Increased resort occupancy and charges, pushed largely by a strong citywide conference schedule, had made San Francisco a goal for resort traders seeking to purchase right into a high-barrier-to-entry market.
However extra not too long ago, a mix of upper value of capital, decrease general demand, a large bid-ask hole on pricing and distressed resorts within the information has traders taking a step again, at the least in the interim.
Pebblebrook Lodge Belief Chairman and CEO Jon Bortz has each a long-term outlook on the well being of the San Francisco resort market and clear eyes on its present challenges.
San Francisco has been a market of curiosity for Bortz for many years, from his time main actual property funding belief LaSalle Lodge Properties by means of his present function at Pebblebrook, which owns eight resorts within the metropolis.
Pebblebrook acquired its first San Francisco property in June 2010, the Sir Francis Drake Lodge, now the Beacon Grand, for $90 million. It was a long-term maintain for the REIT, which bought it in early 2021 for $157.6 million of internet proceeds.
“We had a view that San Francisco was going to enter a powerful progress part pushed by these artistic innovations in know-how and the way that know-how could be used,” he stated, including it was additionally a time when individuals had been drawn to cities for the eating places, museum, retail and tradition.
Like many different resort REITs, Pebblebrook at the moment sees higher makes use of for its capital doing issues apart from shopping for resorts. Nevertheless, whereas Pebblebrook isn’t within the place to purchase in San Francisco, Bortz stated that’s the place he would make investments.
“If it was me and my private cash and I used to be investing in resorts and I had a five- to 10-year horizon, I’d be shopping for in San Francisco,” he stated.
Not all potential traders agree with him, and far of that has to do with unfavourable perceptions of the town, pushed partly by latest information headlines.
In June, resort actual property funding belief Park Motels & Resorts acknowledged it ended funds towards a $725 million non-recourse mortgage it had for the 1,921-key Hilton San Francisco Union Sq. and the 1,024-key Parc 55 San Francisco. The 4.11% rate of interest mortgage is scheduled to mature in November. Park stated it meant to work in good religion with its mortgage’s servicer to find out a path ahead, “which is anticipated to lead to final elimination of those resorts from its portfolio.”
Park President and CEO Thomas Baltimore Jr. stated within the information launch that it was in shareholders’ greatest curiosity for the corporate to materially cut back its publicity to the San Francisco market.
“Now greater than ever, we consider San Francisco’s path to restoration stays clouded and elongated by main challenges — each outdated and new: record-high workplace emptiness; considerations over road circumstances; decrease return to workplace than peer cities; and a weaker-than-expected citywide conference calendar by means of 2027 that may negatively affect enterprise and leisure demand and can doubtless considerably cut back compression within the metropolis for the foreseeable future,” he stated. “Sadly, the continued burden on our working outcomes and steadiness sheet is simply too important to warrant persevering with to subsidize and personal these belongings.”
Within the firm’s second-quarter earnings name in early August, Baltimore anticipated the San Francisco market to recuperate, not in a single to 3 years as beforehand thought, however in 5 to seven.
“It is a market that solely has 32,000 rooms, so it can come again,” he stated. “We’ll comply with the job progress. We’ll comply with the alternatives and the place we will generate the returns. So, we definitely would not rule out San Francisco.”
The 2 Park resorts collectively comprise roughly 3,000 rooms available in the market, stated Michael Bellisario, director of fairness analysis and senior analyst at Baird. Group enterprise is vitally essential to fill these resorts. The opposite concern is each require capital expenditure tasks within the close to future, and that’s on high of the upcoming mortgage maturity and have to refinance at a better rate of interest.
“It is an financial determination for them,” Bellisario stated.
Park continues to be negotiating with its lender because the keys haven’t been handed again but, nevertheless it’s a matter of how a lot that mortgage must be paid again, what refinancing would value and the way far again it must be rolled, he stated. That math simply doesn’t pencil relative to the alternate options of shopping for again inventory, reinvesting in different properties, potential acquisitions and different debt repayments.
“It isn’t nearly San Francisco,” Bellisario stated. “It’s about group, these resorts’ CapEx wants after which all of the issues they may very well be doing inside their portfolio and on the capital allocation entrance as effectively.”
What helps Park on this state of affairs is that the mortgage for the 2 resorts is a business mortgage-back safety, Bellisario stated. Stopping service on the mortgage doesn’t threat the corporate. It’s not financial institution debt or fairness pledges. The collateral is the resorts. If the mortgage was secured by fairness within the firm, Park could be caught with the resorts and wouldn’t have this optionality.
“The worst-case situation, and possibly it’s an excessively simplistic approach to consider it, is that it is advisable save the corporate, so you narrow off an arm otherwise you minimize off a hand to save lots of the physique, so to talk,” he stated. “It’s laborious to inform right now, however possibly giving again the keys is definitely addition by subtraction.”
CoStar information reveals there have been six San Francisco resort transactions for the reason that begin of the yr, with the costliest deal reaching $65 million for the 134-key Huntington Lodge in Nob Hill. There have been 16 transactions in 2022, topping out at $271 million for the 336-room Ritz-Carlton San Francisco as a part of the Watermark Lodging Belief portfolio deal.
California-focused resort dealer Atlas Hospitality Group has lots of shoppers within the San Francisco Bay Space, and lots of of them usually are not seeking to purchase now, Atlas President Alan Reay stated. Costs usually are not at a degree that’s engaging sufficient to make up for the danger, and so they don’t count on issues to show round in 12 to 24 months.
Town of San Francisco has excessive obstacles to entry, and it’s troublesome to construct something new there, he stated. From an investor’s standpoint, that’s a fascinating trait, significantly when paired with current properties that may be acquired at costs under substitute value.
“Nicely, you may positively purchase belongings at under substitute value,” he stated. “The large query is, how lengthy do it’s a must to carry them?”
Carrying resorts with hundreds of rooms available in the market can strike a blow to money circulate, and that’s dissuading lots of traders. The resorts extra engaging to patrons now are smaller, with 100 to 200 rooms.
To show across the offers surroundings, there must be a change in how the town is coping with crime and homelessness, Reay stated. Enchancment there’ll assist deliver conventions again to the town and enterprise again to the downtown space, he stated.
“With out that getting cleaned up, you are not going to have lots of investor curiosity till costs hit what’s perceived as all-time low,” he stated.
Some traders are fascinated about shopping for resorts to transform them to housing, Reay stated. There are incentives for cities equivalent to San Francisco to be extra open with guidelines and laws to create extra reasonably priced housing.
Lodge house owners who aren’t pressured to promote or refinance by their monetary circumstances received’t, he stated. They know they’ll doubtless climate the storm, however additionally they don’t need to promote at costs under the place they worth their properties. Consumers, likewise, are ready for extra favorable pricing.
“That sums up the customer and vendor disconnect,” he stated. “Sellers need costs that had been 2021, ’22, and patrons are saying, ‘Yeah, OK, that’s gone.’”
When Bortz was CEO of actual property funding belief LaSalle Lodge Properties from 1998 to 2009, the REIT checked out a number of resorts in San Francisco however by no means acquired one as a result of the expansion alternatives and pricing weren’t proper.
Circumstances had been totally different in 2010 when Pebblebrook acquired the then-Sir Francis Drake Lodge. The resort was a horny funding on the time, Bortz stated. When Pebblebrook purchased it, the resort generated income of about $40 million yearly, a part of which got here from a Starbucks lease. It had enormous working leverage, although, and the workforce noticed the potential available in the market.
Granted, on the time, condo rents in San Francisco had been decrease, however the metropolis was nonetheless among the many costlier U.S. markets to stay in, he stated. What Bortz and his workforce noticed in San Francisco was the return that may come from the expansion of the know-how and life sciences sectors.
“All of it needed to do with this unimaginable migration again into the town and the expansion of latest companies within the metropolis,” he stated. “One of many issues we all the time discovered interesting about San Francisco was the quantity of enterprise capital that received invested in companies within the Bay Space.”
It’s additionally one of many issues that Bortz nonetheless finds engaging concerning the market. That’s why he thinks the town will recuperate, simply because it has performed in prior downturns, he stated. The quantity of capital that goes into new companies within the San Francisco space is about 50% to 60% of the overall funding within the U.S.
The tradition within the metropolis can be a draw, he stated. It’s OK if individuals fail as a result of they’ll simply strive once more and experiment. In different cities, it’s a catastrophe when persons are laid off. In San Francisco, layoffs result in a wave of latest companies being created. The most recent is the surge in synthetic intelligence know-how. Whereas it alone received’t be the savior of San Francisco, it’s indicative of the town’s increase/bust cycle.
Pebblebrook at the moment owns eight resorts in San Francisco, with properties in enterprise districts and vacationer areas, together with the 1 Lodge San Francisco that opened in June 2022 following a repositioning from the Lodge Vitale. Through the years, Pebblebrook has bought off a few of its San Francisco resorts with out buying extra, however that’s not indicative of the corporate’s emotions concerning the metropolis, Bortz stated.
When Pebblebrook acquired LaSalle in 2018 in a deal valued at $5.2 billion, Pebblebrook greater than doubled its resort portfolio to 66 resorts. It instantly started refining its portfolio, promoting 5 resorts, together with the Park Central San Francisco, for a complete of $820.8 million in closing the LaSalle deal. It continued a strategic disposition plan over the next years, promoting off a number of San Francisco properties amongst others.
The deal gave Pebblebrook an oversize publicity to the San Francisco market, making up roughly 1 / 4 of its earnings earlier than curiosity, taxes, depreciation and amortization, Bortz stated. Over time, the corporate made choices to cut back its publicity to primarily city markets and discover a higher steadiness between leisure and enterprise demand.
The REIT isn’t fascinated about shopping for one other resort in San Francisco, or another metropolis, proper now, Bortz stated. For the time being, given market circumstances and the corporate’s inventory worth, acquisitions are off the desk when there are higher makes use of for the corporate’s capital, equivalent to renovation tasks and inventory buybacks.
“After we take a look at values in comparison with risk-adjusted returns, and we take a look at our distinctive alternative to promote belongings and purchase our inventory again at an enormous low cost, it is inconceivable to justify any acquisitions, whether or not they’re in cities, whether or not they’re in San Francisco or whether or not, frankly, they’re resorts,” he stated.
San Francisco is the punching bag of America now for its progressive politics, and doubtless appropriately so, Bortz stated. Town tried issues out that didn’t work, so now it has to repair it. The politics and insurance policies are altering. Town has a good distance nonetheless to go to deal with crime, psychological well being considerations and homelessness, nevertheless it has additionally come a good distance. On a latest journey to the town, he stated he noticed progress made with components of the town that look cleaner and safer than they did earlier than the pandemic.
San Francisco has nice fundamentals and an unimaginable financial base, Bortz stated. It has funding in know-how, AI, bioscience and different industries together with robust instructional establishments.
“It’s the heart of innovation on the earth, so how can one come to a conclusion that that is not going to recuperate?” he requested.
