Hay Creek not afraid of leases, or acquisitions

DENVER, COLORADO -- Hotel Investment Today interviewed Victory Hotel Partners CEO Greg Mount last week to discuss its Hay Creek Hotels management company’s creative new lease agreement with Osaka, Japan-based Hirakawa Group to operate the iconic Castle Hotel & Spa in Tarrytown, New York. But we’d be remiss if we buried the lead as Mount also mentioned that Denver-based Victory Hotel Partners is in active discussions to acquire a management company that will more or less double Hay Creek’s portfolio, which has already grown from 17 to 34 hotels in a little over a year.

Mount said the acquisition is in the final stages of negotiations and should be announced soon, adding that he was working on a second such deal, which for now has moved to the back burner. The first deal would give East Coast-focused, Exeter, New Hampshire-based Hay Creek greater exposure to the Midwest and West Coast.

As for price, Mount said that currently most management company deals are trading somewhere between 5x and 7x NOI, or 2x to 3x revenue, with the sellers taking 50% of their capital off the table and keeping 50% in the new entity. “If we’re successful, and we hope we are, we will execute on terms that are in that neighborhood,” Mount said.

Greg Mount

“This deal would double our size and our goal is to build something meaningful, and with people we like doing business with,” Mount added. “And when we get to a certain number, we’ll figure out the best way to monetize it.”

More generally speaking, Mount said he is starting to hear about a lot more deals ramping up, which he said most experts were expecting more toward mid-summer. In fact, he said Victory Hotel Partners has a deal in Monterey, California, under negotiations right now.

“There are a number of owners and partnerships that are figuring out that they don’t have enough capital to buy down the loan that they need for their new debt, and they don’t have the money to complete PIPs,” Mount said. “So, there’s a little bit of panic going on and we’re seeing some really interesting deals. We’re working with a bank right now on a deal where they’re selling at 50% of the cost to build the asset a few years ago, and willing to take 70% of the debt to get it done.”

As for deals with less distress, Mount said the LPs he works with are still a little bit hesitant given what’s going on in the marketplace. “There’s still a little discord and discomfort. So, everybody wants to get paid for the risk and make sure the upside is significant. No one’s really interested in buying yield.”

The lease deal

Back to the intended conversation, the lease deal at the 31-room, special event-driven Castle Hotel & Spa was done to provide a balance and assurances for the owners, who bought the asset about five years ago, self-managed and had it shut down for about two years during the pandemic.

They did not want to solely engage a third-party management company as they believed there was a disconnected interest, but they also didn’t want to sell as this is a long-term hold for them.

Mount said they worked on this deal for a few years and stressed how patience, especially with an Asian owner, was the key to getting it done. In fact, Hay Creek took over management of the property on April 11.

“Owners out of Asia look at deals a little different, more long term, with return thresholds that tend to be a little lower,” Mount said. “They were receptive to a lease because it shares the risk. We’re not just going in and collecting a fee with the owners just getting what they get. You must be prepared to take a little risk, which we were because we’re confident in what we can do. The upside for us is probably anywhere between five to 10 times what we would have earned to manage.”

Hay Creek agreed to a minimum lease payment on an annual basis, which escalates over the first three years of the five-year agreement which has one, five-year renewal. Hay Creek then pays the owner 10% of all the revenue and keeps everything else, which includes the management fee. “They’re going to get their annuity that they’re looking for in their returns and, quite frankly, their upside is pretty good, as well,” Mount added. “We’re going to take this asset from a loss for them into something where they’re going to get a good, solid return. At the same time, we’ll share in that.”

Getting the deal over the finish line took patience, Mount said, adding that a lot of where negotiations focused was on minimums like the length of the lease. “You’re locking yourself into having to pay that amount of money, whether you make it or not,” he said.

You’re signing a five-year agreement that could obligate you to $2 million to $2.5 million in lease payments. But I think the risks pale in comparison to the reward for a management company. We can earn 5x to 10xf what we would earn on a management fee.

Greg Mount

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The other focus on was negotiating capex – what needed to be done, what could need to be done in the future, and making sure the real estate had access to capital. Hay Creek will manage any expenditure up to $3,000 and anything bigger falls to the owner. Initially, Mount expects about $200,000 to go into the property for deferred maintenance and necessary items like upgraded TVs for the guest rooms.

Looking ahead, the Castle has not been performing well since reopening and Mount said more than anything the property needs to be reintroduced to the wedding and midweek corporate markets. He wants to see F&B reach 30% of revenue and believes the potential exists to eclipse $500 room rates versus the current rate well below $300.

Flipping the script

While leases are standard in Europe, they haven’t caught on in the U.S., and Mount suggested that management companies generally are willing to take the necessary risks. “You’re signing a five-year agreement that could obligate you to $2 million to $2.5 million in lease payments,” Mount explained. “But I think the risks pale in comparison to the reward for a management company. We can earn 5x to 10x what we would earn on a management fee.”

After admittedly stumbling on the lease option to get the Castle deal in-house, Mount said Hay Creek has subsequently brought it to other owners who are considering it as well.

Bigger picture, Mount said he is of the opinion that the way management fees are charged needs to change. One way they are looking at doing things differently is not charging a management fee but charging on a per reservation basis. “Stay tuned on that,” he said. “I think it's something that you’ll see us do that within the next year.”