In the early days of the COVID-19 pandemic, hospitality deals slowed as industry investors and leaders took stock of the changing landscape and developed strategies to proceed amid an uncertain outlook. But in the first half of 2021, between the rollout of COVID-19 vaccines and rising leisure demand in the summer months, a clearer picture of the industry’s recovery timeline began to take shape, and deal activity picked up in tandem.
From March to May 2020, U.S. hotel transactions dropped 74 percent year-over-year (YOY), according to STR’s annual Hotel Transaction Almanac. At the time, STR analysts predicted robust transaction activity in 2021 as investors looked to acquire distressed assets. While transaction volume has picked up significantly in the first half of the year, the influx of distressed property sales did not come to fruition to the extent that many in the industry previously anticipated; data from Real Capital Analytics showed that between March 2020 and February 2021, just 8 percent of all hotel sales included a distressed asset.
LODGING spoke with several industry executives about how M&A activity and transactions are shaping up in 2021, their outlook for the year ahead, and what strategies they are deploying to seize available opportunities and position their businesses for a successful recovery.
Looking for Deals
In August, JLL’s Hotels & Hospitality Group released the results of its annual Global Hotel Investor Sentiment Survey, reporting that hotel sales volume increased 66 percent YOY in the first half of 2021—just 4 percent shy of the comparable 2019 level. This activity is expected to accelerate in the second half of the year; more than half of the investors surveyed said they planned to implement an aggressive investment acquisition strategy in 2021 and nearly 50 percent expect the best investment opportunities for the remainder of the year to be among full-service hotels, according to JLL’s report.
The full-service space is a focus for Real Hospitality Group, or rather, what the company’s Chief Investment Officer Joseph Yi describes as “full-service light”—for instance, a 150- to 200-room hotel with 4,000 to 5,000 square feet of meeting space versus a big-box property with 20,000 to 30,000 square feet to support the kinds of big events that have taken a hit in the wake of the pandemic.
Yi says his team’s investment strategy evolved as the pandemic unfolded. Initially, he explains, “we thought that the cataclysmic decline in top-line revenue was going to motivate owners to exit out of deals simply because they couldn’t carry the debt service and their financial obligations.” But it turned out to be the case that lenders were willing to work with their borrowers and weather the storm, and many hotel owners were eligible for the federal relief programs. These factors, among others, meant that even though operating fundamentals declined dramatically, incomes were depressed and cap rates were compressed, and properties were trading close to 2019 values, Yi notes.
While investors are typically favoring hotel segments that have outperformed over the past year and a half, including limited-service hotels, which have fared better amid an industry-wide labor shortage, and assets in smaller markets, which have benefited from a shift away from larger urban centers and towards drive-to leisure destinations, Real Hospitality Group’s long-term investment strategy is focused on gateway cities. “We believe in the long-term viability and health of the business, but it’s not going to be equally shared between various demand drivers. Prior to COVID, we felt really comfortable that high-end leisure demand travel was going to continue to grow versus corporate or group travel, and we saw that uptick in international travel in gateway cities. That was our long-term bet,” Yi explains. “We’re still sticking firm to our strategy and long-term view of where we want to invest in the hotel sector. We’re still looking primarily at gateway cities and top 20 cities.”
These markets, which rely more heavily on corporate travel and group bookings, may have a longer recovery ahead. The return of international travel is uncertain as well due to border restrictions in the United States and abroad and low traveler confidence. Yi adds that while drive-to destinations may see demand surge following positive developments, which boost traveler confidence, long-haul travel generally books further out and, as such, doesn’t elicit the immediate response and return of demand that domestic travel does. Given these factors, Yi explains, “We thought that distressed pricing was a prudent thing to do. Even if the intermediate years of cashflow were going to be negligible, at least we’d know that the principle that we invested is somewhat safe.”
This remains the group’s strategy, but, by and large, steep pricing discounts and distressed trades didn’t materialize as expected. As the industry moves further into recovery, Yi explains that the value that would justify a return on distressed pricing is shrinking. “In the beginning of pandemic, I might’ve wanted to get 30-40 percent discount to 2019 value because the recovery was going to take four years. As we are now more than 19 months into the recovery, the amount of time left for the full recovery is cut in half, and so my discount is no longer 30 percent—maybe it’s now 10-15 percent,” Yi describes.
In the next 24 months, lenders and owners alike will come to the realization that they need to exit an asset, which will create opportunities for the right buyers, Yi expects. “It will be a slow trickle of distressed trades. Disciplined investors and those who are not pressured to deploy capital can take advantage of those opportunities.”
Scaling Growth
Jarrad Evans, chief investment officer, Remington Hotels, says that the pandemic hasn’t significantly changed the company’s focus. In 2019, when Ashford Inc. acquired Remington’s hotel management business, Remington sought to grow its third-party management portfolio and has signed 12 deals in the two years since. “Our focus is aligning with high-grade-quality and institutional-grade capital partners, with a primary focus on full-service hotels, but we also do select service,” Evans explains. “We’ve been working with private equity groups, other REITs non-affiliated with Ashford, high-net-worth individuals, and family offices. We have the benefit, being third party, that we can be market agnostic; we’re literally spread from Anchorage, Alaska, to Boston, down to Key West, Florida, and over to San Diego.”
While Evans says that Remington’s growth plan does target existing operations where the company can “effectuate management changes,” he notes that amid the “lower volume of management company churn on existing assets,” the company is spending more time on acquisitions with third-party capital partners and is continuing to grow its development team to meet that need. “We are able to invest sliver equity or key money with our capital partners to help either acquire assets or effectuate a management change where that investment can support transition costs and maybe some short-term cashflow needs given the pandemic.”
In addition to adding individual properties to its portfolio, Evans says that Remington is aggressively pursuing acquisitions to build its platform. He notes that the goal is not to grow to be the biggest operator. As Sloan Dean, CEO and president of Remington Hotels, explains, “The name of the game is smart growth.” The company, which now manages 85 hotels across 12 capital partners, is on track to grow its portfolio to 120-130 hotels with 20 capital partners by the end of 2023, absent a merger or acquisition. Dean says that when it comes to M&A opportunities, the company is looking for like-minded operators and is most focused on portfolio alignment, gaining entry into new capital groups, and adding four- or five-star full-service hotels in good condition to its ranks—the type of deal that creates an equation where “one plus one equals three,” Dean explains.
Dean warns of the dangers of scaling up too quickly. “What we have found when you grow too fast, too soon, you lose sight of operations.” He says Remington has a high cost burden at the corporate level, with 200 corporate associates across its 85 hotels, and, as a result, is positioned to scale up successfully and faster. Of course, he notes, any merger in the current environment means inheriting the property-level scarcity of labor that is prevalent across the industry, which he maintains is an issue for all operators at most properties, regardless of the scale of their management portfolio.
Merging with a like-minded company also presents opportunities to onboard leading talent, Evans adds. “Our philosophy is not to acquire and clean house, if you will, or eliminate all staff, but to find great talent in the industry to continue to grow at the corporate office and through strategic executive leadership,” Evans explains. “I spend a lot of time with our counterparts at companies that we’re looking to acquire to see how we can structure strategically to continue to build the best talent from a leadership standpoint.”
Dean expects more consolidation is ahead in the third-party management space. “You have principal-owned, mid-sized regional operators who are no longer EBITDA positive, and probably won’t be until mid-next year. Their PPP loan proceeds have burned off and they are not wanting to cut checks for working capital shortfalls at the operating company level,” Dean explains, adding that he expects larger management companies will continue to absorb some of these smaller operators through the rest of this year and into early 2022, and those with access to capital with a balance sheet to leverage will continue to seek out opportunities and acquire competitors as the industry recovers.
Evans adds that the benefits of scale will continue to drive consolidation in the industry, particularly amid the ongoing labor shortage and the ever-increasing cost of doing business. “If you’re an operator of 5-10 hotels, you simply do not have the scale to negotiate contracts and get the buying power that larger companies do,” Evans explains. In areas like procurement, master service agreements, OTAs, and investments in technology, scale can potentially deliver a more efficient operating model and structure.
While Yi notes that there have been some significant M&A announcements this year involving hotel brands, such as Sonesta International Hotels Corporation’s acquisition of Red Lion Hotels, which added 900 franchised locations to the company’s branded portfolio, he anticipates most activity in the hotel management space as operators look to compete at a larger scale. “From a company perspective, we’re large enough that we’re already delivering scale, but we’re looking at other opportunities to grow.”
Outlook and Opportunities
Until borders open to foreign inbound travelers, Dean expects gateway cities will continue to underperform non-top 25 markets. “Capital is not patient,” Dean notes, adding that investors will be looking for hotels that are performing at strong EBITDA levels now, which will mean more transaction volume in markets like Southern California, Texas, and Florida, for instance, as well as destinations centered around outdoor activities, like those near beaches or mountains. Some capital groups are banking on the eventual recovery of urban markets in the international, business, and convention demand, Den adds, are willing to invest in currently underperforming assets trusting that their performance will improve down the road. “It’s just a question of how long someone’s willing to wait.”
In 2022, Yi expects trade volumes to return to normal, if not slightly exceed 2019’s volume. He shares two main reasons for this: Firstly, interest rates will likely remain attractive, and secondly, domestic buyers have returned, even though cross-border investors have not. When borders reopen and international investors are able and willing to travel to the United States to visit sites and underwrite and sign deals, that could lead to a “potential pop” in volume, Yi notes. “Q2 volume has been elevated above the historical norm by a significant market margin—and that applies across all commercial real estate as a whole,” Yi says. “We believe that will continue to hold firm.”
Hyatt Invests in Leisure
So far this year, the hospitality industry has seen an uptick in M&A activity, including big announcements such as Sonesta International Hotels Corporation’s acquisition of Red Lion Hotels and Blackstone Real Estate Partners and Starwood Capital Group’s acquisition of Extended Stay America. The latest of these is Hyatt Hotels Corporation’s planned acquisition of Apple Leisure Group (ALG), a luxury resort-management services, travel, and hospitality group, from affiliates of KKR and KSL Capital Partners for $2.7 billion in cash. Announced in August, the planned acquisition is expected to immediately double Hyatt’s global resorts footprint and increase its Europe portfolio by 60 percent—a region where the company is focused on growing is presence—while doubling down on the company’s asset-light strategy.
A Hyatt spokesperson told LODGING that now is the “perfect time” for this move. “Leisure travel has proven its durability and this planned acquisition will allow us to offer our guests the best possible choices and experiences. We are confident in the long-term growth potential of leisure travel and believe we are well-positioned to capture increasing travel demand with our increasingly diversified portfolio.”
Another driver behind the planned acquisition is the companies’ alignment, a Hyatt spokesperson explained. “ALG and Hyatt both share a history of genuine care for our guests, colleagues, owners, and communities. This acquisition will bring the best of both companies together, combining Hyatt’s global brand footprint with ALG’s leisure strength. We look forward to welcoming ALG team members to the Hyatt family. Hyatt and ALG are committed to learning from one another and taking the best of both organizations forward as we expand the care we can provide to an even larger group of travelers.”
Overcoming Barriers to Transacting
David Durell, chief investment officer for Legendary Capital, says that a few years ago, his team experienced an “aha” moment when reviewing industry broker reports on barriers to transacting. Their conversation, which zeroed in on overcoming challenges related to the bid-ask spread, eventually led to the creation of a trademarked process called ValueLock through which Legendary Capital pays the current value of a property based on its trailing 12-month net operating income (NOI); projects a future NOI at a date when the property is expected to stabilize; sets aside the difference between the two values; and, once that future date arrives, tests that projection and runs it against the then-current NOI, applying an agreed upon cap rate to the difference and paying it to the seller. “We’ve allowed the sellers to remain in management of those hotels to truly be in control of their own destiny, let them transact, recycle their capital, and recognize the upside that they earned through management,” Durell explains, adding that this type of earn out structure is more common in entity acquisitions versus real estate transactions.
In recent transactions, Legendary Capital deployed a proprietary Equity Preservation UPREIT (EPU) structure and created a separate class of Transition Partnership Units (T-Units). T-Units were issued at closing based on the asset’s projected future value, allowing for the potential preservation of the contributor’s equity as the property restabilizes. “You take out your loan amount, you take out some closing costs, and then you’re left with a balance—we’ll issue that money in partnership units, and we’ll pay distributions on those units predicated on how the property recovers against its pre-COVID value,” Durell explains. “At an agreed upon timeframe down the road—a projected stabilization date—we’re going to use a formula to reevaluate the property, offsetting the money we put in, and convert those transition units to common shares at the new valuation.” Through this structure, he adds, Legendary Capital ultimately absorbs the burden of ownership while allowing contributors to retain the benefits.
