LODGING brings you the second installment of our three-part Ownership Series, providing owner perspectives on various hot topics and industry trends. We speak with Kunal Dave of Laxmi Hotels Group on his approach to each stage of the conversion process. The third article will focus on development and guest service trends in the leisure market.
Conversions are a popular option among developers today, and for Kunal Dave, president of Charlotte, North Carolina-based Laxmi Hotels Group, LLC, they are his “bread and butter.” “I started my career with conversions, and I’m still sticking with it,” asserted Dave, whose company owns approximately 90 properties, most of which are midscale, limited-service conversions of about 60 to 200 keys.
That specialization has decided advantages given current market conditions. Limited-service properties typically are less affected by the lingering labor shortage, and conversions avoid or reduce certain development costs of new builds. “Land pricing and construction costs have risen so much, making conversions more viable in today’s environment,” Dave observed. “So, if you are building a property, it may take you three years before you start seeing cash flow, versus if you can buy a property at X amount and rehab and brand it, you can generally start making a profit much sooner. It makes much more sense for a lot of developers.”
But capitalizing on conversion opportunities takes astuteness in many areas, including researching the property’s market; working with brokers, lenders, and brand representatives; and project management during the conversion.
Dave cited the abundance of market data available today, compared to when he started in the industry. “We used to go and count cars in the [property’s] parking lot in the nighttime,” he quipped. “But nowadays, STR’s STAR report lays out the market performance and makes it so easy for us. And if the market is healthy enough, then I’m fine, I can [buy a property] anywhere. So, for example if I’m buying a closed-down property or a property that is underperforming, but I see the STAR report says the market is healthy, I can figure out that if put X amount of money into the rehab and convert to brand Y, I can take my expected profit to Z. It’s much easier nowadays to calculate what works and what doesn’t.”
Building Broker Relationships
Finding viable conversion opportunities is greatly facilitated by broker relationships, and the basis of a successful partnership is mutual confidence. The buyer must trust in the broker as an advisor, and the broker must trust in the buyer’s commitment. “They want to make sure that a buyer will perform and is not just a ‘tire kicker’ who will tie up the property for 30, 45, or 60 days of due diligence and then walk away,” Dave explained. “You can do that once if something does not genuinely pan out. But our success rate of closing is 90 percent to 99 percent, and the fact that once we commit to a transaction, we will almost always take it to the finish line is huge for the seller and the broker.” That reputation as a serious buyer carries weight in the marketplace.
As the financing challenge for both new builds and conversions has increased over the last 12 months, adopting the right loan strategy is critical, and a developer must carefully weigh the respective advantages/disadvantages of conventional, CMBS (commercial mortgage-backed securities), and SBA (Small Business Administration) loans. Conventional loans, for example, have lower interest rates but require a higher down payment, and that down payment has increased. “We used to put down between 20 percent and 25 percent, but now we are seeing lenders require between a 40 percent to 45 percent down payment,” Dave noted. “If you’re trying to save on the down payment and go the SBA route, then your rates are higher, between 9.5 percent and 10 percent.”
But even the lower interest rates that come with a conventional loan have risen, so Dave suggested opting for floating rates instead of fixed rates when possible. “I don’t see the rates that we saw 24 months ago or even 18 months ago, and according to more and more bankers that I talk to, the higher rates are going to be the norm for some time,” Dave said. “So, we have decided that we are not sitting on the sideline. We’re moving forward with our current projects, because whether we pay this rate today or pay it eight months from now, rates are not going to drop tremendously.”
Hiring the Right Team
Seeing the conversion project through to completion, on budget and on time, begins with selecting the right partners, including the procurement firm and the general contractor. “If you don’t do your homework and you pick a bad general contractor or procurement group, it will delay your project a lot, and it will start costing you a lot of money,” Dave warned. “So, I highly recommend securing the right partners to take your project to the finish line.”
Closely monitoring their work helps to confirm their pay is justified, especially when it comes to the general contractor. “Every Friday or every two weeks, they will be needing money, and if you start advancing it without checking they have performed the work for the period, the budgeted money for the project may be gone when only 50 percent of the work is completed, for example,” he said.
Another key team member is the brand itself, which “can help you get to the finish line if something goes wrong,” Dave pointed out. Choice Hotels International, for example, provides step-by-step expert guidance through the conversion process.
And brands have been paving the way to successful conversion projects well before the renovation starts, by providing well thought-out prototypes and preferred vendors. “The beauty is that every brand has come up with their own property schemes, so our life [as developers] becomes very easy,” he noted. “For example, you may have three schemes to pick from, and every element is cookie cutter. And the brands have done a good amount of homework in screening their own vendors.” So, while developers must deal with a challenging financing environment to make their project pencil out, if they have the right brand partner, they can look forward to a clearcut and well-supported process to bring their converted hotel to market.