Select-service hotels now legitimate institutional investor play

ATLANTA —  In October 2016, U.S. private investment firm Starwood Capital Group sold a $2-billion stake in a select-service hotel portfolio to China Life Insurance, China's largest life insurance company. Price tag notwithstanding, the deal was startling for the composition of hotels. Up to then, institutional investors, U.S. and otherwise, concentrated hospitality investments primarily on higher-end hotels. In 2014, for instance, Anbang Insurance paid nearly $2 billion for the Waldorf Astoria in New York, and a year later Starwood Capital sold the Baccarat Hotel, also in Manhattan, to China’s Sunshine Insurance Group for a record $2 million per key.

Though select-service hotels don't carry the prestige that upper-echelon hotels do, they do carry something that Barry Sternlicht, chairman and CEO of Starwood Capital Group, outlined: strong cash-on-cash yields, scale and diversification.

Two years later, the cat is out of the bag: select-service hotels are an increasing investment play for institutions, such as pension and mutual funds. This trend was noted by Suril Shah, managing director of Starwood Capital, during a State of the Industry panel at the Hunter Hotel Conference.

“The gig is up,” he said. “Select-service is an institutional investment class.”

He said that when Starwood Capital started to first look at the select-service segment for investment, those around them were curious to the point of asking, “What are you doing?” Shah said. 

Investors, however, have come around to the notion that consistent returns are equally important as high-RevPAR delivery. Shah said that select-service hotels that previously traded at a 10 or 11 cap rate were now selling at 7 or 8 caps. “Significant capital is now coming into it; they know the market,” Shah said. 

Starwood Capital need not look further than itself to drive that point home. Last April, it launched Uptown Suites, a nationwide brand of upscale, economy-priced extended-stay suites.

Noble Investment Group is also eyeing the select-service space for investment. CEO Mit Shah said that the segment is more predictable and, in many instances, the hotels are better run and better quality than some full-service hotels. “The brands will even admit that suburban full-service hotels have a structural problem,” he said.

Not everyone is convinced. Tyler Morse, CEO of MCR Development, which is currently at work developing the TWA Hotel, at John F. Kennedy Airport, in New York, said Wall Street “has an institutional bias toward high RevPAR.” Morse was also quick to point out that select-service hotels are getting pricier to buy and/or develop. “Back in the day, it was $100,000 per key,” he said. “Now, it’s closer to $200,000 per key. Morse said he built a Residence Inn in South Florida that cost $185,000 per key. 

According to Jim Merkel, CEO of Rockbridge, it's not a total matter of investing in select-service or full-service hotels. “Investors want predictability,” he said. “They don’t care if it's full or select. It’s about cash-flow potential.”

Industry Insights

All agreed that the industry is faring well—at least for now. Starwood Capital's Shah pointed out that the industry is 96 months into a cycle of positive RevPAR growth. 

A healthy industry, however, doesn't necessarily equate into voluminous deal flow. “It's hard to do deals today, but I think it’s always hard,” said Merkel. “There is a fear of the peak. Smart people don’t want to do business at the top.”

Morse said there is inventory out there that is just not transacting; instead, owners are opting to refinance, which, he added, has led to cheap debt for acquisitions. 

More concerning for Shah is the amount of new brands. “You have to find one that you can pour capital into,” he said. “When you have a brand you can develop and exert control over, it helps you underwrite cost structures.” 1 Hotels, a luxury brand with a focus on sustainability that Starwood Capital launched in 2015, is that. Shah said Starwood Capital would be spending some $2 billion over the next five years to cultivate and expand the brand. It currently has three hotels open, two in New York and one in Miami. By the end of the year, The Jeremy Hotel in West Hollywood will be repositioned under the 1 brand.

Shah blasted what he perceived to be a homogeneity among today’s brands. “You have to look for differentiating factors,” he said, and cited Yotel as a differentiated brand. (Last year, Starwood Capital made a $250-million investment in it.) 

Mit Shah said it is hard for brands that don’t have scale to create loyalty and drive distribution through their own channels. He said this is a reason there will be continued M&A on the C-corp side.

In Morse's estimation, hotel owners are after one thing when they flag a hotel, guest delivery. “You are paying for a central reservations system,” he said. (Morse said that the TWA Hotel, where construction costs currently amount to $20 million per month, will not be branded because of latent demand endemic to the airport.) 

Morse also shows discontent for the way hotel brands manage their hotels. He said hotel companies need to start acting more like airlines, and charging for more items.

“The hotel industry thinks it’s anathema to charge people along the way for additional services,” he said, such as parking and cancellations. According to Morse, of the $200 billion in airline revenues last year, $65 billion fell under the category of “other,” meaning bags, sale of credit cards, etc.

Toward the end of discussion, Starwood Capital's Shah, somewhat sheepishly, took the hotel brands to task surrounding their ROI. “We've been renovating so much and not getting anything for it,” he said. “We put millions in and I'm making the same amount of money as the year before.”