With the economy in recovery mode, the hospitality industry is beginning to come alive again with more renovation, adaptive reuse, conversion and even new construction projects. HOTEL BUSINESS® addressed the pros and cons of each of these development avenues at its most recent Executive Roundtable held at the Red Roof Inn Columbus Downtown-Convention Center in Ohio.
Hosted by Red Roof Inns Inc. and sponsored by Arthur J. Gallagher Risk Management Services, Inc., participants in the roundtable included Andrew Alexander, president, Red Roof Inns Inc.; Richard Conti, president, The Plasencia Group Inc.; Keith Daub, president/COO, Winegardner & Hammons Inc.; Christopher Diffley, managing director/investment management group, RockBridge Capital LLC; J.P. Ford, senior vp/director of business development, Lodging Econometrics; Robert Habeeb, president/COO, First Hospitality Group Inc.; Joseph Smith, executive vp; Chesapeake Hospitality; and Robert Wallace, executive vp, brand operations & franchising, Red Roof Inns Inc. The event was moderated by Stefani C. O’Connor, executive news editor/managing editor roundtables, HOTEl BUSINESS.
One key topic discussed was assuming control of distressed assets. “One focus for us has been undercapitalized assets,” said Diffley, whose company is now in the process of raising its fifth fund. “We’re taking those properties and properly capitalizing them with renovations or rebranding projects.” In addition to completing a $14 million renovation of a Hyatt in Palm Springs, CA; over the last 18 months RockBridge acquired and rebranded a Four Points in Ann Arbor, MI as a Sheraton.
When taking over assets that already have a property improvement plan in place, Conti stressed the importance of communication even before a deal is finalized. “Since August 2010 the market has really come back in terms of full-service and select-service transactions. When you’re the new owner of a property that has a PIP already in place, it can be very difficult to try to take things out of the plan and it’s hard to negotiate timing. Get involved by discussing things with the seller and the brand,” he said.
“We just started an adaptive reuse project for a Hilton Garden Inn in Milwaukee. We’re doing a lot of those . Things are starting to heat up, but we still need the credit markets to thaw a bit,” Habeeb added.
While there are still a limited number of new build opportunities in the U.S., panelists stressed those particular projects need to be scrutinized more closely than ever before. “We had a great run through 2008, then stepped to the sidelines. We’re still looking for full-service new build opportunities…but there’s got to be a very compelling reason to develop any new construction hotel these days,” said Daub. “We’re about to start construction on a new Courtyard.”
But with new construction scarce, Daub noted Winegardner & Hammons is also looking to adaptive reuse. It is a shift for the company, which prefers to design and develop prototype hotels. “In March we completed an adaptive reuse of a historic building in Cincinnati into a Residence Inn. That [project]opened up a new avenue for us. Adaptive reuse scares a lot of people away because there are surprises around every corner so that makes it difficult to control costs,” he said, adding that in many cases adaptive reuse has become one of the only ways to get into certain high-profile U.S. markets. “You have to anticipate that there will be problems but if that is what can get you into a market, it can be a very attractive type of project. Just make sure you know what’s going on in the building because the numbers can quickly get out of control.”
Habeeb echoed that word of caution saying, “You can never do too much homework on an adaptive reuse because there is a lot that is unexpected. But they can also be terrific deals—there are a lot of tax credits and financing vehicles that can help defray costs. Each one we’ve done has been a home run.”
“Another added risk that comes with adaptive reuse is to factor in if the project ends up not working, will another brand take it?” Diffley added.
According to research by Lodging Econometrics, there were 2,951 projects in the pipeline at the close of the first quarter and the number of projects should be lower in the second quarter, according to Ford. “Early planning starts are growing though. Hotels with longer timelines are being planned for when financing becomes more readily available,” he said. “There have only been 211 new project announcements [this year]—that’s a very low number. There are cancellations and postponements still happening. New hotel openings should set cyclical lows this year so there will not be much new supply to compete with. Demand is the key to more industry-wide development. Until demand picks up, don’t expect a lot of new construction.”
But there are still some bright spots out there if owners can find appropriate financing. “When it comes to new construction we have gone on standby mode the last couple of years,” said Smith. “We just haven’t seen the great deals. But we are developing a Crowne Plaza right now in Madison, WI.”
On the brand side, Alexander commented on the steps Red Roof is taking to foster continued growth. “We’re an owner, operator and a brand/franchisor. For the last two years we’ve focused on the operations side, but now we’re focusing more on the ownership side of the business putting more capital into our properties. We want to take the lead reinventing our properties in major markets and we expect to be able to then capture more rate as a result of those renovations,” he said.
And with the lack of new supply, many brands, Red Roof included, have had to rely on conversions if they want to expand. “We’re looking at a lot of opportunities for conversions,” Alexander said, noting the brand is leaning toward portfolio acquisitions as opposed to one-off deals. “We are watching with interest…the Extended Stay (America) situation is one example. They’re doing a very controlled liquidation of assets. If the right portfolio were to become available, it would be very attractive to us…Most of our new build interest is in Canada. They didn’t have as big a dip there.”
However, the opportunities for brands to acquire assets and convert them is quite a complex process, particularly if an asset will require a significant renovation, according to Diffley. “There are really attractive rates right now in the CMBS market but as soon as you bring in a property with a ‘story’—it needs a major renovation, etc.—it becomes more difficult. As the story gets tougher, it’s tougher to get financing,” he explained. “The brands are being pretty aggressive with conversions in order to bring in new supply. In certain instances they are doing less aggressive PIPs in order to grow their portfolio.”
But other brands remain as stringent as ever with their standards, which pose a challenge to owners who are strapped for funds. Habeeb noted that creates obstacles not just for owners looking to acquire additional hotels, but also to maintain the flags on their existing properties. “When the brands are pushing for renovations and the owners don’t have the capital, that leads to a real quagmire. Those brands that are over-saturated are going to be ruthless with those properties that do not keep up. So be prepared. Don’t rush and rip up something that’s new, but you need to own up when a property needs a renovation and reserve funds,” he said.
In Red Roof’s case, the brand is relying on a new guestroom design to help drive profitability as the economy continues to recover. “We feel with the new designs we have the right product to create a point of differentiation in the economy segment and attract the next generation of travelers,” Wallace said. “Our plan is to incorporate our new designs into PIPs over the next two to three years.”
Ford speculated that many brands may reconsider being so strict with their mandates if it means their portfolios will shrink too drastically. “Everyone was growing through new construction prior to the downturn. Now it’s very tough to grow that way, so brands are looking at conversions and that’s not as easy because when you’re doing it, it’s still not a ‘new’ hotel,” he said. “As a brand if you’re going to be very aggressive and cut your bottom tier [properties]your portfolio will shrink—and that’s not as easy to do when pipelines are not what they used to be.”