What's Going On With Hotel Investments in California - Craig Sullivan, California Lodging Investment Conference [San Francisco Sundays]

Josiah: 0:00

Over the past few weeks, we've been running a series called San Francisco Sundays, covering what's happening in my hometown, and the series wouldn't be complete without diving into what's going on with hotel investments in California these days. To help us understand this, Craig Sullivan, founder and president of the California Lodging Investment Conference, is joining us to walk through what he's seeing. 

Craig: 0:41

I consider myself an ambassador for the state of California. Born and raised here, love it here. Every market's got its own idiosyncrasies. New York is different, Miami is Chicago, LA, San Francisco, Boise, Idaho. Every market's got its own little nuances that can make things difficult and that's why you get professionals to the other that are familiar with the market if you're going into one that you're not familiar with, to make that journey just a little bit easier. But if you're a mid-cap to large-cap hotel company or a REIT, you understand it. You understand that one of the economic engines in this state is hotels, travel, and tourism. That's billions upon billions of dollars of revenue coming into this state every year. Agriculture, believe it or not, is still the largest industry in California. We're still basically the bread basket for the rest of the country, followed by the entertainment industry. I throw sports into that as well. You look at SoFi Stadium. You look at what used to be the Bank of California Stadium for the LA Football Club of the MLS San Francisco, where the Warriors play. We've got all these magnificent palaces for sports and entertainment. Great to go see a concert, great to go see a pro team. Then you look at Disneyland and various other entertainment facilities throughout the state. Plus, our coastline is second to none in the nation. We've got it all right here. You could be surfing or scuba diving in the morning. If we've had rain and there's snow in the mountains. You can be snowboarding or skiing at night. There's not too many other places where you can do that.

Josiah: 2:34

I wonder if we talk a little bit about what's going on in the world of hotel investment these days. In California, CoStar a couple of weeks ago reported that deal volume had dropped more than it had during the great recession. What do you see happening?

Craig: 2:48

Yeah, we're down talking to some of the top brokers in the state and CoStar as well. Sales are down about 60%. There's a lot of money sitting on the sidelines.

Josiah: 2:57

Is that more than the rest of the US, or is that kind of in line with what you see across the country?

Craig: 3:02

I'm going to say it's close. It may be a little bit more. I really don't really go outside the confines of California unless it's Hawaii, and Hawaii's only got one new hotel under construction. I mean, we've still got a number of them being built in Los Angeles and various other parts of California, but our deal volume is down. Now the trophy assets that's a different animal. There's always a reach or somebody that's got money on the sidelines that says, hey, we need to deploy this. So they're going to go find something and buy it it. Also, you've got a lot of new money coming into the hospitality sector. You look at interest rates. They've certainly climbed, but I believe in relationship banking. I'm going to put money in that bank. I want to be able to have access to not only a great hotel lending officer but the person who runs the loan department. I want to be able to talk to them and pick up the phone and go, hey, look, we're thinking about repositioning this hotel asset in our loan covenants. I have to talk to you about that. Are you moving up or down the flagpole with different brand and you treat your lender like they're a partner which, at the end of the day, they truly are and you keep them informed of what you're doing, you're going to have a much better relationship. And if you've got a depository relationship which I believe in it gives you a little bit more latitude, especially if you've got an open door communication policy with your lenders. We've got some lenders that are involved with the California Lodging Investment Conference that are making still doing construction loans. May not be the terms that you want, but it can still be done. You might have to throw some more money into the deal because there's probably going to be a gap there between costs and what the lender's going to loan you. There's still ways of getting deals done. That doesn't go away. Good deal is still a good deal at the end of the day Time kills all deals.

Josiah: 5:09

If we look over the past couple of decades, is this really that bad, or are we just coming off of an exceptionally low interest rate environment for some time?

Craig: 5:19

It's a combination of both. If you look at before the financial meltdown, interest rates were higher or on a par level. Then they certainly went down and you basically can't have a commercial loan at what would be typically a residential rate. That's just not sustainable. The other things that you got to look at as these rates climb. We've had generations now that have come into this Since the financial meltdown. A couple of new generations of hotel people and older people have been retiring as well that have never seen interest rates like that. So this has been quite a bit of sticker shock and I think that they're getting over that. At this point, at least, I hope they are. Where are rates going to be next year? Are they going to come down next year? Well, next year is an election year and that adds chaos to on top of everything else and a whole different level of chaos. Some companies will contract because they want to see what the political shift is going to be. Some lenders may change their programs betting on who they feel is going to be in power. So it just adds another level of uncertainty to a market that doesn't need that. As most of the news people are fond of saying. Wall Street doesn't like uncertainty. We just don't know and it's too early to tell.

Josiah: 6:41

Well, I imagine some of those themes that you're seeing, whether it's some price discovery from buyers or sellers or interest rates, navigating all of that and navigating uncertainty applies in San Francisco. I wonder if we could talk a little bit about San Francisco. I'm based here. I think famously Park Hotels and Resorts stopped making payments and gave up to San Francisco's largest hotels and I'm curious if you see anything different happening in San Francisco compared to California broadly, you know.

Craig: 7:12

San Francisco is that city on the hill. It's had to reinvent itself so many times from fires and earthquakes and everything else. Now, yeah, there's certainly been a share of social issues. Not everybody willing to come back to an office is crippled. The downtown market. But your San Francisco hotel council is already putting it out there on their messaging that 2024, 2025 are going to be better for conferences and visitors. Now, I was just talking to somebody the other day and the flights that used to come from China and the Far East Asia Pacific to the United States. San Francisco is the first port of call and that's like less than 40 flights a day now, so those numbers aren't back. You've also got a lot of US tourist visitors that are gone abroad. They've gone to Europe. But your mayor in San Francisco is making some right moves. The police department, everybody's got to stop bagging on California and San Francisco in particular. I was up there a few months ago and I actually found it a lot cleaner and much more pleasurable to walk around than I did downtown LA. You've got to see it for yourself.

Josiah: 8:39

And I think that's where it's helpful to move beyond just the headlines and to see for yourself, and that's why I appreciate us talking about the world of investment. I guess, maybe just on that theme, though, is like kind of moving beyond the headline into what actually happens. So when, in this scenario where you have a big reed, you know hands over the keys of a property, what happens?

Craig: 8:57

Well, the lender doesn't want to take it back first of all. Okay, now, typically there's going to be a Wall Street, a securitized loan, and the special servicer is going to get involved and they're going to start putting a program together to run the hotel. They've already put on a lock box, so all the money that's coming into the hotel is going to them. Will the flag remain? Good question. But they're going to bring in an outside receiver and a management company to run the hotel. They will typically hold it. When we had the financial meltdown, everybody thought there was going to be all these foreclosure acquisitions that you know. We're going to be out there and you're going to get these trophy assets for cents on the dollar. That didn't happen. It didn't materialize. So they're going to do everything they can to stabilize the hotel and get it running decently to good. Now it could be a case where you know the financial meltdown. We had one hotel read that tried to talk to the special servicers but they had a default on their loans. They bought a hotel in San Diego for $80 million, had a $60 million loan on it. They woke up one morning worth 40. How do you recover from that? That's $20 million. You're in the hole. All of the analysts across the board said that this company did the. This REIT did the thing by handing back these hotels and saved the stockholder value as a Republican traded REIT. So you've got to look at that.

Josiah: 10:29

Does it negatively affect guests at all, because you mentioned they'll figure out a way to keep it running. I'm curious, does? I don't know? It's more of like an investment thing. Does it? Do guests even notice?

Craig: 10:38

That's more of an investment thing and you try and keep it behind the scenes. It's like watching the sausage being made at a butcher shop. So you know now there was so much press about that. And then you also had all these stores and restaurants and everything else all closing and everybody piled on and started bagging on San Francisco. Okay, I'm going to be up there for a commercial lending conference and I'm going to be in a room with I don't know 17 to 20 lenders that are still making loans today on all the asset classes, and most of them are based up in the Bay Area. So it's like, okay, let's sit down and talk to them and see what they have to say, see where they're going, see what you know they're sniffing around and seeing how that they can still be productive and still get loans done, and I think that's a big part of it.

Josiah: 11:32

Well, let me ask you this, Craig - you see and participate in the industry on a lot of different levels. What will it take to make San Francisco and the Bay Area a more attractive place for investment? Because I think, as we've talked about, everybody wins when that happens the participants, money flows in, you can create things, benefits the community, benefits, the people visiting. So I'm curious what needs to happen to make it more attractive?

Craig: 11:58

Well, I think it's going to be a few things, and I don't think it's just limited to San Francisco. I think it's across the board and the nation is one. We have to get a handle on mental health in this country. We need to help people that have decided that they would rather sleep on a street corner than anything else, whether it's drug addiction, mental health, combination of the two, any number of things, and that's everywhere. It's unfortunate and this country's better than the other, but we disassembled mental health in this country quite a few decades ago and we're still paying the price for it, and it's escalated. So that needs to be one thing. The other thing is housing. Housing is a drag on the economy. You look at where prices are today and most people can't afford to buy a house or a condo or a loft in San Francisco, and I think the East Bay is getting priced out as well. Certainly, southern California, Los Angeles, Orange County, and a lot of San Diego Same thing. We've got to get a handle on that. You need that joining, that meeting of the minds and going hey, you know, we're adding a new hotel and there's a lot of tax revenue coming in that we don't have to split with the county or state. Okay, and we want that here. So, yeah, let's give them a hand. Let's, you know, get this open and built. Every city wants a four or five-star full-service hotel. That doesn't work in every city. Okay, I like select service because that helps spread some of the money out on the street. You're being a good neighbor. Okay, it's that restaurant next door because you know the only thing you're offering in select service is a free breakfast with way too many cereal selections. That nobody wants anyhow, but that's my opinion. But you've got to set this up and you've got to be able to. City, county, state needs to step up and help and they need to do it in a way where we're not being taxed on miles that we're driving and a few other things. I also think it starts out with a lot of transparency and accountability out of Sacramento and every city hall across the state and nation.