Why Hotel Revenue Can Rise While Profits Fall | Donald Wise

Interest rates are rising and this is going to have a big impact on a lot of commercial properties. One category is hospitality and hotels. They've been already struggling after the pandemic. Today we sit down with Dr. Donald Weiss, who's an expert in the hospitality field, decades of experience. He'll tell us what he's seeing right now in hospitality. Probably 60 or 70 percent of the hotels that were planned are not being built yet because of interest rates. Your value is going down effectively every time the interest rates go up. What's our alternative? We understaff. We deliver a lesser quality of life, quality experience to the guest, the traveler. Some tough decisions have to be made. Don, it's great to have you on. Welcome. Well, thank you so much. I have to thank the Honorable State Senator John M. W. Morlock for me being here today. It's great to have you on, and you're an expert on hospitality. When it comes to hospitality, we are told you're the man, you know, everything that's going on in the industry. So the interest rates are going up. There's some changes in the hospitality space. Can you tell us what you're seeing right now in the hospitality industry? We're a very healthy industry, but like everyone, we're suffering from, you know, inflation. I believe the latest number is 3.7% approximately. We're suffering from insurance fees that are going ballistic. I heard stories from insurance people in the industry. Some hotels have seen bumps as high as 400% and 700% on their insurance costs. Wow. We still have some dysfunctional transportation issues with items being delivered late because of ships or diesel trucks that aren't delivering or whatever. We have the increased cost of food and beverage supplies, maintenance. So at the same time that we're doing pretty well, about a 0.7% increase in occupancy this year, about a 4.4% increase in ADR, average daily rate, overall positive, but we're still at about 90% of 2019 as far as actual revenue. So yes, we're doing better. Of 2019. I mean, 2019, just before COVID, I suppose. October was actually a very good month, both business travelers and transient leisure. But we're still finding costs that are, I don't want to say they're out of control, but so many of them, obviously, insurance costs, we can't control. What's our alternative? We understaff. We deliver a lesser quality of life, quality experience to the guests, the traveler. Some tough decisions have to be made. And then, God forbid, that your note is coming due in the next, you know, 12 or 14 or 18 months. We had about $42 billion worth of hotel notes due this year. about 32 billion due next year and all this means the net operating income is down the value of the property has probably gone down pick a number maybe as much as 15 percent you know perhaps you were able to finance a property during the good days when you're paying four percent now you're going to be paying eight and a half plus percent so there's just a lot of yin and yang going on it's kind of like artificial intelligence you have to it's a roller coaster you better have your seat belt on and are there now on the hotel side hospitality side are there a lot transactions or is it slower is it harder definitely lower uh we're about 40 percent better this year we're probably going to hit about 20 billion of transactions in the united states domestically historically we're closer to 30 so yeah we're absolutely off we are expecting a little bit of an uptick next year we're all cautiously optimistic we're going to get an uptick it's interesting because part of your question about data centers a lot of the major capital that has historically invested in hotels is currently distracted. And I don't have to tell you where the distraction is. It's artificial intelligence. Do you see, is tourism up after the pandemic? Tourism is actually doing okay, but you have to remember that one shoe never fits all in the hospitality business. You know, you have different buckets. I'll call them buckets to keep it simple. I'll give you an example. Families still love Hawaii, still love to go to Hawaii, a good value. But as recently as last year, 55% of families coming back from Hawaii said they wouldn't go back for five years because it was too expensive. So you have to think about that. It's great when you're able to push the rate in a hotel, but if you scare your guests off so they don't come back, maybe not such a great idea. On the other end of the bucket, with luxury travel, You know, there were stories that one of the Aman resorts in Jackson Hole, Wyoming, they got $10,000 a night for the presidential suite, Fourth of July weekend during COVID. Wow. So, you know, you have a real, you know, different buckets. You have the transient leisure, you have the business, you have the luxury, and you just have the truck driver that needs a Motel 6 so he doesn't go off the road when he's going between Oklahoma and California on a run or whatever. But overall, we're doing pretty well. transient leisure is doing pretty well. And the fact that we're able to budge our average daily rate approximately 4.4% this year is a testimony to that. A lot of that is transient leisure. Business, of course, stock market strong, that's great. So people are, the business traveler is traveling. I mean, if we get into a recession, clearly we go back to Zoom calls like we learned about during COVID. But right now, generally speaking, business travelers are traveling. So that's a good thing for our business. How much of a correlation is there between the economy, the general economy, and the revenues in your industry? Is there a big correlation with how when we hit a recession, you lose a lot of revenue? Well, yeah, of course you would. Of course you would. And I mean, certainly we are as vulnerable, if not more so than anybody, because you lease an industrial building for five or ten years. and you know exactly what your rent's going to be this month, you know there's going to be a 2.3% bump on January 1st, so you know what it's going to be next year. Hotel business, we rent our rooms one night at a time. So it can either be a very good thing or in recessionary times, not such a good thing. And that's the reality of the situation. And it all spells risk. There's a reason why you can afford to buy a Chase Manhattan Bank net lease at a 5% cap rate, and you wouldn't buy a hotel for less than an 8% or 9% cap rate. It's all risk. I was taught historically, very traditionally at Cornell University School of Hotel Management by Stephen Rushmore, who's the intergalactic guru of hotel appraisal and feasibility. And Steve pointed out, you just don't build a hotel unless it's at least a 22% IRR, at least a 22% return. It's too much risk. You just don't do it. And what is it like right now, the return on hotels? Is it in general lower than the 22% or is there an aggregate? Oh, absolutely. Yeah, I would say one of the most important words in a buyer's vocabulary is discipline. There has to be discipline in the approach, a focus on cash flow. And you have to remember, you know, back in the old days, I say that facetiously, in the 1980s, before Leventhal and Horwath as an example, which were not our business, we used to say facetiously that when they did a pro forma, you know, they pushed F3 on their computer and the ADR went up at 4% forever. Well, that's okay in some markets, but guess what? You're talking about a hotel that's getting older every day. Styles change, taste change, hotel product improvement plans that the hotel's demand change. And not only does that require capital, but sometimes capital isn't enough. It's just still becoming an obsolete hotel. No matter how you quote unquote put lipstick on a pig, it's still a pig. So you have to be realistic on all these issues when you're talking about buying a hotel. What is the age? what's the market like. I was taught the most important thing to do when you buy a hotel is you have to look at, quote unquote, barriers to entry. Barriers to entry means there can't be a brand new 500-room Marriott that opens next to you two years from now. And you see your ADR, your average daily rate go from $188 to $150, and you got to climb back up again to where you were because that new hotel just opened. So as a buyer, discipline, barriers to entry, realistic on your assumptions, on your rate. And in many cases, it may be just time if it's a property older and you're kind of pruning your portfolio, whether you're an institutional player or a single or two hotel owner, maybe it's time to get rid of that hotel that's older. It needs CapEx. It's just not worth putting the CapEx in it from your investment profile. So sell that to somebody else and move on is there some properties right now that are not doing well and you don't think you they should stay as hotels absolutely and you remember you've got uh i believe the number is i i think if i get this correct i think i can i think we've got 62 and a half million people united states that are over 65 60 something 65 ish yeah yeah and of course i mean we need we need we need senior housing there'll be changes going on uh you know as seniors several things happen seniors obviously they semi-retire hopefully social security makes part of it pension gets part of it uh but they're going to be more frugal their consumer spending is going to drop off they're not going to have to spend they don't have to have the latest whatever they're not 25 years old anymore so they're just buying kind of simple simon normal stuff to run up their home um but senior housing is a big deal many of these properties it's time as we say in the hotel business we're not oversupplied we're under demolished you know it's time for some of these properties to say aloha and become you know senior housing absolutely positively and that's happening the problem is making the mathematics work some buildings are more uh more appropriately designed as far as the site as far as the massing of the building etc for senior housing but absolutely some hotels it's just time to say aloha you know and this industry did you guys get impacted a lot by airbnb and and tools like that that they came and they're like now essentially they're a competition to the space right absolutely and uh at first uh well several things actually at first airbnb of course was a huge was a huge threat and it's interesting you know one of the founders of airbnb is actually a friend of mine Chip Conley and Chip was the owner of Joie de Vivre hotels which sold eventually to hyatt hotels but uh you know they were a huge threat i think that's kind of uh we've kind of digested that and uh whether it's marketing or other perhaps uh we don't view them as big a threat but the other thing of course was the you know was the priceline.coms and the expedias and all that where the discounting you know became uh you know more aggressive than perhaps a hotel you would of like so we as again we've got we had lots of bumps in the road but we're survivors we'll figure it out hotel people are passionate they must be a little bit sadistic as the economy's changed but they are they are passionate people and they'll figure it out you know we we uh as an industry we're we're pretty darn good shape you know we have to be proud of ourselves for getting through the pandemic and all the all the nonsensical things that happened during that era but we're gonna be okay so don there is a there's an element in this industry that uh there's a number of rooms that stay vacant every night right some people wonder why don't they drop the price lower to get and can you tell us about that how does it work for a hotel what's what this occupancy means to them all i can tell you is what steve rushmore taught me at cornell and again steve is the intergalactic guru of hotel appraisal and peaceability and a very good personal friend. And Steve told me, you never drop your average daily rate, you let the occupancy fall. And there's several good reasons for that. Number one, it's very hard to get it back. People have long memories. I mean, I still have clients that are complaining about the fact that before COVID, you could get a room at the Marriott on the big island of Hawaii for $175, and now it's $450. And that was what You know, that was six years ago, five and a half years ago. So people have long memories. So that's number one. Number two, think about the actual physical asset. When you decrease your occupancy, you're not beating the hotel up as much. You don't have as many people going down that corridor, banging their suitcases on the corners so they don't quite make the corner in time. You know, the laundry is not being washed every day. It's getting washed every three days or whatever. you know the the actual asset is not being depreciated as much as far as actual wear and tear those are the biggest two reasons why you keep your average daily rate and let occupancy fall in terms of the interest rates they've been inching up they've been going up and in some scenarios some people say significantly well yes i would say and how does that impact this industry your value is going down every time effectively every time the interest rates go up additionally you know your your uh your customers are probably a little bit grumpier their cost of living and everything else is going up as well and it takes construction and doesn't put the brakes on but part of the reason that we're doing as well as we are frankly is that we're being undersupplied right now because it's just like you hear about all the data centers the 60 percent of data centers that aren't going to be built because of governmental or residential pushback or whatever, the same thing. Probably 60% or 70% of the hotels that were planned are not being built yet because of interest rates. You can drive the cost down a little bit if the project really makes sense, because your construction debt's going to cost you probably about 12%. If you can get what's called a CPACE piece of debt, C-P-A-C-E all in caps, a CPACE piece of debt, you can get that for maybe about 30% of your capital stack. You can get that debt for probably simple assignment right around 7.5%. Construction debt for 70% around 12-ish, 12.5%. CPACE around 7.5%. Blended rate of the two, 9.75%, 10.25%, something like that. So you can effectively drive your cost of borrowing down a little bit. But again, the math has to work with realistic expectations on your average daily rate and occupancy and realistic expectations on how long it's going to take that hotel to stabilize. uh you know that's that's the name of the game if you if you're realistic and all those things that still works at ten percent well that's two thumbs up but there has to be realism i was taught at cornell a new hotel typically takes three to five years we've been fortunate many new hotels stabilize at one and a half two years especially the extended stay product the product like the Residence Inn by Marriott which is really designed for the extended traveler that comes in to train on some widget so he's at the same hotel for two or three weeks or whatever that's kind of the exception that has stabilized historically very very quickly but historically it takes time so if your pro forma can withstand the fact it may take three to five years to stabilize to your stabilized NOI at a realistic average daily rate and optimism then two thumbs up builder you brought up the data centers are they impacting the hotel industry because that's a place where capital goes now and is that impacting your industry absolutely At least a third of the capital designated for real estate is going to data centers and artificial intelligence. A third. So that means that there's a third less for office buildings, multifamily, retail, you know, self-storage, you know, pick a subject, hotels. Now, in terms of hotels, do they go through the same commercial lending process where you have to refinance every five years or every six years? Exactly. Yeah. Very seldom, much too much different. The problem is, as I said, in this environment, you're frequently going to have to go to what I facetiously call friends and family and put some additional capital in the property. Otherwise, they will not refinance at the current debt level. If the current debt, let's say, is $10 million, they may come back and based on your current net operating income and say, okay, we're only going to refinance $8 million. So you have three options. you hustle with friends and family and you find the two million or you decide to sell or you decide you had to hand the keys back to the lender that's it real simple three options is the sale price right now above the debt or uh in most cases we hope it is but is that happening of course no generally speaking it is the problem is how much you know is it 10 percent is it 25 percent then you're probably in pretty good shape. Historically, I've been involved in many, many over 40 actually development projects over the years. And I've told every single developer two things. Number one, if you don't know who your guest is going to be on a Wednesday night in January, when it's raining cats and dogs outside, you have no business building this hotel. Okay. That's one. And number two, it's got to be that 22 IRR. It's got to have that return there. Otherwise you're just, You're not being realistic. And you are in the middle of hotel transactions. This is what you kind of see. Hotel transactions and financings. And since May of 2023, we've been aggressively doing a deep dive, as my partner would say, peeling back the onion on data centers, artificial intelligence, and cloud servicing. We are actually very excited about that area. We're involved in several major projects right now. where we have exclusive mandates to finance them. And we're very excited about where that's going. Who knows what's going to happen with artificial intelligence. As I said to someone this morning earlier, buckle your seatbelt. It's going to be a roller coaster. And we'll all find out together, good, bad, or indifferent. Maybe two years from now, we won't be here because it's like Hal in 2001, A Space Odyssey. Gee, I don't think I want to let you in back into my spacecraft. You know, we'll see. We'll see. Now, do you see this space being, and this time being a good time to get into hotels. And as long as you're disciplined in your approach, you're a good manager, and you focus on the cash flow and have realistic performance, absolutely positively. It's a great business. And it's going to be around. We're not going anywhere. I mean, you know, can you imagine why you would ever sell a hotel that you owned on Harvard Boulevard across the street from Disneyland? Disneyland's not going anywhere. They're not going to move the park. It's going to be there forever. You're going to have tourists with Mickey Mouse ears on in your lobby as long as the hotel's there. So, you know, it's just every property is different. Some properties, you know, you don't want to own because they were flawed. They're functionally obsolete. They're exterior corridor. But properties in great locations, I mean, they become legacies. Yes, they're more work than owning apartments, certainly more work than owning a Chase Manhattan net lease or an industrial building. But I mean, you know, in my career, who would have thunk that in the 80s, we would, we have gone as an industry, as the redheaded kid with step, with the braces, to one of the five food groups. In the old days, it was office, industrial, retail, multifamily. Oh, you're a hotel guy? Oh, you know, now who would, we're doing better than office. I mean, go figure. In 20 years, we have become a more popular investment item than office buildings. I just read yesterday where this Wells Fargo building in Los Angeles, one point something billion or million square feet, just sold at a dramatic discount on the paper. We had that in the 90s. I was quoting the Wall Street Journal when the Bonaventure Hotel sold for about $58 million to a Taiwanese investor, when two years before, when the Bel Air Hotel had sold, it had appraised for $288 million. That's what we call a significant haircut. 288 million and it was Equitable Life Insurance that owned it by the way 288 million to 58 million dollar sales price in two years two years but now it's a different story different story but again i'm just pointing out that that we've seen this sort of situation in my world but now we're seeing it downtown Los Angeles 1.2 whatever it was million square foot office building you know that's that's huge so it's pretty interesting we world changes just like artificial intelligence This is going to change each one of us. You know, hotels are now on the good guy list. We're one of the cool kids. Used to be. Now, Don, you recently went through some health issues. And you insisted to come in person. And tell us about your background, the will, and the motivation that drives you to be here today. I was a D student in high school. I got Ds in both Latin and German. I decided early on I should not consider being an interpreter. Good choice, because A, I would have taken that job. There you go. And I almost flunked out of college. I think I went to my, what am I, I can't remember what chapter of the Bible it was. I think I went to the class twice in a semester and did a lot of dating, some wonderful dating, and got in lots of trouble. Chris Van Dyke, Dick's son, was my roommate in college. Had a lot of fun, but I was going to get kicked out of college. And I made this rather ridiculous, obtuse, just dumb idea of enlisting in the United States Marine Corps during a war and changed my life. Came back from Vietnam, almost killed more times than I could tell, tell the story about. Started college on Monday. I got a relapse of malaria. I almost died of malaria in Vietnam. Had a relapse of malaria, got out of the Marine Corps a week late, and started college on Monday, scared to death. I'd already flunked out once. You know, who would have thought? Kid had a brain. Graduated Alpha Gamma Sigma. Graduated from the University of Southern California with two Bs. I got a B in physics. I had a challenge with the concept of the mole. And I got a B in biology because I couldn't remember. It was those stupid plant phyla. and I was 4.0 in biochemistry, you know, a tough major. Wow. And I was smart enough, they actually had me tutoring the Chinese kids in mathematics. I went to graduate, I went to apply to graduate school and I hadn't decided where I was going to go yet. I applied to seven schools. I was accepted at all seven and elected to continue my education in University of Southern California and it just kind of grew up from there. But bottom line is the United States Marine Corps, you know, discipline, you know, combat. been a leader in combat my platoon sergeant was killed in the firefight and i got a meritorious promotion at 20 years old to be responsible for 55 marines in combat every day for 23 days till we got a new sergeant at 20 years old you know fighting vietcong and running ambushes and patrols uh so yeah united states marine corps well thank you for your service and thank you for sharing that story and thank you for being here and telling us about the hospitality space and please come back and update us in the near future. Well, I'd love to talk to you further about data centers and artificial intelligence as well because that's an area we're very passionate about and we see tremendous opportunities there. Dr. Donald Weiss, it was great to have you on Marketing Insider. Thank you so much. Tell us what you think about this conversation with Don. We would love to hear your thoughts and ideas on the hospitality industry as well. Make sure to leave your comments below. I'm Siamak. This is Marketing Insider. We'll see you next time.