Hold a hotel through a soft cycle or sell into the first good year

Sell. The reasoning has nothing to do with the submarket and everything to do with the fact that the two things named here carry very different levels of uncertainty. Right now there is a clean, sellable story that only exists for a limited window. PIP done, one stabilized year, no near term capital. That combination is the most marketable a hotel ever is. In three years it becomes a five year old renovation, a soft goods refresh coming into view, and a franchise agreement that is closer to whatever the brand wants next time. The story degrades on a schedule you can already see. The hold case asks you to be right about demand and cap rates and the operator holding margin for three more years. That is three bets to win where the exit is one. Across the deals people say they regret, an unusual number are cases where a clean exit was available and someone waited for a slightly better one.

Question rather than a vote. When you say mid-1.6x net to you, is that after the sponsor's promote? And does path two model a refinance at any point, or is it just hold the fixed debt and collect?

@ryanmck27 that's the right question and I'd bet the answer changes the whole thing.

@carlos_nunez, I run fast deals with thin margins, so I lean toward taking the money every time. But the arithmetic here is annualized. 1.6x in year three is roughly 17% a year. To beat that by holding to year six you need the exit to land somewhere near 2.2x or 2.3x, and that's before you account for the distributions you'd get along the way, which lower the bar some.

So the hold case isn't just do things get better. It's do things get better enough to earn the extra three years of cycle exposure on a hotel in a mixed economy, with one asset and no diversification. That's a big ask on a 132 key select service in a secondary market.

Also, the debt being fixed for four years and the hold being three years means you're selling with about a year of term left, or you're selling with a loan a buyer can't assume, or you're eating a prepayment cost. Ask which. I've been surprised by that one before.

I don't have a vote in me but I want to understand something. Why would a buyer care whether the renovation was one year ago or four? Doesn't the income statement say the same thing either way?

@nataliehsu the income statement isn't the only thing a hotel buyer prices. Two other things move with the age of the renovation.

First, capital timing. Hotel rooms wear out. Furniture, fixtures and equipment, usually shortened to FF&E, gets replaced on a cycle, soft goods like carpet and case goods on a longer one, and franchise agreements typically require the owner to fund a reserve toward that and to complete a property improvement plan, a PIP, at set points. A buyer looking at a hotel renovated last year sees several years before they write a large capital check. A buyer looking at the same hotel four years later prices in that check, and that shows up as a lower offer.

Second, the trailing twelve months of operating results. A hotel that just came out of renovation has rooms out of service and disrupted operations in its recent history, which drags the trailing numbers down. Once there's a full clean year, the trailing figure reflects the asset running normally. That's the window @carlos_nunez is describing.

So the same income statement can be worth different amounts depending on where the asset sits in its capital cycle and what a buyer expects to spend after closing.

On the hold-or-sell question itself, that turns on assumptions about travel demand, the capital-markets environment for hospitality, and the specific loan terms, none of which anyone here can settle. The loan terms in particular should be confirmed in writing with the lender, since assumability and prepayment differ deal to deal.

Hold, and I'll be the minority.

Everybody arguing sell is treating the current cap rate as the reliable number and demand as the risky one. I'd reverse that. Hospitality pricing moves with capital appetite, and capital appetite for hotels has been rotating in. If that rotation continues, the exit gets better. If it reverses, you sell into a thinner bid and the clean story doesn't save you as much as people think.

Meanwhile the operating side is the part you can actually see. You know the operator, you know the submarket, you've got a full year of results, and the debt is fixed at a rate the sponsor says they can't replace. Fixed debt through a soft patch is worth something real.

I hold land for long stretches so I'm temperamentally the hold vote on everything. But @joe_delgado5's annualized point is the strongest thing said against me and I don't have a clean answer to it.

Renovation side, and I'll back @diane_kowalski halfway then leave him.

The FF&E cycle argument is stronger than the sell camp is giving it credit for. You just did the hard capital and the disruption is behind you. The next four years are the cheapest years this asset will ever have, in the sense that you're spending reserve money rather than PIP money.

But that cuts both ways on the exit. Those cheap years are also exactly what a buyer is paying for today, and you only get paid for them once. Sell now and the buyer pays for four clean years. Hold three and you've consumed three of them yourself and you're selling one clean year plus a refresh coming.

So I'd sell, and my reason is that the value of the completed PIP is at its maximum the moment it's finished and stabilized, and it only goes down from there. @carlos_nunez, ask the sponsor what the soft goods refresh estimate is in year six and whether it's in the hold model. On the deals I've priced that number comes in bigger than the reserve balance about as often as not.

Take a 132 key select service hotel in a secondary market, bought in a down window, PIP done last year, finally running at plan, RevPAR up meaningfully year over year and GOP margin back to roughly 40 percent. The plan was a five year hold with a stabilized sale in year four or five, and the sponsor is in year three. Three more years of a single hotel in a mixed economy is three more years of not knowing what's coming, and a mid-1.6x in year three is a real outcome that could be redeployed into something less exposed. The stronger case leans toward selling. @omar_haddad's point about only getting paid once for the clean years tends to be the one that settles it.