Entering the Asset Management Game – A Guide to Successfully Making the Transition
Entering the Asset Management Game –
A Guide to Successfully Making the Transition
By Irvin W. Sandman, and Russell C. Savrann
September 17, 2009
The hotel industry is seeing an increased interest among hotel companies to provide hotel asset management services. What are the pressures that are driving this trend? What are the best practices for securing asset management engagements?
The Old Formulas for Success
In the heyday of easy money and brand consolidation, many qualified, experienced hoteliers opened new ownership and management shops. These new companies, often formed with just a few individuals, typically followed one of two different approaches for success.
In the first of these approaches, the hoteliers connected with one or more equity funds and formed joint ventures. The hoteliers brought to the table their experience as operators, including their industry connections and deal sources; the equity funds brought their experience in property acquisition and, of course, their equity. These “owner-operator” joint ventures used and repeated a simple template: the operator finds a hotel that can be repositioned through application of the operator’s skills; the joint venture buys the hotel, using the fund’s equity and leveraging it with debt financing; and the joint venture executes the repositioning plan, stabilizes the hotel, and sells it for a profit. Typically, these owner-operators had 10 to 20 hotels in their portfolios in various stages of the process, and they provided their equity owners a 12-20% IRR. The operators, as the “finders,” would usually also receive a “promote”—a special equity interest that could give the operator an extra return after certain success thresholds were met.
In the second approach, the hoteliers formed companies that focused exclusively on building a portfolio of management contracts. These “independent management” companies usually focused on a particular segment in which they could demonstrate special skill. By so doing, they presented owners with cost-effective and friendly alternatives to the big, branded management companies.
The Formulas Hit the Wall
Over the past year, several factors have challenged both of these formulas.
The most obvious challenge is the lack of debt financing for acquisition and development. Without credit, most owner-operators have limited ability to purchase, renovate and sell for a profit. Although some lenders are still making hotel loans, interest rates are high and recourse is often required. Additionally, the lenders are demanding much greater equity participation by the owner-operator. Now, the joint venture must put up equity of 40-60% of the hotel’s value (rather than 15-30% in the heyday). Additionally, the operator’s “sliver” is often expected to be as much as 20-30% of that total equity (rather than .05-5.0% in the heyday). This has temporarily blocked many owner-operators from acquiring hotels. Even the largest hotel companies are hesitant to invest these high levels of equity.
The lack of debt financing has impacted the independent management formula, as well. These companies depend on new development and sales of existing hotels, both of which create opportunities for new management contracts and relationships. Without financing, the fuel for this formula has been running dry.
A second challenge, of course, is the decline in RevPAR across the industry. Under both formulas, the operators’ fees are directly tied to hotel performance, and so fee income has declined sharply. This decline has hurt the operators’ ability to make the investments of time and money needed to find opportunities and expand market share. Additionally, the decline in performance has severely hurt the equity funds’ income and balance sheets, particularly those that have relied on higher levels of leverage. Many no longer have the appetite—or even the ability—to fund new acquisitions.
A third challenge is the so-called “bid/ask” spread that separates buyers and sellers. With the evaporation of debt financing, the decline in RevPAR, and the increase in cap rates, hotel values have plummeted in the minds of buyers. Many owners, though, are in denial. Those that aren’t certainly do not find the present time to be an appealing selling opportunity.
Industry observers have predicted that lenders would break the bid/ask stalemate by putting pressure on hotel owners as renewal dates approach and covenant or monetary defaults loom. So far, this prediction has not come to pass. Instead, the lenders appear to be in a surprising mode—we call it “extend, amend, and pretend.”
With the bid/ask spread at an all-time high, the deal flow levels are at an all-time low. The opportunities for hotel companies have been correspondingly scant.
What’s a Hotel Company To Do—Buy Debt?
Most hotel companies have been revisiting their business plans and looking for ways to productively engage their underutilized management talent, shore up their income, and expand if possible. See Hotel Times “Three Point Plan to Thrive in 2009” December 2008.
Some owner-operators have felt that a key opportunity is to seek out and buy hotel paper. This opportunity assumes, of course, that the operator’s equity partner has funds to invest or that the operator has found a new equity partner in a position to do so. Even so, the number of opportunities to buy hotel paper at deep discounts has been relatively few, as lenders continue to extend, amend and pretend. Anecdotal information suggests that discounts on hotel paper have mostly been less than 20%. At 20%, the discount has not been large enough to justify the additional risks inherent in buying paper. Not all hotel owners will give up their equity without a fight. Some will start lender liability suits or file for bankruptcy protection. Once in bankruptcy, the debt holder’s position may be challenged, and the holder may confront unpleasant results. See Hotel Owners, Lenders and Stakeholders Square Off: Equitable Subordination May 2009. Thus the “hotel paper opportunity” has not been a panacea for owner-operators.
Still, the lenders’ current frame of mind is unlikely to continue indefinitely. Few believe that RevPAR will increase substantially in 2010. 2011 looks better, but any RevPAR uptick in 2011 will be coming off a very low floor. As this reality takes hold, lenders will have to revalue their hotel loans. When they do, they will have to take their losses. Then, the motivation to extend, amend and pretend should evaporate and action should follow. At that time, perhaps, good opportunities to buy hotel paper may arise.
Asset Management for Lenders and Special Service Providers—A New Marketplace
Many believe that, as in the past, most lenders whose borrowers have defaulted will follow a more traditional route than marketing their paper—they will foreclose, stabilize, and sell their troubled hotel assets. If so, then these lenders will need help. See Hotel Loans in Trouble – Pointers for Lenders.
The Lenders’ extend, amend and pretend approach has made it difficult for hotel companies to find lenders who want to engage the help they need. But, as indicated earlier, the lenders’ approach is unlikely to continue indefinitely. Most hotel companies believe that, soon, lenders and special service providers will take action and will need help—asset management help.
Additionally, hotel companies are aware that the financing fads of the last five years have multiplied the number of stakeholders in the debt and capital stacks. Even as senior lenders extend, amend and pretend, junior stakeholders might (and should) be less patient. These subordinate parties have seen their interests erode more quickly and substantially than the senior lenders. They are likely to need their own asset managers—perhaps sooner than senior lenders will—to help them make wise choices and protect their investments. The multiplication of layers in the debt and capital stack should correspondingly multiply the needs and opportunities for asset management.
Accordingly, hotel companies are seeking to position themselves to serve these needs and profitably apply their underutilized resources and talent. This rush by hotel companies to re-identify and re-brand as asset management service providers is creating a new competitive market. The competition feels even more acute since there appear to be many hotel companies in the hunt, but the customers are still in hibernation.
Our sense is that hotel companies interested in expanding into this new, still-unfolding market do not yet feel they are on secure footing. Many do not yet know how to best approach lenders and have not really honed their value propositions. This uncertainty is creating confusion for lenders as they are barraged with solicitations. Within the hotel industry, we recognize names and can appreciate the special talents of these people and companies. However, what makes sense to us, as hotel industry insiders, may just be noise to an overwhelmed special service provider or loan credit specialist.
Suggestions for Success
The following are observations that we believe will be helpful in becoming a player in the emerging asset management market and will help your hotel company stand out.
- Find and exploit your sweet spot. Identify what it is that you do especially well. If your experience is unique, then initially build your marketing around this obvious point of distinction.
- For example, if you have owned and operated luxury resorts in the Caribbean, then you should target your marketing to lenders who have financed luxury resorts in that region. A lender holding paper on a distressed luxury Caribbean resort will want to give you fair consideration, based on your very targeted knowledge of that asset or asset class. If you were once with the brand, or even had direct experience operating the particular asset, you have a clear marketing advantage, as you will be able to immediately demonstrate where you can provide real value.
- Do not over sell. This seems like the same point as the previous one, but it really is different. There is a danger in trying to hold oneself out to be all things to all people. It dilutes your credibility and it undermines the value of your marketing efforts. No one wants to appear desperate. Even if you can asset manage an extended stay hotel and a luxury resort, you lose credibility by marketing for both. If you have no experience in a unique market such as Las Vegas or Hawaii, do not claim to be able to asset manage hotels there. Be honest about where your expertise is and capitalize on that segment. It makes little sense to over promise and under perform. Once you are engaged and have a relationship, then you can market internally to your client that you can cover other asset classes or have other unique capabilities of value. If you are not the right company, then recommend the company you feel is best for the job. In making the referral, you will gain credibility with the lender and are more likely to be trusted and hired by that lender for an engagement that is in your sweet spot. The party receiving the referral should reciprocate.
- Leverage your network. Many of you have existing relationships with equity funds and lenders. Let these companies know of your expanded services through the people you are working with. Speak with lawyers and accountants who work within the hotel industry. Lawyers and accountants are expected to provide independent and trustworthy recommendations. If the lawyers and accountants have a good knowledge of your sweet spot, then they can be confident that you will perform well.
- Target the right companies. The largest lenders and special service providers have strong barriers to entry. If you do not already have a relationship with a major lender or special service provider, then you have an uphill battle for acceptance. On the other hand regional and local lenders do not have the same institutional relationships and are more likely to engage a new asset management company. Local and regional lenders generally have smaller hotels in their loan portfolios, therefore, the engagements may not be as large or prestigious as with a national lender or special service provider, but there is money to be made while a reputation is developed.
- Team up. Be willing to create new alliances with similarly situated companies and with other service firms that might offer unique services. For example, if you do not have construction expertise, then you might consider teaming up with a group that is currently providing construction consulting to your targeted client. Then leverage the existing relationship and share the upside with your new partners. Although law firms, due to ethics rules, may not share fees with you, having a relationship with hospitality specialty counsel can help with your marketing. In this ever changing environment, it will help to demonstrate to potential clients that you have the wherewithal to anticipate needs and services outside of your specialty and have developed relationships with the best providers in the other fields.
- Educate the lending and investment community. These new customers need to be convinced that hiring an asset manager is a good investment of time and resources. Individually and collectively, at every opportunity, the lender and investor need to be advised why it is important to have an asset manager representing their piece in the asset. Many lenders and special service providers believe having an asset manager is redundant to their function. It is important that they understand the nuances of branding, market share, deferred capex and many other hotel-specific challenges that can quickly sink their asset and with it their equity.
With over fifty percent (50%) of all hotels anticipated to change hands over the next several years, there will be plenty of work for everyone. The burgeoning asset management community should look to maintain its high standards and credibility by providing the most effective service they can. Then, new and valuable business relationships will develop, the industry’s reputation will be enhanced, and the lending community will gain a respect for the industry that will lead to even more opportunities.