PARTICIPANTS
(from top left)

John Wright
CEO
Access Point Financial

Warren Fields
Chief Investment Officer
Pyramid Hotel Group

David Buffam
CEO
New Castle Hotels

John Salustri (Moderator)
Content Director
ALM's Real Estate Media Group

Kip Vreeland
Chief Officer, Full-Service Franchising
Marriott International

Stephen Schwartz
Chairman and CEO
First Hospitality Group

Suril Shah
Senior Vice President, Acquisitions
Starwood Capital Group

JOHN SALUSTRI: At the NYU Hospitality Conference in June, Jonathan Tisch said the recovery is going great. Then Mort Zuckerman said he's scared. So who's right?

DAVID BUFFAM: In our business you have to have a model that works in either scenario. Frankly, we would prefer a slow, steady recovery to one that's up and down. Because each of our hotels has a long gestation period, we like that we can work steadily on a project, deliver it three or four years later and find that it has a strong market, because we haven't built it for a particular time. We built it for a quality level that will work no matter what the cycle is. You have to tailor your plan to either scenario.

STEPHEN SCHWARTZ: As David said, we build and operate hotels with a long-term perspective, a long-term horizon. This recovery is sporadic and location-specific. In certain markets we've done very well while others are stuck in neutral. We tend to be a bit contrary, and we started a development cycle about three years ago. We opened our first hotel in Milwaukee about six months ago, and we have another that'll open in a couple of months. This too shall pass, and when everybody starts building is when we start really getting cautious, because there's a three- or four-year gestation period. So you don't want to come out in the middle of a recession. We're cautious and we're looking for opportunistic buys while trying to team up with solid partners.

SURIL SHAH: I agree. You have to position yourself for the next downturn, and a private-equity firm like us can't do a five- to seven-year hold on the assumption that it'll be roses for that entire period. You have to maintain moderate leverage and conservative growth assumptions and try to find assets that can weather a downturn. Putting a capital structure in place that helps you do that is very important to us and obviously is one of the big lessons that we've learned over the cycles.

KIP VREELAND: Hotel occupancy is generally back to '07 levels, so things are starting to move in the right direction. As a company, we've got a lot of different brands that we represent, but our big-group houses are starting to feel some strength, so booking pace seems to be coming back. The government segment is certainly a problem in a number of markets with the sequestration; many hotels have been impacted by that. Until supply starts outpacing demand again, the industry should maintain some growth for the next couple of years.

WARREN FIELDS: Demand is better than we had thought over the past two or three years. Some portions of the country have not been able to drive ADR as fast as others. The development perspective is good for all of us in the industry. That has the possibility of changing over the next 24 to 36 months, particularly if more financing becomes available. Even in New York City, where 10,000 rooms have been added or are under construction, demand is still very strong. Markets such as Boston and Philadelphia have exceeded demand expectations as well. The anomaly has been Washington, DC. Revpar is down double digits this year in our nation's capital. We at Pyramid are bullish about the demand picture across the country. The one constant that all of us have seen in our careers is that low basis usually wins. If you have low basis in a market, you can pretty much weather the cycles.

JON WRIGHT: We participate in bridge loans and quasi mezz, which is where we value more robust pricing metrics in the capital stack. Therefore we don't typically lend in the top 5-10 MSAs as they become reverse auctions for the pricing and the money center banks occupy that space. We tend to be in the tertiary markets whereby we garner business via ease and certainty of execution vs. pure commoditization of economics. We are opportunity capital and compete more against community banks and mid-market lending range up to $25 million.

SALUSTRI: How much inventory is out there with servicers, and what are they waiting for before disposing of assets?

SHAH: Obviously in the secondary and the tertiary markets, when a new hotel opens, you can quickly see the impact easily on the surrounding hotels. In Milwaukee, for instance, there are six hotels being developed or scheduled to open. That's 1,100 rooms, and it'll be very interesting to see how that market responds to such an influx of new supply. We're also concerned about markets like New York City, and supply increases there, but New York has so many different demand drivers that can absorb large influxes of supply.

BUFFAM: You're not saying that New York is impregnable to a sharp correction?

SHAH: No. It's not. If you look at the top 25 markets, they're typically more volatile, with more severe corrections than markets 25 through 100. However, the rebound in the top 25 markets from that correction is also pretty swift.

SALUSTRI: How much inventory is out there with servicers, and what are they waiting for before disposing of assets?

FIELDS: There's a huge amount of CMBS loans that are coming due in 2014, and another huge sum in 2017. It will be interesting to see how it all gets refinanced. Some servicers have figured out holding assets a little longer, yields better multiples upon sale as the recovery continues.

SHAH: It's funny. We used to call it extend and pretend. That's a horrible misnomer. It's more extend and wait for the market to recover and get out. It was a brilliant strategy.

WRIGHT: Many regional and community banks are being forced to flush their portfolios. Over the years, we've been funded by both international and hometown concerns which has insulated us from a mono investor retreat from hospitality space or a liquidity crisis. We still maintain stable and globally known brand investors.

SCHWARTZ: There is money available. I'm going to say somewhere in the 65-to-68% loan-to-cost range.

SHAH: Even on construction?

SCHWARTZ: Even on construction. However, guarantees are required through completion, with some burn off over a period of time. But as a developer the only way to get things to happen is to have enough confidence in the project and enough equity behind it.

WRIGHT: We have autonomy and authority to approve a $10-million to $20-million loan in 24 hours. We can compete on execution. We are a less expensive equity alternative with market rates of 7% to 10% with interest-only provisions to ramp underperforming and mismanaged assets that have a refresh strategy. We'll lien up an asset with a chattel mortgage and it's an asset-backed loan. We service it. Low entry, low exit fees and an efficient method for our clients to transact quickly, reposition and take us out with a CMBS or long term mortgage within 24-36 months.

SHAH: So if you did the $10-million loan in 24 hours, you're trying to take a deal off the market, what kind of term would you have?

WRIGHT: It's a 36-month term. We'll amortize it up to 25 years and it needs to have a 1.25 debt service coverage ratio post projection stabilization in month 24.

SALUSTRI: CMBS. We've discussed what's coming due. What's new issuance looking lilke?

SHAH: Good question. CMBS is back and something that we're tapping into. We're lucky that we have an in-house debt team that's able to look at both the on-balance-sheet lenders and CMBS lenders. We're finding that especially in the smaller transactions in secondary markets, that CMBS is available and it's cheap. It's obviously not as flexible as on-balance-sheet debt, but it's back and becoming more liquid.

SALUSTRI: Smaller deals are actually more in line with the original CMBS model.

SHAH: Absolutely. You're seeing single deals with CMBS.

VREELAND: CMBS is coming up more. But a lot of different ownership structures are coming to play in all the hotels.

SALUSTRI: David, you said you're on the eastern seaboard. How do you define what's a viable opportunity?

BUFFAM: We have other criteria, but the first thing we look at is whether we can achieve a rate that, under our business model, works for the kind of project we're going to be doing, because we tend to overbuild a bit on both the select-service and full-service sides. We prefer to do fewer deals, but make them non-generic, make them as unique as we can and finish them off in a way that gives them an immediate market-share premium. That's what we're going for. But that premium has to be $130 for a select-service hotel, or we're not going to spend time on it, and it probably needs to be 200 bucks for a full-service hotel or resort hotel. But that isn't as hard to find as you would think. Obviously there are some segments of the country, such as suburban markets, where we'd be hard pressed to do that, but in secondary or urban markets, it can be done. So although we're primarily Atlantic seaboard, we're looking in other areas. We also look for barriers to entry. We're doing a resort on Jekyll Island next to the convention center and we're finishing up an Autograph in New Brunswick. So there are exceptions to these rules, but fundamentally if you want to run a resort, you've got to get to $200 at least to make things work in our book.

SALUSTRI: Steve, talk to me a bit about the franchise situation and the fees.

SCHWARTZ: Everybody is euphoric about reaching the revenue levels that we were at in '07 and '08. But they ignore the continuous compression on the bottom line, because although the revenues are maybe equal to where they were at peak times, we've experienced eight years of cost increases. Healthcare costs alone have been going up at phenomenal rates. So there's a huge compression. And there's increasing pressure on the franchisors, driven a lot by key licensees to keep costs in line and do cost/benefit analyses on all the new programs they're putting out. I serve on a couple of advisories, for Marriott, Hilton and Hyatt, and I can tell you that licensees are increasingly vocal. Franchisors continued to introduce new programs over the last three or four years, creating major cost initiatives. Everybody is trying to reposition the brand on the licensees' money, their pocketbook. The only way really to slow this trend is to stop buying licenses. And as long as licensees continue to buy them, their fees come off the top. So it's really a challenge.

SALUSTRI: But what about the franchisor?

SCHWARTZ: Well, there's also an increasing move by franchisors to pass as many costs as they can onto licensees—management costs and remodeling costs and internet-management costs. There's no end in sight.

SALUSTRI: But franchising is exploding in Europe.

SCHWARTZ: Europe is a different environment. There's a dearth of licensees. You have a lot of small mom-and-pop operators. Globally, people want to be part of the system. The real magnet to franchising is the rewards program that drives a lot of business. Those programs are driving 60% to 65% of the guest arrivals at the top brands. Those are big numbers and they can't be ignored.

SALUSTRI: David, if you had to focus on one area of your company that's contributed most to your success, what is it?

BUFFAM: The thing you think of first are the partnerships that you make, whether it be the brands or the financial partners. But the truth is that the way you get strong partners is by having strong operations and successful operations.

SALUSTRI: Warren, are the brands becoming too aggressive?

FIELDS: Absolutely.

VREELAND: No.

FIELDS: (Laughing) Sorry. I didn't know you were here. If you look at a hotel that's going through a repositioning or a brand change needing a significant upgrade, they're probably okay. If you have a hotel that's leading its market, and all of a sudden, you're required to invest significant dollars because the “brand standards” have changed, we think that is inappropriate. The rational brands are allowing owners with competent management and good service scores to have some flexibility. If the product is poor and not delivering the service, it is an uphill battle with the brands.

SALUSTRI: It's 2014. We're back in this room. In retrospect, what did 2013 look like?

SCHWARTZ: This will have been a solid year. Operationally, we will have gone through continued cost control and will probably have cut back on some of our development plans going into 2014.

SHAH: I agree. This year will be a very good year, and '14 appears to be strong as well. We'll be talking more about government decisions or government plans. There's a lot of power concentrated in Washington that is affecting—and will affect—our business, potentially more than it has in the past.

VREELAND: We'll be talking about how quickly things changed for the new customer. The new customer right now is a smaller percentage of our collective business, but it's going to grow. Every week, every month we learn something new. And as more of those customers come, the way in which hotels make money will shift.

FIELDS: We'll be talking about the imbalance of supply in our industry, and we'll be talking about interest rates rising.

WRIGHT: As a lender, I certainly agree with those comments. What we've tried to keep keenly aware of, but what we don't know as a lender, is how the next generation of borrowers will think and behave at times. We have to watch very closely for misrepresentation and fraud in the very high-tech world we live in.

BUFFAM: I agree with everything that's been said. We have to stay with quality brands and strong locations and places that we have experience with success. If we just look at our pipeline, there are two Westins, there's an AC Marriott, there are two Residence Inns, there's a Courtyard/Residence combo. Basically we stick to things that have given us success, and we're willing to take a new brand, for example, AC Marriott, and put it on a very strategic asset, the gateway at JFK Airport. That's our plan.