321 | Here to Help: Pandemic crisis fuels third-party management growth

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PANDEMIC-ERA GROWTH: Hersha Hospitality Management or HHM of Philadelphia in January added the Sea Crest Beach Hotel in Cape Cod, Massachusetts, to its management portfolio. In the past 12 months, HHM added 25 hotels totaling 4,000 rooms to its portfolio. Naveen Kakarla, president and CEO of the Philadelphia-based company, said new and long-term investors in need of experienced operators amid the coronavirus crisis has fueled the growth of HHM and other third-party management enterprises.

Operators that specialize or are built for scale may emerge stronger post-crisis, say experts

During the worst economic crisis the U.S. hotel industry has ever faced, Hersha Hospitality Management or HHM added 25 hotels to its portfolio.

HHM was joined by other third-party hotel management companies that saw their business expand as the coronavirus pandemic hammered the hotel industry. Many owners, small operators and investment groups have turned to outside sources to help manage their hotels’ business amid present and unforeseen challenges.

It’s what HHM has experienced over the past 12 months, says President and CEO Naveen Kakarla.

HHM was borne out of Hersha Hospitality Trust, a self-advised lodging REIT begun by Hasu P. Shah when he entered the hotel business in 1984 with a single hotel in Harrisburg, Pennsylvania. He named the company after his wife, Hersha. Today, Shah’s sons, Jay and Neil, lead the REIT, which formed in 1998 and went public the next year.

In 2014, HHM spun off into its own entity and began to take on the management of hotels outside the REIT’s portfolio.

In April, HHM announced it added to its portfolio the properties that total 4,000 rooms. It now manages 140 hotels across chain scales and markets throughout the country. It clients are institutional and long-term investors.

NEW ADDITION: Hersha Hospitality Management or HHM in February added the full-service Delta Hotel by Marriott Philadelphia Airport to its management portfolio. The property is among 25 management contracts HHM signed during the coronavirus pandemic.

It’s no small feat that HHM added new business as well as hold onto its current client base while the coronavirus pandemic laid waste to vast segments of the hospitality industry, says Kakarla. But the crisis is just one of the reasons the third-party manager attracting new business.

“We saw a flight towards us for a number of reasons,” he said. “A lot of new owners either knocked on our door or decided to work with us after knowing us for a long time, and then a few others where we made an investment.”

Kakarla said it’s a management company’s reputation and the relationships it builds over the years that fuel growth spurts, especially attracting business during a crisis, whether it be a distressed situation, a change of ownership or a pandemic.

But HHM was not in the market to acquire new clients amid the pandemic, he said.

“The primary goal when we learned of the pandemic was our existing owners. We really didn’t focus on where else we might find growth. The only thing we should be thinking about are the hotels that we’re running,” Kakarla said.

HHM’s response amid the pandemic, he said, is “the basis for continued stability, continued growth.”

HERE TO HELP: Hotel owners and operators who believed they could go it alone before the coronavirus pandemic devastated the hotel industry are having another think and turning to third-party managers to work their way back to profitability in the post-pandemic recovery. Another trend contributing to the growth in third-party managers’ business is more commercial real estate investors armed with cash entering the hotel sector and in need to an experienced operations team. Episode 321 of Lodging Leaders podcast explores the growth of third-party management companies over the past 12 months.

New Game Plan

As an example of how HHM helped owners weather the coronavirus crisis, its parent Hersha Hospitality Trust closed some hotels in urban, business transient markets when occupancy fell below 10 percent.

The REIT also sold or agreed to sell a few hotels and reopened its shuttered assets in December.

It was HHM that guided the REIT and other owners through critical operational and investment decisions that were in many cases exclusive to each hotel.

“The pandemic for me, when I think back, the first thought I had was that we’d always considered ourselves really scrappy,” he said. “You’re really tested when you have this type of a challenge. It not only requires you to be nimble and quick and make clear decisions but to really think beyond what you thought was possible, because the circumstances require it.

And for me, the first of those was moving away from a profit-and-loss statement, if you will, where you’re thinking about the business you’re expecting to get and spending cash against it to really being more of a cash-based business. And regardless of the size of the hotel … we took all of them and started being clear on what cash we had, what needs we had against that cash.”

Another step HHM took was to work closely with owners by providing as much data and operating information as possible. “It didn’t matter if you were in our accounting and finance team or if you’re a regional leader or if you’re a general manager, we just decided transparency was the way to go.”

Working closely gave owners and investors accurate and timely information about their hotels’ business performance. The added bonus is it strengthened the ties that bind the owners to HHM.

“We made our game plan together,” Kakarla said. “And that game plan was hard. It ranged from whether hotels would stay open or closed [and] new staffing models. We talked about what we might be able to do to cluster operations or to, in some cases, keep the wheels on the bus.”

HHM’s portfolio is diverse and each hotel required specific operating decisions, including properties that supported essential workers, truck drivers and government business. “We needed to kind of isolate those hotels and put a different type of energy” into them, he said.

Recovery, Kakarla said, is going to be as if not more challenging than operating in a pandemic. Another reason owners are turning to outside expertise.

“We have many, many more bright spots. It’s obvious that we’re on the road to recovery. On the other hand, it’s going to be harder to rebuild and relaunch our hotels; to really enhance our culture; to fight for talent; to meet the expectations of travelers who were taking their first trips; and to balance the needs of owners.

“I could be optimistic about where we’re at, but it’s going to take in many cases a couple of more years to get to the revenue levels that we were at just a year and a half ago.”

In 2020, HHM opened three independent hotels in Texas, Boston and Miami. Kakarla and his team pondered whether to open the properties amid the crisis or wait at least a year to do so. He said he’s glad they moved ahead with the launches as the openings gave HHM an opportunity to recruit top talent and learn new ways of operating and providing unique guest experiences.

Like the locations of the three newly opened hotels, HHM has taken on a diverse range of owners as well as their hotels, including independent boutique and lifestyle properties and branded full-service, select-service and extended-stay assets. Its fastest-growing segment is destination resort hotels, driven by leisure demand that began last year and is expected to get stronger in spring and summer months.

Many of the management agreements came from new owners or investors looking to put their cash into an asset for the long term.

“I would tell you that our industry is remarkable,” Kakarla said. “If you look back a few decades, we were once considered a much more risky investment versus the sophisticated real estate player we are today. Information and technology and brands have evolved.

“Our hospitality industry has benefited and brought in very sizeable players who are making bigger bets. What I see on the other side of the pandemic is that our industry should have outsized capital coming into it. The trend towards us from an investment basis is growing.

“The second factor is at one time you would always think about either running your own hotel or you would think about a major brand running your hotel with their brand’s name on it. Today, you’re seeing that brands are really pulling away from a focus on the management area.

“And you have more independent hotels and sophisticated brands and markets that require the third-party manager. And so where you have the technology and the locality and the capability, I think the growth is really trending toward experienced third-party hotel managers. Not just our company, but I think our sector will thrive in the coming decades as well.”

Big to Bigger

Hotel management enterprises will not only thrive, they will grow, says Del Ross, chief revenue officer at Hotel Effectiveness, a technology provider that helps hotels and third-party operators manage labor costs.

Aimbridge Hospitality became the largest hotel management company in October 2019 when it merged with Interstate Hotels & Resorts. The combine portfolio totaled 1,400 hotels in 20 countries, including the U.S.

Though the deal occurred pre-pandemic, Aimbridge and other management companies know the value of scale when surviving an economic crisis.

That’s the underlying reason for growth whether it be organic, through partnerships or mergers and acquisitions, said Ross.

“Big management companies are growing. The small ones are not, actually. The small ones are being gobbled up by the big [ones],” he said. “I think that it’s a combination of a couple of factors. The way that management companies make money is off base fees and incentive fees. And last year, of course, there were no incentive fees and base fees are really low. They’re 1 percent of gross room revenue. In a year where you have 30 percent of your normal gross room revenue it’s a pretty lousy revenue source.”

Companies managing five to 10 hotels are willing to sell for $300,000 to $400,000. Sit out the market for a couple years and start another management company when the industry has recovered.

“It makes sense; the big guys can handle it because they have the cash and they have scale,” Ross said. “The smart ones use their scale very well. They can drive down their costs. They can pool labor; they can have best practices; they can have productivity standards; they can have ways of working that they can police and implement much more effectively than others.”

CRAFTED EXPERIENCES: A guest room at Hotel Morgan, a Wyndham hotel in Morgantown, West Virginia, that Charlestowne Hotels partnered with Thrash Group to open. The 81-room boutique property is an adaptive-reuse project that restored a 95-year-old building. Morgantown is home to West Virginia University. Collegiate markets are among Charlestowne’s specialties.

‘Swimming Naked’

Charlestowne Hotels in South Carolina manages more than 50 hotels, primarily independent or soft-branded boutique and lifestyle assets.

Everett L. Smith, CEO, founded the company 40 years ago and has led its organic growth over the decades.

The company added hotels amid the pandemic for a couple of reasons, says Johnathan Capps, vice president of revenue. First, independents used to fly without a compass but today technology and data analytics has armed managers with a load of information as well as the ability to gather it and make sense of it.

“We’ve seen independents or where a flag drop off something do well at market as the data has been out there,” Capps said.

Travel consumers also have come to value independent hotels that can curate experiences with a focus on the local market, something Charlestowne Hotels is particularly good at providing.

Capps echoes Kakarla at HHM in seeing the trend of more new hotel owners looking for third-party manager. ‘They’re looking for that experience. Brands caught on 20 years ago because they knew how to perform in a certain model with a certain hotel, but now that model has changed a little bit.” The growth of soft brands has proven the value of unique guest experiences in independent hotel, he said. “The brands are even realizing that they need to move in that direction a little bit. They got a great case for their ability to do distribution and to have loyalty, but the curation of an experience around a theme or a place may call for an operator like ourselves.”

Kalibri Labs reports of the 1,700 U.S. hotels that have closed since March 2020, nearly 600 or 4 percent are independent. Capps said perhaps among the 600 are hotels that will “change hands and need an elevation from an owner-operator. Or someone’s coming in and buying them and are going to buy four or five at a time, which we’ve heard talk of during this time.”

Capps said he has also seen lenders who used to only finance branded hotels now accept “what an independent property can do with a third-party manager attached.”

Another anticipated trend that may impact the demand for third-party managers now and post-pandemic is financially distressed hotels going into receiverships or special servicing and/or being acquired at lower than normal prices.

“We’ve had success with receivership going to a new ownership and the asset completely turning around,” Capps said. “And I do see those coming.

“I also see some money entering whether it’s private equity money or small groups of people putting some funds together to say, ‘We like these three markets. If we get all three, we’ll buy all three assets. And if we end up with one, we’ll end up with a property in the Keys or in South Carolina, in the mountains in Colorado. But we were targeting these three to differentiate and to grow as real estate opportunities.’ And we jump in there with them too, from branding to concept team, to realigning and then get it operating and get it going. I think a lot of those are going to present itself.”

He also expects some franchisees to not renew a licensing agreement and take a chance as an independent and call on a third-party manager to help with the transition.

The coronavirus crisis has changed the minds of owners, investors, lenders and developers. The severe downturn has also revealed weaknesses in business models.

Matthew Barba is vice president of operations at Charlestowne Hotels. He shared the Warren Buffet quote “Only when the tide goes out do you discover who’s been swimming naked.”

“And so the tide went out in 2020 and where people may have been successful without the assistance of third party management prior to 2020 – it may have been happenstance; it may have been pure luck; it may have just been a hot market. And I think 2020 flushed out that some of them couldn’t do it on their own and needed some assistance.

“Charlestowne has been in the business for 40 years now and we’ve navigated some other storms, and the pandemic showed us areas where we could make improvements, but also where our strengths lie.”

Barba said a lot of owners turned to Charlestowne over the past months to help them navigate out of a bad situation or help with a transaction. “They’re recognizing this is not the time to try and do something yourself it that’s not your core competency.”

New Doors Open

The Witness Group is a hotel development and investment company in Columbus, Ohio, formed five years ago by second-generation Asian American hoteliers when they merged their families’ businesses.

Lodging Leaders featured Sagar Patel, principal at The Witness Group, in Episode 319 in which we reported on pandemic-era partnerships and joint ventures. The Witness Group was included because last September it turned over the operation of its 36 hotels to Hotel Equities, a third-party manager.

Like Barba’s observation about owners identifying their core competencies amid the coronavirus crisis, Patel said he and his team at The Witness Group realized pre-pandemic they needed an experience outside operator to come in to manage various aspects of their hotels’ business, including retaining, recruiting and training employees.

In addition, for The Witness Group to grow beyond its current portfolio, it needed to partner with a management company that has its own strategy to scale its growth.

The decision to go with a third-party manager paid off last year and Patel sees it making a world of difference as The Witness Group takes part in the post-pandemic economic recovery.

“Once you have the recovery, then you want to make sure you have the right people three to four months in advance of that, especially with our new hotels,” he said. “Our whole thought process was if we can get ahead of that and not be scrambling to figure it out during the recovery, then we’re investing some dollars in talent upfront, but it will pay off in quarter two, quarter three of this year. That was our 30,000 foot view of the timeline.”

Patel noted other advantages the deal between The Witness Group and Hotel Equities can achieve in the years ahead included access to Hotel Equities’ capital arm, Virtua Partners.

“That can help with financing and deal capitalization that we didn’t have. We weren’t very institutional. All of our assets are owned by a select group of families,” he said.

“So learning from that in terms of underwriting and how to view assets and maybe collaborating on the equity side. We’re starting to share deal flow back and forth, which is something that we’re hoping to get some momentum on and actually do some deals.”

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