk a little bit about that what are some of the similarities and differences you know compared to owning you know apartment buildings which is really a lot of investors where in my audience are, we’re used to residential stuff or maybe we’ll do a little self storage or stuff like that but what are the unique aspects about this space in terms of you know whether it’s property management other issues you know obviously it’s more hands-on etc.

Steve: Yeah I think the main difference is with hotels is typically you’re renting the rooms day by day versus apartments and on a profit or loss statement the main difference is going to be the number of fixed costs that you have. You’ve got obviously it’s an operating business. You have housekeeping, you have a general manager, you have a director of sales, you pay franchise fees, your capital costs are a lot higher because these are furnished units that are getting a lot of wear and tear so I think you know it’s funny because when I grew up my dad owned some apartment buildings and I think your margins are probably what 60 to 65 as far as your net income margin on a hotel it’s probably more like 35. Your gross is higher obviously because you’re getting a higher daily you know revenue but you’ll probably net 35 generally speaking. So that’s really the main difference, they’re much more hands-on you know. It’s a business. It’s really not like real estate. You own the real estate but it’s really not a real estate deal.

Buck: Yeah and that’s yeah you know in in apartment buildings again we have we have different classes you know they’ll be like A class B class C class even D class stuff, obviously you want to stay away from some of those you know they have different risk reward profiles, is that kind of the same when it comes to hotels and you know what kind of investors tend to flock to each one of those classes if they exist?

Steve: Yeah like any other real estate type we have our class A and kind of moving down the spectrum the class A would be your obviously your Four Seasons type deals your bigger full service expensive deals you know those would trade at a lower cap rate part of that is because they’re they have you know obviously higher varied entries so they’re considered less risky although in a moment like this they tend to be maybe more risky because you got to fill all those rooms and they rely on groups and all this but generally speaking those are your class A deals those are also obviously more institutionally owned and sometimes that alone drives down the cap rate versus their their risk profile and then you work your way down the food chain all the way down to you know say your Motel 6 kind of roadside type motel which is more of a pure mom-and-pop operation that the kids may be working in the front desk, I mean it really is a you know mom-and-pop business and those would trade at higher cap rates mainly because of the fact that you have to get more involved in them, you can’t afford to have third-party management so it takes more of your time and also there’s lower barrier to entries for those kind of deals you know those things can get built all the time you know so that also drives up the returns and I’d say in the last cycle you know your institutional class A deals may be traded at a six cap and maybe those motel deals traded at an eight cap so there’s maybe a 200 basis point spread between class A and your motel type deal.

Buck: When you say in the last cycle was that at the peak?

Steve: Yeah until February, up through February.

Buck: Yeah so I mean even like you know getting sort of really nice nice you know class A if you will hotels and stuff six cap sounds pretty attractive they’re certainly compared to other asset classes but I guess that’s really one of the advantages right where you really you have functioning operating business and therefore you know the potential returns are a bit higher and that’s the trade-off.

Steve: Yeah exactly right. I look at a hotel is I think sometimes I think six cap is probably tough for me to invest in the deal at because I see a lot more inherent risk they go up quick they go down quicker you know hotels are much more you know it’s not like residential where you’re gonna that’s your house or it’s your apartment you’re always gonna need it and I think the other thing that sometimes gets a little deceiving is the true capex of a deal what you really have to spend to renovate that hotel over the course of a five or ten year cycle tends to get underestimated so yeah I mean I’ve always felt that’s a pretty low cap rate for a hotel, I would personally invest in it.

Buck: Let me ask you this you know just again sort of riffing off of that is the what are the issues with debt? I mean in an apartment building is pretty easy you know most there’s it’s very readily available and you know they want to invest in they want to loan to apartment buildings and we’ve obviously on the larger ones we’ve got a lot of opportunity with non-recourse debt and freddie and fanny and all that. What does the lending world look like in this space?

Steve: Well under normal times again non-Covid times it’s pretty easy to get a conventional loan say 65 loan to value you know we were probably getting loans in the mid fours fixed and again I don’t know what your apartment rates look like but you could get a you know deal like that done pretty easily you could go to securitized route and probably get a higher leverage maybe 75 percent loan to value there it is a truly non-recourse loan but then you have all the issues with securitization you know it’s very hard to pay them off and and in troubling times like this there’s no bank to call you gotta wait for the special servicer so that’s typically you know 65 conventional 75 securitized and then a lot of buyers you know for deals say under 20 million would do an SBA loan and there you could get upwards of 85 leverage with some of their green initiatives you know if you also finance solar panels and put them in the parking lot you know you could get upwards of an 85 yeah leveraged loan with SBA.

Buck: Interesting. So obviously you’ve kind of alluded to it but you know we are in the middle of a very unusual time you know we’re in we’re in the middle of a pandemic. Covid 19 has destroyed the travel and leisure industry worldwide right. So can you give me a sense of of the scale of the problem and how hotel owners right now are coping with the pandemic?

Steve: Yeah we were like everybody else just cruising along through February in fact I’d gone to a really big hotel conference in downtown LA which is one of the biggest conferences in the country and you know covid was referenced but everybody kind of universally just kind of cast it aside and then to think seven weeks later you know we’re in a you know global lockdown so it’s been been pretty amazing we’re now you know what six months into it immediately occupancies went from you know you probably have a 65 national occupancy rate probably went down to 10 to 20 at hotels I mean everything just stopped. So a lot of hotels had to close and then PPP came up pretty quickly so that allowed you know some to open because they could you know afford to to make payroll and as we’ve worked our way through the six months of this I think what I saw recently was about 70 of the hotels that had closed were now reopened and really the only markets where you have pretty significant inventory close say 20 to 30 percent would be your big urban center San Francisco, Manhattan, Miami, or markets like you know still have 20 to 30 percent of their inventory down but you know most hotels have been able to reopen you know I think I also saw 90 over 90 percent have gotten some sort of forbearance from their lenders so they’re able to kind of make it work for now and everybody’s just I think in a wait and see attitude to see if we get this vaccine yeah and and if we do then you know in short order we’ll get you know we’ll start to see some real light at the end of the tunnel in terms of where we went on the revenue side like I said we went from probably 65 national occupancy down to 10 to 20 percent and even july just this last month I think national revenue stats were down like 50 and that was better than the previous month which was better than the previous month so we’re slowly coming up that floor but you can imagine I mean if your revenue’s down 50 and you’ve got all those fixed costs it’s really, really, really tough right now very tough.

Buck: Yeah for sure you know it’s funny because you mentioned how revenues are down but then there’s certain markets it seems like and this is the same with the part apartment buildings where you’ve got certain types of class you know working class apartment buildings are actually performing really well in some of these stronger markets and you know we have a common friend who’s got a you know hotel in Palm Beach and he’s saying like it literally is his revenues up like 50 compared to last year right now so it seems like again it’s one of these like this entire pandemic has done it is taken you know it sort of really segregated the economy where some parts of it are getting hammered and others or not.

Steve: Yeah the headlines are going to be the you know the manhattans and the San Francisco’s because that’s where all the networks are based and the reporters but there are some markets I think extended state hotels you know which are much more like apartments you know they’re they they have separate bedrooms and kitchenettes, they’ve been doing much better than they’re still down but they’re not it’s not a blood bath and that’s because you have a lot of these essential workers and they’re basically short-term apartment rentals that’s what’s gonna happen there. Some drive to leisure markets are doing exceptional central coast you know Santa Barbara, Pismo Beach areas like that are doing really well because people are gonna travel and they they’re not gonna jump on a plane and they’re not going to go to a city center and they want to get outside so certain areas are doing well and then there are some other smaller markets like I’m doing a deal in Bakersfield right now you know maybe down 10 to 12 in the last month it’s just not you know it’s not an international market it’s much more of a localized community so but your bigger markets have been you know crushed I mean you know Disneyland’s not open, San Francisco nobody wants to go there, no one’s going to do a convention there are no sports teams. I think I read where you know 75 of corporate travel has been you know basically taken off the board. So yeah there are a few spots that are okay but generally speaking it’s been really tough.

Buck: Yeah so with that in mind are you are you seeing much distress in this space you know from the perspective of sellers you know buying opportunities for for individuals or has you know the ppp program really kind of held you know held things together for people and maybe that’s something we may see in the next few months?

Steve: Yeah I think it’s too early for great distress opportunities I think what you might find or deals you might have an opportunity to buy something that’s a good asset but you’re not necessarily going to get a great price on it so I don’t see any real distress yet. I think again people are kind of in a wait and see attitude for the vaccine I think that obviously would be a game changer you know it’s very hard to get owners to to sell unwillingly and a lot of times in today’s market they have title but they have no equity so they can’t really sell. And the lenders it’s the same thing every one of their loans mark to market today might be underwater so they don’t want to you know force the issue too much so everyone’s willing to kind of be patient you know for the next maybe 90 days or so and see what happens. There are some hotel notes that are being sold but that’s maybe a 10 to 15 percent discount that’s not distressed so at this point I don’t see any great distressed opportunities, I mean I think if you want to invest in a hotel sector right now I’d probably just go to the stock market and buy REITs because I just pulled this today I mean I’m talking about hotel companies actually own the real estate not branding companies like marriott or hilton which really you’re just buying the franchise the branding name they don’t own any real estate but some of these REITs are still are now trading at 50 from their peak value and these are really, really good portfolios, well-maintained, great operators so it’s really as simple as that I mean I can’t get a private owner to sell at that great of a discount but you could buy public shares right now at a pretty great number.

Buck: What are some of the REITs that are well known in this space?

Steve: The ones that I like and again I have no vested interest right right I’ve done business with them all, Summit Hotels INN is the symbol, Pebblebrook which is at a pretty big discount but they own a lot of these urban center hotels in San Francisco and New York but once those cities get back on their feet they’ve got some incredible assets. RLJ and Apple. Those are kind of the four that I like I know their portfolios great great markets the best brands and they’re anywhere from 40 to 55 off their peak and I think they’ve got enough cash on hand to get through their cash burn over the next 18 months or so and if you look their cash bar has been getting less and less each month as they’ve opened up hotels and the markets slowly start to improve.

Buck: Well that’s actually very kind of you to share those kinds of that kind of information for a guy who’s a hotel broker. Now so let’s talk a little bit though about you know obviously knowing what you know and you’re interested in and and and buying you know getting into or exploring the possibility of buying a hotel for the first time Covid or not, okay knowing what you know what would you say some basic criteria if it were you what would you target as a first-time hotel buyer and why?

Steve: I would probably buy a select service which a well-branded select service hotel like a Hampton Inn Hampton Inn is Hilton or a Marriott brand it selects service that’s where it’s a rooms only property in a high barrier to entry market. What’s good about the branded hotels is that there’s so much brand loyalty in this business that you know for the you know loyalty the the points programs that Hilton and Marriott customers are extremely loyal the brand the hotels always do well they’re very standardized in their operations and in most instances they tell you what you have to do who you have to hire so there isn’t a lot of they take most of the thinking out of it for a first-time owner and then in a high barrier to entry market that saves you from because really the longest term risk for you as a hotel owner is the new inventory that comes in and that stops that from happening so I would do a well-branded select service hotel in a high barrier entry market.

Buck: It’s interesting so is there a certain minimum size that you think is a you know if you get too small it starts to you know not really be something you’re going to want to do?

Steve: Yeah I would probably go try to be over 100 rooms because you know you’re always going to have a general manager whether you have 50 rooms or 150 rooms that GM might be your sales person they may not but you’re gonna have all these fixed costs and to really start to hit your margins your operating margins you probably want to be you know certainly north of 100 rooms and most of those prototypes are that they’re anywhere from 100 to 150.

Buck: And then I’m curious too like are these, if you’re an investor say you’re an individual investor or maybe you’ve got a you know small syndication or something like that you’re putting together something like this how much, if you’ve got a branded service select service like a Hampton or Marriott or whatever, how hands-on is that because you know you also have these you know management companies etc I’m not exactly sure how that works but is this can this be a relatively passive investment or is it gonna be pretty hands-on?

Steve: It’s gonna be passive until you hit Covid crises you know what I mean. And then nothing’s passive.

Buck: And then you’re sitting at the front desk yourself.

Steve: If you’ve done your homework and you’ve bought a well-branded hotel yeah in a high barrier to entry strong market it’s not going to be a lot of brain damage operating it you would probably want to start off with third party management until you got your feet wet and maybe after a year or two you know if it’s the only deal you own and you’ve got a good general manager in place and a good brand you might be able to get rid of the management company. Management company will typically charge you three to four percent of gross revenue so I would probably do that you know and just try to then own or operate yourself after you’ve got your feet wet but it’s not a lot of brain damage you know 90 percent of the time it’s just moments like this. And then it’s stay low levered I mean because that’s the thing is you’ve got these big swings in the revenue things can get really good and then they can go really south for a while and you just don’t want to be stuck with an 85 leveraged loan.

Buck: What do you recommend typically to your clients, more like a 65?

Steve: Yeah I would say 50 is conservative anywhere from 50 to 65 percent you know especially today where you know you’re probably looking at a four four percent rate I mean right now would be tough to get any loan but you know you know 10-year treasuries are what 0.7 so I think once we reach some level stability here you know you’ll probably be still be sub five percent in hotel interest rates.

Buck: Your business is focused I know in California and a lot on the central coast actually where I am in the central coast of California. First of all, your business limited to brokering in California I guess the second question would be how important do you think it is to buy a hotel where you actually live locally?

Steve: Yeah I made a decision I mean California is what the sixth largest economy in the world so I just decided I’m I can make hay in California I don’t need to spread myself so thin and the way I work is traditionally I take about 30 percent of my deals are probably exclusive listings and the other 70 percent are opportunistic so I need to be more localized to the extent that California’s localized so I’ve just decided to stay in California. If I were to own something you know again it just depends on your familiarity with the market I mean if you’re very familiar with it you maybe you grew up in a state you know you don’t necessarily need to be there I think it’s more about the quality of hotel you buy the brand the high barrier to entry and all that I don’t think you need to be right there. I mean and if you have a management company that’s their job now if you’re gonna jettison out the management company and own or operate you know when the cat’s away the mice play you need to be closer to your asset because make sure everyone’s showing up on time. But now there are guest reviews on tripadvisor you can really kind of see you know how your assets doing from a far away distance so it’s not as important to be there, be right on top of it right.

Buck: So if you’re you know just in general again speaking and of course you’re a broker in this space and and you’ve been kind enough to already talk about going to REITs right now. If you’re a buyer if you’re thinking about this space when when would you start looking at it given the conditions right now, what when do you think if you’re like hey I really am interested in this class and maybe as we’re rolling out of this recession this may be something I might want to look at ,what signals in the economy would you would you want to wait for or you know are you just kind of plant yourself somewhere and just wait to see if there’s distress. I mean I’m just curious if you have any suggestions for people who are seriously considering this.

Steve: I think right now there’s just you can’t get deals done you can’t get the two sides to meet. I think though let’s say there’s a vaccine at the end of the year let’s say you know within six months thereafter we’re back to some sort of normal scene we’re just in a normal recession at that point, I think then you’re probably gonna have some owners that say you know I wanted to I was kind of on the fence of selling before this Covid thing and man this was a pain in that I’m out of here and you can probably get a good quality asset at a some discount to what you would have paid say February just before Covid, I don’t know if that’s 10 or 20 less or whatever. So I don’t know if we’re going to see great distress I think we see great distress that just means this thing goes on a lot longer than I’m anticipating you know so if we pull out of this within 12 months then I think you’ll have an opportunity probably to buy some good quality hotels at something less than what you would have paid six months ago and hopefully you know we’ll still be in a pretty low interest rate world that’s what I would probably recommend.

Buck: So Steve tell well obviously you know you told us a little bit about your business but you know if people are interested in getting in touch with you and maybe talking about potentially buying something or you know picking your brain on that how can they get a hold of you.

Steve: Sure they can call anytime 626 926 0000 is my phone number and then my website is titan hospitality the number one at gmail.com or if they google titan hospitality I’m based in Pasadena and it’ll come up quite easily.

Buck: It’s very helpful Steve, I really appreciate your time today and thanks for being on Wealth Formula podcast.

Steve: Great thank you again.