A hotel’s exit strategy should be formulated before the deal to purchase is struck. However, no two strategies will be the same as owners work to get the most value out of their assets before saying goodbye.
Robert Leven, chief investment officer at Procaccianti Companies and TPG Hotels & Resorts, said exit strategies aren’t stagnant, but rather they can alter as the world changes around the asset. But for starters, it’s important to at least have a concept of what is envisioned for the full roundtrip of the investment.
“You can conceive and plan for an exit strategy and a million different things can happen between investing and the time you decide to exit and ultimately do exit,” Leven said. “We always want to have a conceptual plan of how we see the investment from start to finish before we buy. It gets reevaluated every year as to what has happened with the original concept or what hasn’t happened—and we make adjustments.”
Although the living concept of the exit strategy can vary on an asset-by-asset basis, sources said there are some top things to consider when formulating a plan.
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Michael P. Marshall, president and CEO of Marshall Hotels & Resorts, said it’s important not to fall in love with the real estate.
“It has to be a business decision through and through,” he said. “The problem with real estate, and hotels in particular, is that people fall in love with the physical structure of the building and tend to make decisions based on ego rather than basic business tenets.”
Mary Beth Cutshall, senior vice president and chief business development officer at Hospitality Ventures Management Group, said there are a few things her company considers when planning for an exit, including: having a well-defined deal objective, process and activities; targeted hold period and buyer pool; and the expected investment returns and resources required to accomplish the objective.
The hold period of the asset is also key to consider when formulating an exit strategy. While this period will usually vary based on the asset, sources said there are many other variables at play.
“HVMG typically has a five-year hold period. However, this can vary by deal. We have sold assets at the completion of occupancy, and we’ve also held properties over five years,” Cutshall said. “Also, other things to consider include changes in the market, where we are in the cycle, ability to add value further and new supply expected.”
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Marshall said that although the hold period is determined on a one-off basis, whether someone is the initial developer also comes into play. If a hotel is built, owners are looking at a much longer hold period than if they buy existing.
“As a developer, you’re going to get a 20-year franchise, but as a buyer you might only get a 10-year franchise,” he said. However, he noted that hold periods can depend on the franchise. For example, companies such as Hilton Inc. are offering a 15-year extension for its Forever Young prototype property improvement plan for existing hotels.
“If you’re going to get a 15-year, then your hold period is maybe seven to 10 years. If you’re only getting a 10-year extension, your hold period should probably be five to seven years,” Marshall said. “It really depends a lot on the franchise being offered and whether or not you develop the hotel from the ground up. And you’ve got to consider that whoever is buying the property has to have some upside.”
Leven said different types of investments lead to different hold times.
“There are investments that are more yield-oriented investments, which tend to be more stabilized type assets that we’re looking to generate investment multiple by holding that yield for a longer period of time,” he said.
On the flip side, value-add investments usually have a shorter-term hold period, he said. “You’re looking to take advantage of some disconnect and take residual value and harvest that. It could be that you’re doing that to turn cash flow around.”
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Property improvement plans are underaccounted for the most in the industry, according to Leven.
“It’s so complicated and so uncertain in terms of what that picture of the course of investment holding period will look like, particularly larger full-service branded assets,” he said. “We’re quite careful and diligent about trying to account for not only the [capital expenditure] requirements going in but what they are going to be over the course of hold and what the brands are likely to expect on change of ownership.”
All told, Leven said the analysis can be imperfect due to the changing nature of brands and their requirements. It can be difficult to discern what the brands will expect at any given time in the future.
“PIPs are a huge thing right now, especially since the economical downturn and because franchise companies got lenient on what they required owners to do because business was down and there was no money to do it,” Marshall said. Now, times are good and brands are requiring large PIPs.
“It’s harder for [brands] to force existing franchisees to do something,” he added. “But a new buyer coming in doesn’t have that flexibility. That’s a consideration on the buyer and seller side. The biggest PIP you will see is when a hotel transacts.”
Probably one of the biggest falsehoods of the industry is that a 4-percent CapEx reserve is needed, according to Leven. For example, a large branded full-service hotel will never be covered with 4 percent due to its heavy ongoing maintenance and cyclical cosmetic needs that brands require to be changed over time—especially when these types of assets typically have a longer hold period.
“Every situation and asset will be different. Some assets might require an 8-percent reserve, while some won’t be far off from 4 percent,” he said.