Alan Reay, President of Atlas Hospitality Group, speaks with Robert Braun, senior member of JMBM’s Global Hospitality Group® at JMBM’s 2016 Meet the Money® – the national hotel finance and investment conference. They discuss the California hotel market including sales and purchases, pricing, RevPAR, financing, and the impact of the Marriott/Starwood merger and Airbnb.

A transcript follows the video. See other videos in this series on the Jeffer Mangels YouTube channel.

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Bob Braun: I’m with Alan Reay of Atlas Hospitality. He’s the foremost hotel broker in California, I’d say. At least that’s what I tell my clients, and I’ve always been proved right. Alan, thanks very much for coming and talking to us today. I think you have your pulse on the market, certainly here in California, more than possibly anyone else. What do you see in the hotel market today? What kind of trends do you see?

Alan Reay: During the first quarter we’ve definitely seen a big drop off in sales in California. In the U.S., down 52%; in California, down 35%; that really has nothing to do with the economic fundamentals, because RevPARs are still increasing, profits are up and a lot of the numbers are positive throughout California. It has been a fundamental shift from a buyer’s sentiment in terms of how they’re looking at deals and how they’re pricing them. We had a lot of turmoil in the public markets, as you know, in the first few months of 2016, and a lot of REITs have pulled out of the market, and a lot of lenders have pulled out of the market. So that’s created a disconnect between what buyers and sellers expectations are on pricing, which in turn has created a big drop in hotel sales volume.

Bob Braun: Now do you think this creates an opportunity for people? Or is the lack of lending and the lack of interest something that’s just going to continue through the rest of the year?

Alan Reay: I think it’s going to create some very good opportunities. For people that have to sell, they’re going to have to reprice their assets in today’s market. And what we’re seeing is an increase in cap rates and, obviously, more money down on the larger transactions. So if you don’t have to sell in today’s market then you’re not going to sell – a bit similar to what we saw in 2009. Last year we saw almost 400 sales; in 2009 it was less than seventy. When we have a disconnect like this, either sellers have to reprice their properties or we’re not going to see transactions.

Bob Braun: You talked about a drop off. Was this something consistent in every segment of the market? Or are there still some parts of the market that are stronger, more significant than others?

Alan Reay: There’s no question that the huge drop off has been in the bigger transactions – $20 million dollars, plus. There are a number of reasons for that. One is, as we said earlier – REITs. Their stock prices have plummeted and a lot of publicly traded companies are now trading at above 8 to 9 caps. So assets that they were buying in San Francisco and L.A. at 6 cap – they can no longer afford. So that’s what’s happening on the buy side. On the lending side, a lot of lenders are basically bucked up with hotel loans. So they’re not looking to finance any additional properties, or they’re being very selective. But in the $10 million dollar and below, or the $20 million dollar and below, we’re still seeing a lot of local lenders that are out there. We have a lot of 1031 exchange buyers and SBA financing.

Bob Braun: Really, so SBA financing is getting active again?

Alan Reay: Very active, yes.

Bob Braun: That’s very interesting. Where do you think we are in the hotel cycle – whether you talk about it in terms of innings or periods or quarters or whatever – I guess we’ll have to go with baseball.

Alan Reay: Well, being from England then baseball’s not good for me. Maybe cricket.

Bob Braun: And by the way I hope you’re a Leicester fan…

Alan Reay: I became a Leicester fan! For a team to go from a thousand-to-one longshot and win the premiership is a pretty amazing feat.

Last year, in terms of my presentation, I looked at which year were we in, and 2014 almost matched identically to 2006 in number of transactions, median price per room, dollar volume and everything else. This time last year, the first quarter of 2015 versus the first quarter of 2007 – exactly the same number of decline in assets in terms of dollar volume and number of transactions. So that would lead us to believe that 2015 was going most closely resemble 2007 and 2016 is going to be like 2008.

The only difference in 2015 is we had a record volume of transactions, just under $10 billion dollars’ worth of hotels traded in California – by far a record by any stretch of the imagination. The number of transactions and the median price per room in California is now over $100,000 dollars per room. So those were all record prices. As we go into 2016, I think it is close to 2008, which would put us at a decline in values, or flattening out in 2017, 2018.

Bob Braun: I think the common wisdom is there are some areas which are more or less exempt from the downturn. Do you feel that there are any? Like San Francisco or other areas that are going to hold value better than others in California?

Alan Reay: There’s no question, when you have areas that have huge barriers to entry. So any of those markets like San Francisco – which is very difficult to build in, west Los Angeles, anywhere up and down the coast – those are all tough areas. Areas that there aren’t huge barriers to entry like the Inland Empire, Sacramento, Kern County, Bakersfield, Fresno – those are areas that where you will see a lot of development. But I don’t think that you’re able to have the same control over prices in those areas as you do in the prime markets.

Bob Braun: So, what would be a reasonable strategy for someone? If one of my clients says they want to get involved in the business, that they’re looking to be spending a $100,000 to $150,000 a key and they’re looking to spend somewhere between $15 million and $20 million on a property. What kind of advice would you give them? Where would you steer them?

Alan Reay: Well if they’re currently not in the hotel business, then –

Bob Braun: No, say they’re all virgins at this point in time.

Alan Reay: So, someone asked me once what’s the most important thing to look for when you’re buying a hotel – and it’s management. So it really doesn’t matter what price you pay for that hotel; if you’re not going to be able to manage it well – either by yourself or a professional management company – then you shouldn’t get into that business. You have to understand it is very management-intensive.

I would speak to a client and first and foremost find why a hotel versus an apartment, or retail. Understand what their desires are and what cap rate they’re looking for, what kind of return they’re looking for, and then focus in on where they are located and what market did they want to have a hotel in. If they’re located in Los Angeles, does it make sense to be buying something, you know, in Eureka or some of those markets? Did they want to be able to go see the asset and touch and feel it?

So once you get through all of those questions, and understand what their desires are, what their return is looking for. If they’re saying they want to be San Francisco but they want to buy a 10 cap then obviously we’re not going to find that. If you are going to be in San Francisco you’re still going to be paying probably a 6 or a 7 cap. But as long as they’re okay with that relatively low return in the early years and good appreciation, then that’s what I would be showing them.

Bob Braun: What do you think of the upcoming merger of the Starwood/Marriott – the Marwood or Starriott, whatever we decide to call them? Does that have any impact on you, or on what your buyers, what your clients might be doing?

Alan Reay: Yeah, I think that one of the benefits of that is the unbranded hotel. Because a lot of people, both from a buying standpoint and a lending standpoint, want to be associated with the major brands whether that’s Marriott, Starwood, Hilton. And I think that Marriott right now, even before the Starwood merger, has 13 brands. So if you’re buying into a Marriott and you have no area of protection and someone can build another Marriott product – even though it’s a different hotel next door – the argument is that that is not going to be competition for you, that they’re going after a different clientele. I think when you have that many brands, it’s a little bit difficult to say that they’re not merging.

Bob Braun: Yeah, I think there’s always been some overlap. I mean, it’s hard to say how much different a Courtyard is from a standard Marriott in a lot of places.

Alan Reay: Yeah, I think that if you’re always going to stay at a Marriott Hotel or a Starwood Hotel because you want those loyalty points, then that’s great. But personally, I like the boutique brands, I like the independent brands, as long as they’ve got good reviews on Trip Advisor. I think the internet has been a good at leveling the playing field because people can do their own research, as opposed to going into a market and not knowing what kind of hotel that was.

Bob Braun: And taking the brand just because that’s probably the best indication of what it might be.

Alan Reay: Yes.

Bob Braun: Just a couple of last questions. Another disrupter, that we all talk about and don’t really know what to do with, is Airbnb. Are people considering that? Does that impact the market, as far as you can see?

Alan Reay: Well, it’s hard to say that it has impacted the markets because for all of the markets that we track in California, the RevPARs have increased. So the question is, would they have increased even more if Airbnb had not been out there? I’ve talked to a lot of people, people that come to the ALIS Conference have tried Airbnb, and I think that it doesn’t work if you’re out on business travel or a business trip. I think it works in a resort area. If you have a family or a group of friends that are going to go to – and I spoke to someone on this recently – Colorado Springs. They looked at the resort hotel in Colorado Springs and for those room rates for 4 or 5 rooms, they were able to get a much better deal renting a very large estate home and having all the family stay there. So I think that that’s where the impact is.

But I was at a conference last week, and I heard an interesting statistic that the three major hotel groups control around 2 million rooms. Airbnb right now is over 2 million in terms of available product on their site. So I think for people to say that it has little to no impact as Airbnb – what Chip Conley says about the studies that Smith Travel Research have done in New York – I’m not too sure I believe that. So yes, it’s definitely going to have an impact.

Bob Braun: Okay, so we always ask everyone – come the 2017 Meet the Money, what do you think we’re going to be talking about then?

Alan Reay: That’s a very good question. I think it’s going to be financing. Well, obviously – “Meet the Money.” It’s going to be what’s happening with all of the CMBS debt that’s coming due in 2016 and 2017, and who are the new lenders? Who are filling this gap, because right now I’m hearing at this conference so many deals are falling out because people are not either able to get financing or they’re certainly not able to get financing at the rates that they expected to get when they put the deal under contract 60-90 days ago. So, again, two things have to happen there. Prices have to adjust down or you’re not going to see deals trade. And I think that that’s just a short-lived phenomenon. I think we’re advising our clients that if you want to sell, you want to try to get ahead of this curve because we’ve got a tremendous amount of inventory that’s hit the market. And it’s sitting there.

Bob Braun: And the sellers can be competing with the people refinancing.

Alan Reay: That’s correct.

Bob Braun: And there is going to be more stuff on the table because people won’t be able to refinance.

Alan Reay: And more importantly, the buyers, unlike the REITs that are using other people’s money – it’s their own money. They don’t necessarily need to buy. So unless they get their price, then they’re not closing the deal.

Bob Braun: Alan – I really appreciate your taking the time out. Look forward to seeing you again soon.

Alan Reay: You’re very welcome, thank you Bob.