Pebblebrook Hotel Trust (PEB) Q1 2019 Earnings Call Transcript

Transcript

Speaker 0

Greetings and welcome to the Pebblebrook Hotel Trust First Quarter Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Raymond Martz, Chief Financial Officer.

Thank you, sir. You may begin.

Speaker 1

Thank you, Donna, and good morning, everyone. Welcome to our first quarter twenty nineteen earnings call and webcast. Joining me today is John Bortz, our Chairman and Chief Executive Officer. But before we start, a quick reminder that many of our comments today are considered forward looking statements under federal securities laws, and these statements are subject to numerous risks and uncertainties as described in our 10 ks for 2018 and our other SEC filings, and future results could differ materially from those implied by our comments. Forward looking statements that we make today are effective only as of today, April 2639, and we undertake no duty to update them later.

You can find our SEC reports and our earnings release, which contain reconciliations of the non GAAP financial measures we use on our website at pebblebrookhotels.com. Okay. So the 2018 started off well for us as we exceeded our outlook for same property total RevPAR, adjusted EBITDA and adjusted FFO. In addition to the $252,000,000 of property sales in February, we also executed a contract to sell the Hotel Onyx in Boston at an attractive price and multiple. And last night in our earnings release, we announced several operator and brand changes at our hotels.

So we've been busy since we last updated you just sixty days ago. In the first quarter, same property RevPAR increased 4.3% and same property total RevPAR increased 4.4%, which is above our outlook and driven by a strong growth in food and beverage revenue, which is up 5.3%. Our RevPAR increase was a result of a very healthy 5.3% increase in ADR with occupancy declining 100 basis points. Our best performing markets in the quarter as expected were our hotels in San Francisco, which generated a RevPAR increase of 23.7%. This was above the San Francisco urban RevPAR gain of 17.8%.

This growth was fueled by the more than 130% increase in convention center attendees in the quarter versus the prior year as well as continued strong corporate and leisure demand in the market, which created many compression nights for our hotels throughout the quarter. Key West and Naples, Florida also were strong markets for us during as our Southern Florida markets grew RevPAR 7.1% led by the marker Key West and Southernmost Key West. We continue to see a resurgence in leisure travelers returning to South Florida following the declines in demand that we experienced after Hurricane Irma in September 2017 and we expect this favorable trend to continue throughout 2019. Boston was another solid market for us in the first quarter producing a 7.7% RevPAR gain compared with a 1.7% RevPAR increase in the Boston CBD. This was driven by the Western Copley Boston, which is ramping up nicely following its comprehensive renovation in 2018 as well as Revere Boston Common, which also had a strong quarter as it continues to ramp up with some healthy share gains following its redevelopment in 2017.

Our underperforming markets were the ones we expected though they performed slightly worse than we thought. In addition to supply growth, Chicago also suffered from a weak convention calendar and a tough winter as the Chicago CBD RevPAR declined 11.4% with our Chicago hotels faring worse at down 16.5%. This was primarily due to the continued Marriott integration challenges at our West And Michigan Avenue where RevPAR declined 24% as our booking production unfortunately continues to be poor. Our hotel Chicago actually outperformed Chicago CBD as the hotel continues to gain share from its conversion to a Marriott Autograph. Portland was also a tough market as RevPAR was down 9.6% in the urban track with our hotels declining 10%.

West LA was another challenging market for us, again, primarily due to supply growth. West LA was down 3.6% and our hotels declined 5.1%. Our weaker market performance was largely due to the renovation at Mondrian and the negative impact from the dramatic decline in redemption rooms and revenue at our Meridian in Santa Monica due to the Marriott integration of its various loyalty programs. Overall for the quarter, transient revenue which made up about 72% of our teleportfolio room revenues increased 1.5% compared to the prior year. Transient ADR increased 3.8% for the quarter driven by strong increases in San Francisco and South Florida.

Group revenues increased 13% in the quarter with room nights increasing 3% and ADR increasing 9.7%. This was largely due to strong corporate group and convention related demand assisted greatly by San Francisco. Group room nights made up 27.3 of total room nights for the portfolio, up over 100 basis points from last year and group revenues represented 28.4% of total room revenues in the quarter, up two thirty seven basis points from last year. In terms of monthly RevPAR growth, we saw a 4.4% increase in January, a 9.9% increase in February due to a record convention calendar in San Francisco and the Super Bowl in Atlanta, which benefited our Intercontinental Hotel and Buckhead. March was much weaker than expected as RevPAR was flat.

We believe the softness in March is likely due to several factors, including an additional Sunday in March versus last year, the holiday shift and extension of spring breaks into late April, residue from the government shutdown which affected February and March, travel cancellations due to winter storms, as well as lower than expected income tax refunds, which seem to have impacted consumer spending throughout March. Leisure travel, as represented by weekends, was softer throughout the quarter versus business travel, which remained solid throughout the quarter. Although April RevPAR growth is forecasted to be the weakest month of the second quarter for us, primarily due to holiday shift, May and June booking pace are looking positive, but May expected to be the strongest month in the quarter for us, reversing the trends we saw in the industry and our portfolio during March and some of April. June is expected to be a solid month for us as well, but not as strong as May. For the remainder of the year, meaning quarters two through four, pace continues to be positive.

Group revenues are ahead by 1.8% with transient up 3.5% and total revenues ahead by 2.6% with 85% of it in rate. As a reminder, our Q1 RevPAR and hotel EBITDA results are same property for ownership period and include all the hotels we owned as of March 31. So we excluded Hotel Palomar, Washington DC and the Lays on Capitol Hill since we sold these hotels during the quarter. Our hotels generated $100,100,000 of same property hotel EBITDA for the quarter, which is $1,900,000 above the top end of our outlook and $3,400,000 above the midpoint. This was due to the healthy total revenue growth of 4.4% that I discussed earlier.

Same property total hotel EBITDA margin declined 45 basis points and would have

Speaker 2

been an increase of 24 basis points, but for the impact of the forecasted increases in real estate taxes from Proposition 13 related to the California hotels acquired last year in our corporate

Speaker 1

transaction. Moving down to the income statement, adjusted EBITDA was $90,500,000 which was $3,100,000 above the upper end of our Q1 outlook range. This was a result of the same property hotel EBITDA beat of $1,900,000 combined with $1,400,000 of G and A expense savings spread to our outlook. These savings in G and A are largely related to the timing of expenses, so these should not be viewed as savings for the year. Adjusted FFO was $60,700,000 or $0.46 per share, which exceeded the upper end of our outlook range by $05 per share.

This resulted from the hotel EBITDA beat of $0.15 per share, the timing of G and A expenses adding another $01 per share and a tax credit from our taxable REIT subsidiary, which is $03 above our outlook. This tax credit is largely due to timing, so we expect this to be reversed in future quarters. Compared to the prior year, FFO increased 31.3% to $60,700,000 but adjusted FFO per share declined 31.3% to $0.46 per share. This decline in adjusted FFO per share is largely due to the increase in diluted shares from 69,400,000.0 shares to 131,000,000 shares in the prior year period due to our corporate acquisition in November. On the disposition side, as you saw in our press release from last night, we executed an agreement to sell the Onyx Hotel in Boston for $58,300,000 which if completed would be at a 15.3 times EBITDA multiple and a 5.9% net operating income capitalization rate based on actual 2018 results, which is within our NAV range for the hotel and consistent with the values, multiples and cap rate in our outlook.

This sale is targeted to close by the end of the second quarter and we received a hard money deposit from the buyer securing the sale of the hotel. We continue to make progress marketing for sale additional hotels in our portfolio and remain confident that we will achieve the additional $290,000,000 of asset sales inclusive of the Onyx sale during the balance of 2019 and at the sales multiples and cap rates that we previously detailed in our 2019 outlook. At quarter end, our debt to EBITDA ratio as forecasted was at 4.7 times, our fixed charge coverage ratio was at 3.2 times, 60% of our debt is at fixed interest rates averaging 3.440% of our debt is at floating interest rates averaging 4.1%. And with that update, I would now like to turn the call over to John.

Speaker 2

Thanks, Ray. My focus today will be to inform you as to how we're doing with the integration, the strategic disposition plan and strategic redevelopment plan for the new Pebblebrook. As it relates to the people integration, as stated last quarter, we're complete. We believe it's gone extremely well, and we believe this year's outlook reflects the $18,000,000 plus of annualized savings in the G and A of the two companies. So we believe we successfully achieved what we estimated and promised related to corporate synergies, and that risk is off the table, if you will.

As Ray mentioned earlier, assuming the On X sale moves forward to completion with the current buyer, we will have sold $1,160,000,000 of properties, of which all but $30,000,000 come from the acquired portfolio. When we first executed the deal, we indicated that our goal was to sell between $600,000,000 and $1,000,000,000 of properties above and beyond the $715,000,000 related to the three pre committed hotels. We've sold $447,000,000 of property since then, assuming the On X sale closes, leaving us a relatively small amount of additional sales to meet the bottom end of our initial commitment, which we expect to do this year as evidenced by the $289,000,000 of additional sales contemplated by our current outlook. To date, and including the expected Onex sale, our $1,160,000,000 of sales have been achieved at 5.55% NOI cap rate, well within the NOI cap rate range of 5.25 to 5.75% that we estimated upfront and below the 5.9% NOI cap rate we calculate the acquisition was completed at, including all transaction costs. And in fact, if you exclude the grand, which came out of the PEP portfolio, our NOI cap rate on the remaining assets are at 5.4%.

Based on our strategic property review and current plan, we expect to sell an additional $350,000,000 or more of properties sometime next year following this year's activities. By the end of our disposition efforts, we believe we will have sold around $1,800,000,000 of properties, optimized our portfolio for growth and brought our debt to EBITDA ratio for leverage to a level that is at or below our targeted level of four to 4.25x. Given where we are today and what we have in the works related to sales, we believe we're close to completing this promised part of our overall strategic disposition plan and should be in a position to check this objective off in the next couple of quarters and completely eliminate this risk as well. In addition, we're almost complete with a plan for every hotel that we acquired. And yesterday, in our press release, we announced a number of operator and brand changes we've made or are in the process of making in the portfolio, which we believe will provide opportunities to create value over the long term.

In particular, the brand changes, both of which happened to occur last week, involve converting Hotel Colonnade Coral Gables from a tribute to a Marriott Autograph collection and following the completion of a full hotel renovation, converting Hotel Madera to the Hotel Zags Portland, the sixth hotel in our proprietary unofficial Z Collection brand and the first Z Hotel outside of San Francisco. Operator changes involve benchmark hotels and resorts, assuming management of Skamania Lodge on May 1, which we believe will allow us to create some meaningful sales and marketing benefits between this resort and our Chaminade Resort and Spa in Santa Cruz, which is also managed by Benchmark. Noble House Hotels and Resorts being installed to operate L'Oubert's Del Mar, which fits in well with Noble House's extensive luxury resort experience and their numerous resorts elsewhere in San Diego and along the California coastline, including our Hilton Resort and Spa in Mission Bay. Noble House also manages our La Playa Beach Resort and Club in Naples and both the Argonaut and Hotel Zoe in San Francisco. This change will occur on May 1.

Also in Mission Bay, Davidson Hotels, through their lifestyle division called Pivot, will be assuming management on May 1 of Paradise Point Resort and Spa. We'll be working closely with Davidson on our plans for the redevelopment, upscaling and reconcepting of this incredible property that has such huge upside potential given its unique attributes and terrific location. In San Francisco, we'll be making two additional operator changes. First, in mid May, Access Hotels will become the manager of the Marker San Francisco. Access currently manages Hotel Spero, which is just one block from the marker and offers us significant operational and sales synergies by combining the management of both hotels with a single operator.

In addition, Access, who is actively involved in the successful redevelopment and repositioning of Hotel Sparrow, will also be involved with us in the repositioning, renovation and transformation of the marker into an unofficial Z Collection hotel by the 2021. Second, next week, Schulte Hospitality Group will be assuming management of Villa Florence. Schulte will be actively involved with us as we plan the improvements to this extremely well located hotel just down the street from the Sir Francis Drake. We've been working with all of our current and future operators very closely for some time now to provide for smooth transitions. And while we know there will be some short term disruption to performance due to these changes, we believe we've properly accounted for the impact in our outlook and believe all of these changes will be far, far less impactful than brand integrations.

Most, if not all of our existing executive management teams will remain in place at these hotels, which will minimize the disruption and ease the transition to the new operators. More importantly, we believe that all of these changes will ultimately improve performance at each of these hotels, and many of them were done to maximize performance due to both operational synergies as well as following redevelopments and repositionings that are planned at many of the hotels. Additional brand and operator changes are planned in the portfolio as we phase them in over the course of the year, and we'll inform you of them over the next few quarters. We also have a number of redevelopments and renovations planned throughout the portfolio over the next thirty months or so. The ones for this year have been announced and provided in our earnings release.

As we finalize plans for additional projects, some of which will involve operator and brand changes, we'll provide them to you. For now, you should expect that total annual capital investment, including regular capital maintenance in the portfolio in 2020 and 2021 will be similar in total to this year, and roughly 50% to 60% of the capital will represent renovations and redevelopments where we would expect to earn substantial returns on our invested dollars, similar to our redevelopment and transformational projects at Pebblebrook over the last nine years. Speaking of redevelopments and renovations, our properties renovated last year are doing very well so far in 2019. The 11 projects last year included the second phase of the redevelopment and upgrading of La Playa, a complete rooms renovation at Hotel Zelos, a rooms renovation at Sir Francis Drake, the second and last phase of the renovation and conversion of Hotel Madera to the Hotel Zags Portland the full redevelopment and transformation of the Serrano in San Francisco into Hotel Sparrow the rooms renovations at Weston Copley and Paradise Point and the complete renovations of Chamberlain, West Hollywood, Montrose, West Hollywood, Harbor Court, San Francisco and the Heathman Hotel in Portland.

In the first quarter, EBITDA was up a combined $7,100,000 versus last year, and this is even with an increase in real estate taxes of roughly $600,000 in the quarter at the five California hotels acquired last year due to automatic reassessments from Proposition 13. These renovated and redeveloped properties are on track to achieve an improvement of $13,000,000 in EBITDA for the year. Our twenty seventeen redevelopments are also doing well so far in 2019. Revere Boston Common, Palomar Beverly Hills and Hotel Zoe Fisherman's Wharf have all gained significant RevPAR share and improved EBITDA by a combined $600,000 even with the challenging West LA market and seasonally slow Boston market in the first quarter. We expect EBITDA at these twenty seventeen redeveloped hotels to increase by roughly $1,000,000 for the full year 2019.

Ongoing ramp up of EBITDA at these redevelopments over the next few years should continue to provide a fruitful organic tailwind to our operating performance. In addition, the projects this year, next year and in 2021 should continue to provide us with a pipeline of significant performance improvement and value creation that is similar to the projects we completed throughout Pebblebrook's first nine years of acquisitions and redevelopments. I wanted to also briefly discuss an additional benefit from the combination of the two companies' portfolios that we did not anticipate or underwrite. I'm specifically referring to the benefits of scale overall as well as scale in our major markets. Based upon discussions we've already had with many of our vendor partners, we believe there's an opportunity to reduce the cost of many of our products and services on a portfolio wide basis over the next twenty months or so and deliver an annual run rate of savings of $10,000,000 or more, which would mean value creation of $150,000,000 or so at a 15 EBITDA multiple.

This would represent about a 1% reduction of our total hotel portfolio wide expenses and all else being equal, improve EBITDA margins by about 60 basis points. We have a team of people focused on these efforts, and we should begin to reap some of these benefits next quarter and ramp to a full run rate of savings by the end of next year. We're equally excited about the informational benefits that we believe we and our hotel operating teams are gaining from having many more properties in most of our major markets. We believe this constant and detailed information sharing between properties in the same market, which we're providing through detailed daily reports that we've created, should allow us to improve pricing behavior and ultimately improve RevPAR share in markets where we have significant numbers of properties, including San Francisco, West L. A, Portland, San Diego, Boston and Washington, D.

C. Finally, there are a number of operational synergies at the property level that we believe we will achieve through local consolidation of operations in close proximity to each other, which are managed or will be managed by the same operator. Similar to what we've achieved at our three Z hotels around Union Square that Viceroy Hotels operates for us, our two hotels in Seattle that Kimpton manages for us, and the two hotels that we're about to put together in Union Square

Speaker 3

with

Speaker 2

access at both the Marker and at Spero. While cost benefits may be limited to several $100,000 per property that we pod together, we also think it will help attract higher caliber executive leaders at our hotels due to the additional responsibilities and overall compensation that we can provide them with multi property oversight. Coupled with the benefit of being the largest lifestyle oriented hotel owner in The United States, we believe over time, we'll be able to improve the overall caliber of the senior leaders at our hotels, which should lead to outperformance versus other competitors in our markets. I hope you can tell that we're very excited about the many benefits of the corporate acquisition we've just completed late last year and the huge opportunity we expect from the new, larger, even more efficient Pebblebrook. And we also hope that it's clear to you that we continue to work hard to accomplish the objectives we laid out when we first described our strategic plans, achieving our financial objectives while at the same time reducing the risk that resulted, albeit on a short term basis, from the combination of the two companies.

That wraps up our remarks. We'd now be happy to answer any questions you may have. Donna, you may proceed with the Q and A.

Speaker 0

Thank you. The floor is now open for questions. Our first question is coming from Anthony Powell of Barclays. Please proceed with your question.

Speaker 4

Hello. Good morning, everyone.

Speaker 2

Good Good morning.

Speaker 4

Good morning. Just a follow-up question on the cost savings you mentioned. What is your what is the RevPAR you need right now to breakeven on margins? And where can that go over the next few years as you benefit from some of these scale related cost savings you mentioned?

Speaker 2

Well, I think as it relates to the scale benefits, our what we indicated is we think it's about a 60 basis point overall opportunity for the portfolio, assuming we achieve $10,000,000 of savings. So that's above and beyond anything that we forecasted that we've included in our outlook for this year. And obviously, don't have an outlook for next year. I think that the first quarter is a good indication overall that if you take out the impact that we're going to have this year from Prop 13 reassessments, we probably need to be in the 3% range for RevPAR and total RevPAR. And to the extent that we can drive other revenues higher, while that does increase our expense rate and one of the reasons our expense rate is higher than it has been historically is because when you have a 5.3% growth in your food and beverage, as an example, you have a lot our margins in food and beverage are obviously a lot lower.

And so what we're focused on is while that may hurt our expense growth rate and even our margins, it does increase our EBITDA per key, which is what our ultimate focus is. So we do think being able to drive Food and Beverage and other revenues higher, while that may not increase the margins per se, it will increase the EBITDA per key.

Speaker 1

And Anthony, just as a reminder, the Prop 13 impact, the twenty nineteen margins this year is about 60 basis points. So after this year, but as we get to 2020, those property taxes will increase at the CPI, the kind of 2% level. So those this year, it's a headwind to us, going forward, they'll be growing less than what we see property taxes at other non California locations.

Speaker 4

Got it. Thanks. And you talked about some the softness in March that the industry saw. Could you maybe talk about how maybe forward looking metrics like group production or even things like food and beverage and AB spend at groups that were already in hotels? How did those track in March?

And did you see any kind of other softness or weakening in any other kind of metrics in March or April relative to your expectations?

Speaker 2

But how much cushion do you want in that number just given all the moving parts? And then as far as the dividend philosophy goes, I know different management teams think about it differently in in terms of what is sacrosanct or not. And then obviously, there are REIT requirements that go along with that. So just how do we think about the moving pieces in Pebblebrook's dividend payout philosophy from here?

Speaker 2

So our philosophy on dividend a company is that dividend follows operating cash flow. And so I think on an operating cash flow basis, if you assume a 4% reserve against revenues for sort of regular capital maintenance within the overall portfolio. I think we run around 70% or low 70s in CAD. So you're looking at a 1.4 to 1.5 coverage over the common dividend as a result of that. We're obviously very comfortable at that level.

So the way we look at it is we're not getting to the same level that you are when you say 80%. We view the capital investments within the portfolio, which have returns related to them no differently than we would view an acquisition, if you will. So we look at that and say that's eliminating the coverage for our dividend. That's going to primarily be covered by free cash flow after the regular capital maintenance within the portfolio. So we're very comfortable with the dividend.

Obviously, at a minimum, it needs to cover taxable income. And with sales. It's a complicated situation, but our objective is if we can, I think we can for the most part avoid any additional dividend, special dividends that would have to be paid out?

Speaker 0

Our next question is coming from Michael Bellisario of Robert W. Baird.

Speaker 7

John, can you maybe give us an update on kind of how you're thinking about balancing buybacks and leverage today just in the context of a large NAV discount versus your internal estimate?

Speaker 2

Sure. So our priority is to do what we said we were going to do when we made the acquisition late last year, which is bring our leverage level down from the mid-5s to our target in the low-4s. And that would continue to be a priority from a timing basis. So we're going to continue to use sale proceeds to reduce debt until we get down to that level. And then to the extent that we generate additional proceeds from additional sales and or we see that that's committed, meaning it may can always happen well before we actually disclose a sale, we could at that point and might at that point use those proceeds to buy back our stock if there continues to be a significant discount between our NAV and where the stock trades in the market.

Speaker 7

Got you. That makes sense. Then just maybe a follow-up on that. Kind of in terms of incremental asset sales beyond the placeholders that you guys have in guidance for this year, kind of what are you seeing on the transaction front today that may or may not cause you to potentially sell more assets or accelerate the asset sales process?

Speaker 2

Yes. So the acceleration of what we've talked about for next year, is $350,000,000 plus, those are assets everything in the program to date is identified internally. And so we made decisions based upon maximizing our long term growth potential and value creation opportunities with every asset in the portfolio. And so the additional dollars next year, because there's some things we need to do related to those assets, are not likely to get accelerated into this year. We could, on the other hand, make decisions to accelerate additional and make additional asset sales similar to what we did three years ago in 2016 to the extent that the discount to NAV remains significant.

And so that's something we'll look at over the course of the year. We like to think it's going to narrow as we achieve our objectives and we deliver what we've said we're going to deliver, and we begin to minimize the number of moving parts within the company. But the investment community will speak on their own and will pay attention and make a decision that we think ultimately is going to create the most value for the shareholders.

Speaker 7

That's helpful. Thank you.

Speaker 0

Thank you. Our next question is coming from Wes Golladay of RBC Capital Markets. Please proceed with your question.

Speaker 8

Hey, good morning guys. Can you comment on the level of RevPAR disruption you have this year for all the changes at the hotels? And you mentioned a similar amount of spend for next year. Would you expect the disruption to be comparable?

Speaker 2

Yes. So as it relates to the disruption from renovations, I think our estimate this year is 60 basis points. It's a little over $8,000,000 of EBITDA in terms of how that flows through. We think that will be similar, Wes. Again, we're a long way from refining the exact scope and timing on every project for the next two years, but we have some general parameters.

And we're certainly going to try to do our best to manage to a similar level of disruption based upon the timing of when we do these projects. As it relates to the cushion for the operator changes, I can't give you a specific number for that. In retrospect, we'll be able to tell you what we think the impact was based upon looking at share and where we might have had specific problems knowing that it might have affected bookings or overall business levels. But in advance, we're basically estimating by the cushion that we're providing between what we think the assets would do and what they are likely to get impacted by. So And timing matters.

These are spread out over the course of the year. And the estimate for disruption for operator and brand changes is for the whole year built into our full year outlook. So some of it involves changes that are going to get made later in the year.

Speaker 8

Okay. And then can you expand upon what happened at the MRIdian? You mentioned something about the loyalty program change. Is that a onetime thing at Yeah, the

Speaker 2

so basically what happened, and we've seen this, everybody who owns Marriott and Starwood properties has seen changes in their redemption, in the behavior of the customer in terms of redemption behavior and use at their properties. And it varies from almost insignificant to very significant. And so what's happened is, as you've combined a program, your Starwood customers basically went from Starwood properties to a portfolio of opportunity for use of redemptions that include Marriott and Ritz properties. So Santa Monica is a good example where it was our highest redemption property. We were running pre integration, which started in August as related to the loyalty programs, we were running mid-20s in terms of level of redemptions compared to our total occupancy in the hotel.

That's a very high level, obviously. It was the only Starwood property in the Santa Monica market. When they combined, and there are other Marriott properties in the market, and the way they assigned how many points you'd have to use between all the different properties, Meridian had the biggest impact of any property in our portfolio. The redemptions went from 25% down to the low to mid single digits. So basically, we lost 20% of our occupancy because of the combination of the loyalty programs.

And that's a large amount to replace on a short term basis. So we've been working hard ourselves and with Marriott to mitigate that, to drive replacement business into the hotel. But it's been a significant impact. And we don't know whether 5% is gonna be the long term run rate, or whether that'll rise a bit as they even out some of the redemption point requirements for a guest. But for now, we have to assume that that's a new long term level.

And we have to replace that business with other business.

Speaker 8

Okay. So hopefully you can devalue the currency. That's it for me. Thank you.

Speaker 9

Okay.

Speaker 0

Thank you. Our next question is coming from Shaun Kelley of Bank of America. Please go ahead.

Speaker 10

Hi guys, good morning. I think most of the ground has been covered here, but I just sort of one follow-up on the like larger scale benefits that you kind of outlined. Ray, I apologize if I missed it, but what was sort of the timing that you guys were thinking about? I assume this type of initiative will take some time to kind of get going. But what would be a reasonable ballpark?

Or over what time period would something like this take to roll out?

Speaker 1

We're estimating over the next twenty months or so.

Speaker 10

Twenty? Twenty?

Speaker 1

Months.

Speaker 2

Yes. So we expect to get to the $10,000,000 plus run rate of savings by the end of next year.

Speaker 10

Great. And then the only other question I have was just I think, John you called out supply in a handful of markets. I mean we've known about Portland for a while, LA is another one. Any sign of sort of, I guess, you guys are looking out at pipeline or particularly CBD level statistics in your specific markets. How is that supply outlook trending as we look out twelve and twenty four months?

Is there any kind of light at the end of the tunnel or some of these places remaining elevated and still managing to squeeze whatever select service and all kinds of things? Or is it getting tougher to see that in some of the markets you operate in?

Speaker 2

I think for the most part, what we're seeing and keep in mind, we're right, we're primarily the major urban markets. What we're seeing is that with the rise in the dramatic rise in development costs without an equivalent rise in operating performance that the development yields have come way down, which means for someone to develop, they either need lower cost of capital or they need more equity capital or both. And so what we're finding is for developers, it's taking a lot longer to find the capital stack if they want to proceed and if they can convince their capital to proceed at these lower return levels. And so starts are really declining as compared to deliveries, which means total rooms under construction are coming down in the urban markets. They're actually increasing in the suburban and secondary markets, which I guess is naturally what happens with capital availability in a cycle.

So when we look out at our portfolio on a weighted average basis, because they bounce around from year to year, we're looking at around three or just over 3% supply growth for 'nineteen, a similar number for 'twenty, and then a more meaningful drop down into the low 2s for 2021. And that would represent what I just said, which is fewer starts, longer delivery times, which is originally we thought 2020 would be that first down year. But because we've had deliveries stretch out, we actually had a decline in what we estimated in 2018. And we've had a bit of a decline in what we expect to be delivered in 2019 now as these delivery schedules stretch out. And that's why 2020 now is similar to 2019.

Speaker 1

And Sean, just to add to that, bank financing for new construction is also becoming more and more difficult. If you look at take the average bank and they start looking out to 2021, 2023 for these construction loans, that's pretty risky, especially where we are in the cycle. So that's also causing a hedge about capital for new development.

Speaker 2

And I think what sometimes gets lost is, I mean, we've been seeing in the major markets probably, I'd say on average, close to a 10% increase in development costs on an annual basis over the last three years. And so you take a market like San Francisco, we just heard a month or two ago, development, somebody's working on the development of a select service hotel in a tertiary part of the urban market in San Francisco, and they're looking at $600,000 a key, including land. So the numbers are getting up pretty high. West LA, Sunset Strip, you're looking at $1,000,000 plus a key for development in that market, given the challenges of construction in that market. So we do think that's helping to slow down construction starts.

And frankly, we're a bit amazed in markets like some markets like New York, where new developments continue despite fairly rapidly declining bottom lines over the last few years.

Speaker 10

Thank you very much. Appreciate all the detail and color.

Speaker 2

Sure.

Speaker 0

Thank you. Our next question is coming from Bill Crow of Raymond James. Please go ahead with your question.

Speaker 11

Hey, good morning, John, thanks for taking the lead off slot here in earnings. Couple of questions for you. Marriott announced the completion of the negotiations with Expedia. I'm just wondering if they've shared those results with the owners. And if so, do you have a sense of any benefits that may accrue to your portfolio?

Speaker 2

Yeah, I mean they have shared the detail with the ownership community. I would say they did a very good job. They've improved flexibility and terms. And there's a slight improvement in the cost. So that would be the way I would categorize it.

Beyond that, I don't think it would be appropriate to share any further.

But help us think about what your portfolio faces in 2020 from a comp perspective.

Speaker 2

Yes, I think a few things I would say. And here's the challenge is that the only real information is the information on convention bookings, right? We don't have information on corporate transient bookings, and for the most part, in house group that wouldn't be booked yet for 2020 unless you're a really large hotel. So I think when it comes down and you look at the convention data, 2020 sets up as a better year overall for the major markets. Markets like

Speaker 0

San

Speaker 2

Diego, Chicago, Boston, DC are all much better in 2020 based upon what we see now in the convention calendars. Portland, much better. We think LA is flattish. New York City is not relevant. Philly's flat to slightly better, coming off a record year this year for convention bookings.

Atlanta will be a little bit weaker because of the lack of Super Bowl. Miami will be better, or South Florida partly because of Super Bowl in Miami next year. So the industry overall sets up better. San Francisco, I guess the way I would look at this year is this year is much more representative of the run rate in the city, albeit probably slightly elevated on a convention basis. And yes, clearly the growth percentages are as a result of coming off a year where the convention center was still under renovation and expansion.

But the run rate is much more representative of the market, the strength of the underlying economy locally. So we haven't done work yet on how each of the days stack up versus this year. Frankly, we're not through enough of this year to be able to have a base for comparison that's accurate. But as we get through the year, we get into the summer, we can begin to look at next year as we start to prepare for budgets for next year in terms of how San Francisco shapes up. They're almost at 1,000,000 rooms on the books, which would be the second highest ever.

They're already at a level that's the second highest ever in terms of rooms on the books. So we think San Francisco will be a good year next year.

Speaker 11

So we shouldn't take this year's up 24% 1Q and anticipate that it's going to be down 15% year? I mean, that's the wrong conclusion, sounds like.

Speaker 2

Correct.

Speaker 11

Okay. That's it for me. I appreciate it, John.

Speaker 2

Thanks,

Speaker 0

Thank Our next question is coming from Stephen Grambling of Goldman Sachs. Please proceed with your question.

Speaker 12

Hey, good morning. As it relates to some of the benefits from scale and perhaps as a follow-up to the question on OTA costs, can you provide a little more color on your overall distribution costs and mix of distribution channels now and how you might expect those to evolve?

Speaker 2

Yeah, so our transient business runs in the low 30s. 31%, 32% of our transient comes through OTAs. That's all of them. And so I think our as we look at the non major brand properties in the portfolio, I think we run about 400 basis points higher on a commission basis than what we average on the brand levels. And the one thing I would caution you about, the commission agreements with every organization are different.

It's not just one number. It's what's important to the company and the properties in their portfolio. So some of the agreements are they have different commissions on weekday versus weekend. They have different commissions for shoulder days. They have different commission rates for package business versus direct business.

Sure.

Speaker 0

Thank you. Our next question is coming from Jim Sullivan of BTIG. Please proceed with your

Speaker 9

John, I just have a couple of questions on some individual assets that you've talked about or listed in the on your strategic plan update in the release. You noted the the the change of management at Skamania to benchmark, which as you note has been managing Chaminade for a long time. Both of those assets have a significant amount of land around them. And I know that that land provides kind of recreational amenities, which is part the attraction of both of those properties. But is there any scope to increase room count at either of those assets or facilities in terms of meeting space or what have you that could be important material changes for those two assets?

Speaker 2

Yes, good question, Jim. We are working on we're at very early stages for master plans for both properties to utilize all the excess land. It is quite substantial and in fact, we probably use it a lot more at Skamania, though not all of it, than we do at Chaminade where really very little of the land has been utilized for recreational activities. So I'll give you what we've done. Part of what you asked, we have started and are in the process.

We've added four tree houses at Skamania. We added a zip line through the trees. We've added an aerial adventure park in the trees. We've added, of all things axe throwing at Skamania. And so we were thinking of an investor outing there.

Hey, thanks, Donna. Thanks, everybody, for participating. We got a lot to do, so we got to get back to work. And we know you all have a lot to do, too. But thanks for spending time with us, and we look forward to updating you over the next quarter and with our earnings release ninety days from now.

Have a good one.

Speaker 0

Ladies and gentlemen, thank you for your participation. This concludes today's conference. You may disconnect your lines at this time, and have a wonderful day.

Pebblebrook Hotel Trust - Earnings Call - Q1 2019

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