Risk, renovation, recovery factored into the “buy” decision for new owners Rockbridge, Aparium Hotel Group.
PORTLAND, OREGON -- Despite its modest $45 million price tag, the deal for Portland, Oregon’s 151-room Heathman Hotel could prove to be one of the most influential transactions of 2023.
The result of more than six months of negotiations between the seller, Pebblebrook Hotel Trust, and buyer Rockbridge (with sliver equity from Aparium Hotel Group, which will manage the 151-key hotel), this sale could be an acid test for whether struggling West Coast cities such as Portland and assets like The Heathman, which were hammered by COVID, have finally turned the corner.
It’s also going to be a bellwether for how well downtown urban gateway hotels can perform at a time when businesses and residents are seeking the seclusion of the suburbs or relocating to cheaper, easier to navigate and more citizen- and business-friendly blue-road destinations.
ROI for a major renovation planned for The Heathman’s public spaces and guestrooms and the reopening of its flagship restaurant will invite closer scrutiny among investors tempted to cash in on attractively priced city center hotels as transient corporate and group business rebuilds.
Buying into potential
Jim Merkel, Rockbridge’s cofounder and CEO, acknowledges that Portland has challenges. However, unlike some existing hotel owners who launched a firestorm of criticism about local officials’ handling of the post-COVID business climate, social and safety problems in the urban core and lack of initiative in stopping the mass residential and commercial exodus, he sees progress that signals the advent of a turnaround.
“We’re not afraid to go into opportunities that, at least on the surface, don’t look good,” Merkel said. “All markets suffered during COVID, but some cities in the Pacific Northwest—including Portland—suffered a bit more. Now, we’re seeing a change in sentiment. In the short time we’ve been involved in pursuing and closing on The Heathman, the city is making progress in cleaning up the downtown and making it more welcoming for visitors. Certainly, the infrastructure in Portland and the surrounding area is in place. The locals see the need for change and expect to act on that.”
Accepting the risk-reward possibilities of being in the vanguard is integral to Rockbridge’s signature twist on buy low, sell high investment. “Fortunately for us, the headlines about the city’s current performance and its challenges sent investors to shop other markets. We saw the opportunity to get a good buy on an iconic historic hotel in a city that will be relevant in the long term. For the last 25 years, buying properties, fixing them and aligning them to what customers want is what we do,” Merkel said.
Recent data gives some support to his read on Portland’s present and future. Although STR reported improved numbers for the city’s hotels for the week of March 5, 2023, compared with the same period in 2022: average occupancy rose 4.5% to nearly 0%; rate jumped 10.9% to $132; RevPAR increased 15.8% to just over $79; room demand advanced 3.2%; and room revenues posted a 14.5% hike to a citywide $14,901,847. Equally good news for existing owners and new entrants like Rockbridge, supply dipped 1.2%, leaving a room supply of 187,537.
However, Portland’s has only started its municipal renovation work. It still has the second highest local income tax, in the country (14.69 %) behind New York (14.78%) while neighboring Vancouver, Washington, has zero personal income tax, and it continues to see population losses and income losses. The Portland Business Alliance had some mixed good news in February that employee and visitor foot traffic has been recovering steadily since 2021 may be plateauing, driven largely by office vacancies.
Right asset, right upside
As in other cities, demographic and economic shifts may be pressuring hotel EBITDA and ROI, but they haven’t yet led to major dispositions. Three downtown Portland hotels facing foreclosure late last year have had a series of reprieves.
But for Rockbridge, finding the right asset was easy. “Aparium was tracking this project and brought the opportunity to us,” Merkel said. “We both saw the benefits of marrying up our teams. We share a very similar philosophy. We like the independent market, and we both love historic hotels that are leaving money on the table. We share a vision for elevating the potential experience of the hotel. And, we have the same investment considerations. With their management track record, Aparium is a great partner that creates experiences that drive project performance.”
They also had a joint understanding of just where this 96-year-old Portland landmark was leaving money on the table. The biggest upside lay in reopening the restaurant and bar, which had been closed since the outbreak of the pandemic. Plans call for the addition on a “bespoke” cocktail lounge and activation of the ground floor.
“It’s important to design the public spaces so that people can see the energy of the F&B outlets,” Merkel said. Like Aparium, Rockbridge also wanted the renovation to activate the lobby with a hyper-localized experience where people would want to meet, conduct business and gather. “We knew we would need to make some changes to position the hotel back at the top of the market,” he said.
Merkel declined to comment on how much the renovation will cost or when it will be completed but did confirm it will provide “necessary updates” to this historic hotel’s public spaces and guestrooms, more than 3,800 sq. ft. of meeting space and skylit second-floor mezzanine. He also noted that previous owners had maintained the bones of the hotel, obviating the need for costly structural repairs and HVAC improvements. “It’s a beautiful hotel. Our goal is to make it a place where people will want to be. And that, in turn, will drive rate and revenue,” Merkel said.
Securing financing, setting return expectations
This plan and the proven success of both Rockbridge and Aparium resulted in a strong story to take to lenders—even now when debt financing is scarce. The bargain price tag for The Heathman was a big plus as well.
We’re not afraid to go into opportunities that, at least on the surface, don’t look good.
Jim Merkel
Basically, relationship banking drove the deal. “It was pretty straightforward,” Merkel said. “It was a single lender we do a lot of business with. It wasn’t complicated. We come to deals like this right around 60% LTV, give or take 5%. We weren’t looking for any special structures."
Rockbridge did benefit from the timing of its debt hunt late in 2022, months before the Federal Reserve launched the series of rate hikes and the bank collapses that made headlines in Q1 2023. “We did factor rising interest rates, the challenges of inflation and potentially a smaller recession into our underwriting,” Merkel added. “That was the blessing of being able to do the deal when we did it.” He would not discuss specific terms but said the maturity will be “at least five years”—syncing it to play well into Portland’s renaissance.
“There’s clearly been a major inflection point in the capital markets this year and things are slowing down and resetting,” Merkel said. “The economies of a project changed when we went from a free 4% cost of capital to a 6% to 7% cost of capital. Those economies are now going to the lender and they have to come from somewhere. So the owners are adjusting valuations or they're holding on.”
One thing that hasn’t changed is return expectations. “The way we look at risk and reward hasn’t changed since we founded the company,” Merkel said. “I don’t think equity risk if above 20, so that’s what we expect.” How soon that would be accretive depends on the market. “If Portland rebounds quickly, this hotel could be accretive right away,” he said.
Despite macroeconomic uncertainty, Merkel said Rockbridge is continuing to look for and do deals. The firm has major redevelopments under way in Phoenix and Houston, and another project in its hometown, Columbus, Ohio.
“We’re active in the market,” he said. “We'll do 10 to 15 deals a year. We’re looking to create value the same way we’ve created value for 25 years. That means buying the property at the right price and fixing it in line with what the real estate market and customers expect to drive the performance and value creation and then and then sell or recap it. It’s pretty simple.”