Sunstone Hotel Investors - Q2 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Sunstone Hotel Investors Q2 2023 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. I would now like to remind everyone that this conference is being recorded today, August 4, 2023, at 12:00 P.M. Eastern Time. I will now turn the presentation over to Mr. Aaron Reyes, Chief Financial Officer. Please go ahead, sir.

Aaron Reyes (CFO)

Thank you, operator. Good morning, everyone. Before we begin, I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties, including those described in our filings with the SEC, which could cause actual results to differ materially from those projected. We caution you to consider these factors in evaluating our forward-looking statements. We also note that this call may contain non-GAAP financial information, including adjusted EBITDAre, adjusted FFO, and property-level adjusted EBITDAre. We are providing this information as a supplement to information prepared in accordance with generally accepted accounting principles. Additional details on our Q2 results have been provided in our earnings release and supplemental, which are available on our website. With us on the call today are Bryan Giglia, Chief Executive Officer, Robert Springer, President and Chief Investment Officer, and Chris Ostapowicz, Chief Operating Officer.

Bryan will start us off with some commentary on our Q2 operations and recent trends. Afterward, Robert will discuss our capital investment activity, and finally, I will provide a summary of our current liquidity position, recap our Q2 earnings results, and provide some additional details on our outlook for the remainder of the year. After our remarks, the team will be available to answer your questions. With that, I would like to turn the call over to Bryan. Please go ahead.

Bryan Giglia (CEO)

Thank you, Aaron. Good morning, everyone. We are pleased that our Q2 adjusted EBITDA and adjusted FFO per share exceeded the high end of our guidance. Continued strong demand at our urban and convention hotels, combined with productivity gains, operating efficiencies, and expense controls led to increased hotel profitability. The Q2 saw a divergence in trends across our portfolio as urban and convention hotels generated strong growth, while our resorts saw demand moderate as the quarter progressed. These trends reinforce our focus on maintaining a balanced portfolio of high-quality convention, urban, and leisure hotels and resorts. Following a very strong RevPAR performance in the Q1, we anticipated that growth would normalize in the remaining quarters of the year as we lapped the impact of the Omicron variant.

While strong domestic leisure travel accounted for most of the industry growth coming out of the pandemic, during the Q2, demand increasingly shifted to corporate travel and group events. In Q2, our urban and convention hotels increased occupancy by 460 basis points and grew rate by 4.2% as compared to the Q2 of 2022, which contributed to robust year-over-year RevPAR growth of nearly 11%. Once again, San Francisco led the portfolio, growing RevPAR by over 32% on further occupancy gains and higher rates. While there is no shortage of negative press surrounding the San Francisco market, we remain encouraged by the hotel's ongoing recovery, and we continue to believe that the city is a desirable long-term market in which to own a well-located, fully renovated hotel.

During the quarter, our hotel ran nearly 11 points of higher occupancy as compared to its competitive set, as the property is able to capitalize on its more than 70,000 sq ft of meeting and event space to create its own in-house group compression and not have to rely solely on the convention center and citywide events. In addition, our fully renovated guest room product is allowing the hotel to drive higher rates and attract new and higher quality demand, which together with better occupancy, contributed to a 124% RevPAR index relative to the competitive set in the Q2. We also saw strong growth at our hotels in Portland, Boston, and Orlando, which all generated double-digit RevPAR growth in Q2. Hilton San Diego Bayfront had its best Q2 EBITDA performance on record.

The recent Comic-Con event in July was very strong, as the hotel remained nimble and was able to resell all rooms that were canceled related to the Hollywood strikes at average rates that were nearly twice as high. In total, room revenue was up 10% relative to the Comic-Con event last year, and our hotel led the competitive set over the multi-day event. As I noted earlier, the operating fundamentals at our resorts were less robust as domestic leisure destinations faced increased competition from U.S. travelers going abroad without offsetting benefit of inbound foreign visitation. This was particularly the case at our Florida coastal hotels, which were early beneficiaries of very strong pent-up leisure demand coming out of the pandemic, but have seen some normalization as travelers opted for other destinations and vacation options that had been limited in the last two years.

Despite this moderation, our two Florida resorts maintained average room rates that were 46% higher than the Q2 of 2019. We also saw softer leisure trends in Napa and Sonoma as the wine country continued to be impacted by unseasonably cool and wet weather and the surge in international travel. In Wailea, our hotel grew rate to another all-time Q2 record, beating the high water mark set last year and a staggering 53% increase as compared to 2019. Despite still garnering very strong rates, our resort portfolio underperformed our expectations, particularly in May and June, which contributed to nine points of lower RevPAR growth for these properties as compared to our forecast at the start of the quarter. While this trend continued into early July, we have seen some pickup in forward bookings over the last couple weeks, which is encouraging.

Overall, we think it is reasonable that this heightened preference by American vacationers for international travel will normalize as we move into next year, as much of the pent-up demand for trips abroad gets worked out this summer. This should also be bolstered by increasing levels of foreign visitation to the US, which continue to recover but remain well below pre-pandemic run rates. Overall, the combination of steady corporate and group demand and a slower leisure backdrop contributed to 280 basis points of occupancy growth across the portfolio in the Q2, and when combined with generally flat rates, drove total portfolio RevPAR growth of 3.6% as compared to the prior year.

While room revenue growth was below the low end of our expectations, we were pleased to see that out-of-room spend remained strong and came in above forecast, benefiting from continued increases in group activity and increased ancillary revenues. Banquet sales per group room was $230 in Q2, which was above 2019 on a comparable basis. Our urban hotels saw strong out-of-room spend with Boston Marriott Long Wharf, JW Marriott New Orleans, and The Bidwell Marriott Portland, all generating spend per group room above the Q2 of 2022 and 2019. Including the robust out-of-room spend, our portfolio generated an additional $146 of revenue per available room in the quarter for a total RevPAR of approximately $392, an increase of 5.4% from last year.

As the demand environment evolves, particularly at our resorts, we are working with our operators to drive efficiencies and mitigate costs where possible. Wage growth has continued to ease as some of the excess pressures come out of the labor market. Food and beverage costs also improved relative to the prior year, driven by a combination of easing inflation, menu optimization, and a higher mix of banquet business. As you have likely heard, the property insurance market for real estate of all types has been increasingly challenging in the recent years. Late in the Q2, we completed the annual renewal of our insurance program that covers most of our portfolio, and while our outcome was more favorable than what I have heard from many others, we were not immune to rising costs.

Despite the various cost pressures, our total portfolio generated an EBITDA margin of 32.3% in the Q2, which was only 100 basis points lower than a very strong Q2 margin performance in 2022. Our urban and convention portfolio grew margin by 10 basis points year-over-year, even with 80 basis points of margin headwind from the Renaissance D.C., which is in the final phases of its repositioning to the Westin D.C. Downtown. Turning to segmentation. Our portfolio generated 240,000 total group room nights in the quarter, and the group segment comprised roughly 44% of our total demand. Q2 group room night volume represents approximately 96% of comparable pre-pandemic amounts, with average rates 10% higher, leading to total comparable group room revenue that was 6% higher than the same quarter of 2019.

For the total portfolio, group room rates were up 3% year-over-year, with total room nights up 10%. Group production for all current and future periods in Q2 was 221,000 room nights, resulting in a 7% increase in group revenue production relative to last year. In terms of transient business, which accounted for 50% of our total room nights in the quarter, comparable rate came in at $324, or 20% higher than the pre-pandemic levels we saw in the same quarter in 2019. For the total portfolio, the transient rate was $345 and was down slightly to the prior year, driven by softening leisure demand.

Partially offsetting the decline in leisure volume were increases in both average rate and room nights for our corporate negotiated channel, which posted revenue growth of 10% versus last year. This is indicative of the ongoing recovery in business travel and is encouraging as it is the segment where we have the most opportunity to grow occupancy across the portfolio. While the Q2 RevPAR performance came in below expectations, we continue to see areas for optimism and expect full year earnings growth in 2023. The outlook that Aaron will discuss shortly assumes that the demand environment for leisure travel remains soft in the near term, and while we have seen some encouraging data points in recent transient bookings, it is too soon to tell if it is indicative of a resurgence.

We will continue to monitor these trends at our resorts. We expect that our well-balanced portfolio of urban and convention hotels will make up a larger contribution of our earnings in the coming quarters. Lead volumes and group production are strong. Group pace for the second half of the year is 6% higher than 2022, driven by increases in both room nights and average rates. The Renaissance D.C. is in the final stages of its transformation to the Westin D.C. Downtown, which will be completed and rebranded during the Q4 and contribute to further profitability growth later this year. Competition for international travel and inclement weather have combined to hamper the performance of both of our Wine Country resorts.

While the fundamental backdrop has not yet been conducive to demonstrate the full earnings power of these assets, these are world-class resorts, and we have conviction that our attractive basis in each will give us the ability to create value from these investments over time. We remain focused on building the group base at these resorts, which will ultimately lead to transient rate compression. Record outbound international travel and lagging inbound visitations is negatively impacting domestic summer travel, especially at high-end resorts like these, as well as other domestic luxury destinations. We are ensuring that our operators remain diligent in managing their operating models so that when the transient leisure demand resumes, these resorts will be able to maximize flow-through and profitability.

Our low leverage, well staggered debt maturities, and ample liquidity gives us the optionality to continue to pursue our strategic objectives of investing in our portfolio, recycling sales proceeds into new growth opportunities, and returning capital to our shareholders. We are working through the final steps in the planning for the Andaz Miami Beach transformation, and the model rooms have been completed. We will be sharing some exciting new details with you related to the project in the Q3. Robert will discuss some additional updates on the other investments we are making across the portfolio that should provide multiple layers of growth in the coming years. While the transaction environment remains challenging, we retain significant investment capacity to deploy when opportunities arise, and we are actively searching out ways to recycle capital.

We remain committed to returning capital to our shareholders. As you saw in our press release this morning, our board of directors has also increased our base quarterly dividend to better reflect the normalized taxable income our portfolio will produce over various cyclical periods. With that, I'll turn it over to Robert to give some additional thoughts on our renovation progress, as well as upcoming capital investments.

Robert Springer (President and Chief Investment Officer)

Thanks, Bryan. We started the year with several projects underway, and I am pleased to report that we have made substantial progress. The conversion of the Renaissance, Washington, D.C., to the Westin brand is in the final stages. The rooms are largely complete, and renovation work is now progressing in the lobby and fitness center, along with some exterior work. The hotel is on schedule to be relaunched as a flagship Westin property in October and will contribute to earnings growth in the Q4. Work is now also underway to convert the Renaissance in Long Beach to a Marriott. As we shared with you before, we expect a Marriott flag will enable the hotel to better compete for business, grow earnings, and ultimately increase the value of the asset.

The work will be substantially complete by the end of the year, with a plan to relaunch the hotel under the Marriott brand in March 2024. As Bryan noted earlier, we have finalized the construction details and are preparing to begin work at The Confidante as the resort begins its transformation to the Andaz Miami Beach. We will have additional details on the refined scope and timing later this quarter. While the transaction market remains challenging, recycling capital continues to be a primary component of our strategy as we seek to harvest gains and redeploy proceeds into new growth opportunities. We maintain considerable balance sheet capacity, which will allow us to take advantage of dislocation and opportunities that may arise as existing loans come due and as owners seek liquidity. With that, I'll turn it over to Aaron. Please go ahead.

Aaron Reyes (CFO)

Thanks, Robert. We continue to maintain a strong balance sheet. As of the end of the Q2, we had approximately $164 million of total cash and cash equivalents, including $56 million of restricted cash. We retain full capacity on our credit facility, which, together with cash on hand, equates to over $660 million of total liquidity. We have addressed all debt maturities through December 2024. As of the end of the Q2, our net debt and preferred equity to EBITDA stood at 3.6x, and our net debt to EBITDA was only 2.6x. Shifting to our financial results, the full details of which are provided in our earnings release and our supplemental....

Our quarterly profits, which surpassed our expectations despite softer revenue growth, reflect steady corporate and group demand with a moderation in domestic leisure travel. adjusted EBITDAre for the Q2 was $85 million, which was just above the high end of our guidance range, driven by stronger non-rooms revenue and better margin performance across our urban and convention hotels. We estimate that we incurred approximately $3 million of displaced EBITDA in the quarter, related to the renovation work at our hotel in Washington, D.C. adjusted FFO for the Q1 was $0.33 per diluted share, which was also just above the high end of our guidance range.

While the evolving demand backdrop makes forecasting incrementally more challenging, based on what we see today, we expect Q3 total portfolio RevPAR will range from a decline of 1% to an increase of 2% as compared to the Q3 of 2022. Based on this level of RevPAR, we estimate that Q3 adjusted EBITDAre will range from $57-$62 million, and our adjusted FFO per diluted share to range from $0.18-$0.21. Based on Q2 performance and our outlook for the Q3, we now estimate that full year RevPAR growth is likely to be near the low double-digit end of the range we shared with you on prior calls, which excludes our hotel in Miami that will soon be undergoing renovation.

Assuming this level of RevPAR growth, it could translate into a full year adjusted EBITDAre range of roughly $255-$265 million. Based on the current renovation timelines, we now anticipate that we will incur between $11 to $13 million of EBITDA displacement in 2023, with approximately $7 million of that total already incurred during the first half of the year, roughly $1 million expected in the Q3, and the balance in the Q4 as work ramps up at The Confidante in preparation for its conversion to Andaz Miami Beach.

Now, shifting to our return of capital, we repurchased a modest amount of additional stock in the quarter, bringing our year-to-date total to $21 million at an average price of $9.46 per share, a meaningful discount to consensus estimates of NAV and a compelling implied multiple on our earnings. In addition to the repurchase activity, our board has declared an increase in our base quarterly common dividend to $0.07 per share for the Q3, a 40% increase over the prior amount. While we continue to believe that our measured payout approach in the first three quarters of the year, combined with a catch-up dividend at year-end, is well suited to our dynamic sector, we believe this higher base dividend amount better accommodates our commitment to returning more capital to shareholders.

In addition to the common dividend, our board has also declared the routine distributions for our Series H and I preferred securities. With that, we can now open the call to questions. That we are able to speak with as many participants as possible, we ask that you please limit yourself to one question. Operator, please go ahead.

Operator (participant)

The floor is now open for your questions. To ask a question at this time, please press star one on your telephone keypad. If at any point you'd like to withdraw from the queue, please press star one again. You'll be provided the opportunity to ask one question. We'll now take a moment to compile our roster. Our first question comes from the line of Duane Pfennigwerth from Evercore. Please go ahead.

Duane Pfennigwerth (Senior Managing Director and Senior Equity Research Analyst)

Hey, thanks, and good morning. Just with respect to 2024, could you speak to the puts and takes, on earnings growth and, and maybe margins into next year as we think about these ROI projects, you know, assets that are ramping and, and some of the, displacement impact this year?

Bryan Giglia (CEO)

Sure. Morning, Duane. I'll start, and then I can, I'll let Aaron cover some of the displacement, puts and takes. When we, when we look at next year, first, from a, you know, from a group perspective, while we're not, we don't typically give group pace at this point, pace is positive for next year. That's something that will continue as we've seen in the Q2 and expect throughout the rest of the year, that those markets, the convention, the urban markets, we continue to, continue to be strong next year. When you look at the citywide calendars, you know, in, in 2024, D.C. is very strong, New Orleans is strong, San Diego is strong.

Then when you look at D.C. specifically, we are completing the renovation in the Q3 of this year, so there's some additional displacement that will happen during this quarter. Although, as we've said throughout the process, you know, because of the lack of availability in D.C., we've been pleasantly surprised with our ability to work around the displacement and work with groups to minimize that loss. So D.C. will start to ramp in the Q4. Now, from the group perspective, there's already quite a big group business on the books, and it's being sold as a Westin into next year. From a transient perspective, the Westin flag will go out in the Q4, and it'll start booking from there. So we have that, we have that ramping up.

Our expectations on San Francisco is that, while the market has its own challenges, we continue to utilize and take advantage of our meeting space and our ability to, to build on, you know, create group compression of our own and not have to rely on citywides. The main, the, the main renovation next year that will be happening will be in Miami, which demolition will start in the, the back half of this year. It will be under renovation for the majority of, of next year, looking to open up in the high season, you know, starting in, in, well, in December of next year. I'll let Aaron go through kind of the, EBITDA displacement put and takes for both time periods.

Aaron Reyes (CFO)

Sure. Just to add to what, to what Bryan commented on, as we noted earlier in the call, what we're expecting for this year is $11-$13 million of EBITDA displacement, and that's split roughly kind of 50/50 between the first part of the year related to the work in D.C., and then the back half of the year, primarily related to the work at the Andaz. As we think about as we just move from 2023 into 2024, I wouldn't expect much in terms of the way of earnings contribution on a full year basis from Andaz, just given the work that'll be happening in the back half, the first half of the year relative to the earnings that we'll generate once it's done. That'll be a net headwind from a displacement perspective.

The positive, I think that we'll have, will be the renovation work at Long Beach, that Robert had referred to, and that conversion will take place earlier in the year, so we should see some lift there. Then the primary driver will just be the Westin D.C. Downtown coming online as a fully flagship Westin, which should be, you know, a, a significant contributor for us.

Duane Pfennigwerth (Senior Managing Director and Senior Equity Research Analyst)

Okay. Thank you.

Bryan Giglia (CEO)

Thank you.

Operator (participant)

Our next question comes from the line of Chris Darling from Green Street. Please go ahead.

Chris Darling (Senior Analyst specializing in Lodging)

Thanks. Good morning. Going back to The Confidante-

Bryan Giglia (CEO)

Good morning.

Chris Darling (Senior Analyst specializing in Lodging)

Morning, guys. Bryan, going back to The Confidante, could you offer any updated thoughts on the return profile there, just given some of the recent trends we've seen in that market? I know you've spoken to conservative underwriting in the past, but it would be helpful to hear any updated perspective.

Bryan Giglia (CEO)

Sure. Yeah, so for, you know, it's numbers that everyone has, has seen, for last quarter and, and probably going into, into Q3 this year, too. The Miami market has, has definitely pulled back and has moderated, still, substantially higher than what it was in 2019, but a little lower than where it was in 2022. You know, quite frankly, we've seen that, and I think others have talked about it, too, in, in most of the higher-end leisure market, domestic leisure markets. You know, I, I won't be the first one to say this, but there's a lot more international travel happening than inbound international travel happening. We see that coming from the higher segments, and, and so the top destinations are definitely feeling some of that moderation, in Q2 and Q3.

Miami is, is absolutely not immune from that. When we go back to our investment here, you know, the, the, the game plan followed a lot of what we did in Wailea, and it's a. We have a, we have a asset in a fantastic location. You know, mid-beach has become a very high-end destination. Aman is under construction just a block down. You have the Faena, you have the EDITION, it is, it is definitely, the right, you know, zip code, much like Wailea was. We have an asset that has a fantastic footprint as far as the campus size and the ability to create a backyard destination. That's, that's a big positive. When we look at the opportunity here, the opportunity is to draft.

While 2023 is down in the market, 2022 finished substantially higher for that market than where we had underwritten. That way we can, you know, even with the pullback, the amount of room that we have is even more than we initially thought. That all bodes very well. What we're also doing with the property, and we're finishing up, you know, we finished the model room, backyard demolition will happen soon. We're working with some various partners that we'll be able to announce shortly. Sometime in the quarter, we'll be able to provide a full picture of, of what this asset is gonna look like and what the resort will look like going forward.

What we have, we think, is you know, an exceptional room product, a fantastic food and beverage environment, and a great pool experience. A couple of things we've done with the rooms, too, is that we're, we're making some modifications to make sure we have the right suite counts, to make sure that we have the right product offering for that market. While, you know, all leisure markets have had, you know, some big wins and some, some pullbacks, Miami is no different. Where we are, where we ended-- where the market ended last year and where we need to position this hotel, we, we feel better about it than we did when we, when we executed the transaction.

Operator (participant)

Understood. Thank you. Our next question comes from the line of Smedes Rose from Citigroup. Please go ahead.

Smedes Rose (Director and Senior Equity Research Analyst)

Hi, thanks. Good morning out there. I wanted to ask you, it looks like the pace of share repurchase slowed in the Q2, and I just wondering kind of how you were thinking about that going, going forward, or are you just kind of trying to preserve capital here with your upcoming CapEx projects, or any thoughts on that?

Bryan Giglia (CEO)

Yeah, I mean, I, I think when, when we look at, at share repurchase, we would look at return of capital to shareholders. You know, that's a combination of, of dividend and share repurchase, and we did, we did increase our dividend, our base dividend, to more accurately, address what our, our current structure is and what our current taxable income is to minimize the, the catch-up dividend as much as possible, knowing that that's a difficult thing to do in, in our space. So when we look at allocating capital going forward, it, it really is It's, it's a continued balance of what we've been doing.

It's, it's making sure that we have the right amount of capital for investing in the portfolio, future acquisitions, whether that comes from using balance sheet capacity or recycling capital, and then, and then repurchase. While, yes, it did slow a little bit, and sometimes you get into, you know, you get into blackout periods where you have to set certain parameters far in advance, you know, I think when you look back at 2022 and into 2023, we've been, for our market cap size, at least, one of the more aggressive, when it comes to share repurchase. We have a fantastic balance sheet. We have plenty of capacity. So, like you said, it really is just balancing everything.

You know, again, when our share price gets to a certain level, we definitely have the capacity to, to go ahead and, and buy back.

Smedes Rose (Director and Senior Equity Research Analyst)

Thanks. Could I just ask you on the Napa properties, you mentioned, you know, I know for a number of reasons, it's probably been underperforming your expectations. I mean, do you think, is it 2024, where you sort of start to realize better value there, or do you think it's more like 2025 for the managers to get, you know, the kind of group business that you were talking about on the books that would cause some compression on the transient side?

Bryan Giglia (CEO)

Yeah. And, and it's definitely later than we initially thought, and, and we're, you know... That's actually absolutely disappointing. When we look at both of the resorts, and they opened close to each other, you know, several months apart, but when they both opened up, they both had, you know, it was in 2022, and you had the pent-up domestic leisure demand that was really just through the roof. Both, both hotels out of the gate did very well from a leisure standpoint. As we talked about before, got a little bit overly confident in that leisure demand and didn't do a good job of putting on the group base. Last year, we corrected that and have the hotels focus more on, on group base going into this year.

Four Seasons actually has fantastic group base in Q3 of this year. So that, that has been fixed and will be fixed going forward. Now, with the strong group base, the leisure demand has, has fallen off for all the reasons that has been mentioned on-

Smedes Rose (Director and Senior Equity Research Analyst)

Mm-hmm

Bryan Giglia (CEO)

Several of the calls. So we haven't had the hotels firing on all cylinders yet. Usually, when you have a newly opened hotel, what you like to do is get the revenue up to where you want it to be, and then you go, and, and you work the, the cost model to make sure that the profitability is in there. Since we've seen the various components of the, of the revenue side just not working at the same time, we're now actively working with both of the management teams, with the highest levels of both of those organizations, working through fine-tuning that cost model. You know, Montage may be a little bit ahead of Four Seasons, where even in the Q2 where you saw revenues were kind of flat, you saw a little bit more profitability than the prior year.

You're starting to see the beginnings of that. Remember, these are luxury assets, it's very important that we balance the customer experience, the service levels with our, you know, desire to have the right profitability. We believe that there's plenty of opportunity here, right-sizing and working through the cost model, working through the different staffing and the way that things are done, where we can extract significant margin upside without impacting our guest experience. That's something that's underway now. What we will need is, we'll need the leisure side to come back, to reaccelerate. If, you know, we can get into that next year, we're working, the group base side is, is a continuation, and we'll continue to be, to be working through that. When the leisure comes back, we'll start to really see that.

Our expectation and, you know, time will tell, is that a lot of this international travel will get out of the system this year, and we should revert back to a more normalized, you know, leisure demand as we get into next year. Yes, you should start to see some additional earnings acceleration next year. Other things that are happening for the properties, you know, we've continued to make some, some enhancements at Montage, Four Seasons, our winery there, which is again, it's a resort inside of a winery, and with, with everything, the vineyards and, and all the components of a winery surrounding it, so it's a quite a unique experience. Our winery is doing very well. We're actually looking for, you know, our profitability this year.

Another thing for the Four Seasons, which is a huge win, is the restaurant, Auro, there, was recently awarded a Michelin star. Everything is starting to really, you know, as far as recognition from the winery, recognition from the restaurant, Four Seasons, obviously is, is a, is a well-regarded, you know, premier luxury operator. It has the components right now of everything kind of lined up. You know, we have the revenue, we have the, the expense plan, and when this ramps up, it's, it's gonna start putting off the, the...

Smedes Rose (Director and Senior Equity Research Analyst)

Okay. Thank you. I appreciate it.

Bryan Giglia (CEO)

Thanks, Chase.

Operator (participant)

Our next question comes from Chris Woronka from Deutsche Bank. Please go ahead.

Chris Woronka (Senior Equity Research Analyst)

Hey, good, good morning, guys. Morning. My, my question kind of relates to the Hyatt San Francisco. I know you provided some color in the prepared comments, but you know, obviously, it's an outlier relative to everything we see in San Francisco, and there's reasons for that, you, you mentioned. How, how sturdy is that demand? I mean, is that, is that a function of other things going on with other hotels in the market, or is this some kind of contract business? I'm just trying to get a sense for, you know, what, what that could look like later this year and even next year if the, you know, if the office vacancies continue to rise.

Bryan Giglia (CEO)

So San Francisco is, and what we're seeing in the market now, are the submarkets are performing differently. Being in Embarcadero, in the financial area, we rely and have for several years now, relied a lot less on the citywide compression and conventions. It would have to be a very large convention for it to really get out to us and impact us. So what the hotel is focused on is we have good meeting space. We have a lot of meeting space relative to the size of our hotel, and so to use that to go after groups that are, you know, 10 to 100 room nights is really the kind of the bread and butter, you know, 100 to 200.

Groups that, that need the space that, that, you know, would be a much smaller group somewhere else. So we're able to do that. We're able to then compress the transient demand, while the office vacancies are not where anyone would want them to be, they are. We are surrounded by office, and so there are companies that are, are back to work certain days. With our new rooms product that we did, and maybe we have some companies that are, you know, that were staying at a higher price point hotel previously, but we are able to capture good corporate business that we couldn't get before with the room product that we had. So that's what really the secret to the success for this hotel is now.

The transient demand is strong, is strong for the rest of the year. We, you know, we anticipate meaningful EBITDA growth, and, you know, EBITDA probably doubles this year over last year, but we're still we're down quite a bit from 2019. You know, to your question, is it a sustainable model that we have there? Yes, it is because it's, you know, is there some crew and some other things? Yes, there is, there is that in the hotel, but we do have, we do have a good, a good model, a good location, and in a market that's suffered and will, you know, certain segments of it and, and submarkets of it will continue to suffer. You know, some of the products getting a little worn down there.

We have a basically brand-new product that we're offering guests. The hotel is really well-positioned. Does that give it legs of growth for next year? It should have some growth. It should still continue to grow next year. What we'll need is we'll need to continue for the market to continue and to get more people into the city. The good news is, especially in our location, the city looks a lot better than it did previously. You know, look, we're optimistic. We think we have the right hotel in the right location, it's still a long road ahead for San Francisco.

Chris Woronka (Senior Equity Research Analyst)

Okay. Thanks, Bryan. Appreciate all the color.

Operator (participant)

Our next question comes from the line of Michael Bellisario from Baird. Please go ahead.

Michael Bellisario (Senior Research Analyst and Managing Director)

Thank you. Good morning, guys.

Bryan Giglia (CEO)

Good morning.

Michael Bellisario (Senior Research Analyst and Managing Director)

Could we go back you mentioned 9-point shortfall at your resorts in the quarter. A couple parts here. How much of that was occupancy? How much of that was rate? The pickup that you mentioned in forward bookings over the last couple weeks, was that broad-based, specific to any properties? What did the rate look like on those bookings? Thank you.

Bryan Giglia (CEO)

Okay. We'll start with the resorts in the quarter. Q2 was mainly, a good piece of it was, the majority of it was occupancy. ADR was, was down, but not, not as much as the occupancy. As we look in the Q3, and July specifically, we'll see some more or we'll see some more rate, deterioration.

Where we're seeing that is really, you know, it's the question of is, is, and I, I think it was asked on one of the calls yesterday, "Is, is this just demand, or is it demand or, and rates getting cut?" The answer is, it's a little bit of both, but on the rate side, what we're seeing is, of the leisure segments, it's the retail segment that was the weakest in Q2 and the weakest in Q3. Maybe just to simplify that retail segment, that's the brand.com customer. We think that that's the customer that is more likely the one taking the international trip now. So while that customer has gone away, you know, in the leisure segment, we're not seeing that in the BT or, or other segments.

If that customer's gone away for the short term, our expectation is that they come back. The, the occupancy, and rate mix, is more a function of the retail customer going away and more wholesale, more, more discounted channels, more OTA that you would have typically had. On the, on the, the BT and the, the transient pickup over the next, you know, those are bookings over the next 6 months, that's being heavily led by our, our urban assets. The, you know, San Francisco is a big piece of that. Portland has, has actually picked up, picked up some, Boston Long Wharf, even, even San Diego, where, you know, some of that is, you know, you'll have government or government-related, a lot of, a lot of defense contractors, aerospace, that sort of thing.

You know, Long Beach is another one, where we're seeing a lot of pickup on the government and contractor side.

Michael Bellisario (Senior Research Analyst and Managing Director)

Great. Thank you.

Bryan Giglia (CEO)

Thanks.

Operator (participant)

Our next question comes from Dori Kesten from Wells Fargo. Please go ahead.

Dori Kesten (Executive Director and Senior Equity Real Estate Analyst)

Hey, thanks. Good morning.

Bryan Giglia (CEO)

Good morning.

Dori Kesten (Executive Director and Senior Equity Real Estate Analyst)

I, I believe back in June, you mentioned the potential to increase, the total, total cost of the Andaz renovation. I think it was from, was it 60 to 70? Is that still being considered?

Bryan Giglia (CEO)

We are in our final stages of, of finalizing everything, and I used final twice there. What we're gonna do is sometime in the Q3, when really what's holding this up now is just finalizing our partnerships to announce, 'cause we wanna provide a complete picture. We will update both the costs, any scope changes, you know, where the final room count's gonna be, who the food and beverage operators are gonna be, and then provide some photos and, and the, you know, renderings of that. On any scope changes, we'll update our, our projections to include returns on those scope changes.

I'm kind of dancing around your question right now, and I will say that we will, we will have a more wholesome update during the quarter. That said, the construction costs have increased over that time period or over this time period, while shipping is really the only thing that has come down. Normal inflation in the expense side should be expected, but we'll provide a total view of everything. I think once everyone sees the opportunity, sees some of the, the, you know, the, the name brand recognition that we'll be able to bring to the Andaz, it'll be pretty exciting.

Dori Kesten (Executive Director and Senior Equity Real Estate Analyst)

Okay. Are you able to put a little finer point around what the potential displacement could be for next year for that project?

Bryan Giglia (CEO)

You know, I think if you look to what we said for this year, before we were able to get the timing and everything down, down, is, is that we said that we would be, you know, close to zero this year, and I think the hotel is going to put off about $4 million-$5 million of EBITDA. So, it did $12.5 million in 2022. So, you know, looking at 2023, the majority of your earnings comes in the, you know, Q1 or so of the year, and then the very end of the year. You know, we plan to be open for the end of the year, but it will probably be minimal earnings coming off that hotel next year.

Dori Kesten (Executive Director and Senior Equity Real Estate Analyst)

Sorry, the last part kind of broke up. You said, your earnings next year could be comparable to this year?

Bryan Giglia (CEO)

Minimal. It'll be, it'll be minimal earnings from the hotel-

Dori Kesten (Executive Director and Senior Equity Real Estate Analyst)

Okay.

Bryan Giglia (CEO)

next year.

Dori Kesten (Executive Director and Senior Equity Real Estate Analyst)

Okay. Then just last one. Based on what you all are working on today, would you, would you expect to be recycling capital by year-end?

Bryan Giglia (CEO)

We are hopeful to be able to recycle capital by year-end. You know, part of our, our plan is to be able to be active recyclers of our, of our real estate, and when we, we get to the point at which we're done with our investment life cycle of, of each hotel, it's time to move on to something new. You know, it's been challenging up to this point. Smaller deals, obviously, easier to be done than larger deals. We have recently seen, you know, several CMBS deals get done, so for large, for larger assets. Larger cash flowing assets are now at least financeable, and so that should help things move along. We are, we are absolutely endeavoring to be able to, you know, hopefully get some recycling done this year.

Dori Kesten (Executive Director and Senior Equity Real Estate Analyst)

Okay. Thank you.

Operator (participant)

Our next question comes from Bill Crow, from Raymond James. Please go ahead.

Bill Crow (Senior Research Analyst and Managing Director)

Hey, good morning, guys. Trying to make this quick. Good morning. I have three quick ones. One's a yes or no. We'll start with that one. Do you have any assets, and this is following up from Dory's question: Do you have any assets currently on the market for sale?

Bryan Giglia (CEO)

We have. And normally we don't talk about deals until they're done, but we, I will tell you, we always have at least one asset in some form of, either marketing, soft marketing, or in talks with others.

Bill Crow (Senior Research Analyst and Managing Director)

Okay. Appreciate that. Bryan, I guess when I looked at your results last night, I was surprised that the, the RevPAR miss relative to your guidance that was provided a month in, and I, I get that it's, it's resort driven. Was that a failure of kind of in the, in the quarter, for the quarter, demand to materialize? Was there cancellations in there? You know what? I'm just trying to figure out what the, what the miss was?

Bryan Giglia (CEO)

Cancellations are pretty static to where they were. They're up a little bit to 19, but that's more a function of D.C., where we have group contracts, and we're under renovation, so some of them, we are able to work it out with the groups, and some of them we're not. So I think we're probably from a total dollar amount, maybe up $800,000, $900,000 to where we were in 2019 in cancellations, but that's predominantly D.C. It, it, it's to your first point. It, it's a, you know, very short-term visibility that you have on transient demand. In certain markets, and Wailea was, was one of them, was, you know, we had shortfalls in Q1, then we opened up certain channels, and they filled. Q1 was, was fine.

It was great. When we got into, into, you know, Q2 and, and starting, you know, really kind of accelerating in, in June, in May and June, is that those bookings didn't... You know, were not happening like they happened in, in Q1. When we look at the different markets, and it tends to be the higher end and luxury, leisure, domestic markets, and when you go, you can look at our portfolio, you can look at others that have given numbers, you look at the STR data, it's, you know, it's the higher end markets. It's the Florida coastal, it's Southern California, Northern California, and Hawaii, domestic Hawaii, call it. I know Oahu has, has inbound from, from Japan that it, it's benefited from.

It was the, the typical pickup started to slow down, and that coincided with this imbalance between international outbounds and inbound travel.

Bill Crow (Senior Research Analyst and Managing Director)

Yeah. No, thank you for that, Bryan. That's the third question I wanted to ask, because it came up, I know, on post call, and I asked Jim a similar question, but we've been tracking this inbound-outbound differential for more than 1 year, and it's not getting much better. You made a comment, you hoped that this would kind of normalize by next year, you know, we had 3 years where people weren't able to travel internationally. I'm curious why it might normalize that quickly.

Bryan Giglia (CEO)

Well, we, we are seeing international airfare become very expensive. I just, there was a article out yesterday, too, showing that domestic airfare has come down a little bit. While, you know, it tends to be the more, you know, affluent traveler that's doing these type of trips, you know, the cost of that, that international ticket does weigh on, weigh on the overall cost. That in, in, you know, our, our European trips, something that people do every year or every couple years. You know, look, you're, you're absolutely right. It's, it's a, the, the time for visas and other things to get into this country has been difficult.

The inbounds, you know, Prior to the pandemic, we did about 10% international business, and it's kind of hard to calculate because, you know, our hotels may do 10%, but maybe the markets that we're in have compression from more that stay in other, other places. We're half of that now. You know, China is a piece of that, especially on the West Coast. European inbound is a, is a piece of that. I mean, even in, in Wailea, the, the biggest international is, is Canada, and we've seen a decline from that. You know, the airline fares are probably the one thing that gives us a lot of confidence that, that once because that's what we see. When we see the prices of flights to Hawaii go down, we see, we see demand go up.

And so-

Bill Crow (Senior Research Analyst and Managing Director)

Yep.

Bryan Giglia (CEO)

you know, we'll have to watch it.

Bill Crow (Senior Research Analyst and Managing Director)

No, I appreciate that. Thanks for the color, Bryan.

Bryan Giglia (CEO)

Yeah. Thanks, Bill.

Operator (participant)

Our final question comes from the line of Floris van Dijkum from Compass Point. Please go ahead.

Floris van Dijkum (Managing Director and Senior Equity Research Analyst)

Hey, thanks, guys. Encouraging progress in the wine country and San Francisco. My question has to do with the dividend. Again, you raised the dividend. What would the dividend have been raised to if you, if you did not have any tax loss carryforwards?

Bryan Giglia (CEO)

We're The dividend right now, that decision was independent of our tax loss carryforwards. We have substantial carryforwards, and our plan is to use those for our capital recycling to make it so, you know, we'll have, as we sell hotels, we'll have gains. You can always take care of that through a 1031 exchange, but that sometimes, you know, timing needs to be on your side for that. By keeping our NOLs to shield those gains, if we're unable to do a 1031, that allows us to be more efficient with recycling that capital.

Right now, what, what the increase today was, was when we came out of the pandemic and taxable income started to, to flow back in, we went back to our previous dividend, which was based off of a different portfolio, based off of a different capital structure, based off a different depreciation. All these factors are. We, we just kind of went back to what we were doing. As we look forward and wanting to maintain a dividend that can handle normal cyclical fluctuations, and minimize the amount of a catch-up dividend at the end of the year, this was a step, maybe a little overdue step that could have happened earlier this year, but this is a step that we needed to take.

We still anticipate, and we'll have an update next quarter, we still anticipate to have a catch-up dividend at the end of the year. This will not, Q3 and Q4 dividend will not take care of that full taxable income. We'll have more information on that, projections on that, and then views on the base dividend going forward, on our next call.

Floris van Dijkum (Managing Director and Senior Equity Research Analyst)

Thanks. Appreciate it.

Operator (participant)

I would now like to turn the call over to Bryan Giglia for closing remarks.

Bryan Giglia (CEO)

Well, thank you, everyone, and thank you for the interest in the company, and we look forward to meeting with many of you at upcoming conferences and investor meetings. Have a good day. Thank you.

Operator (participant)

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.