Investments in three hotels currently under development power this young investment/development group over a major portfolio-building hurdle.
SAN MATEO, California – At a time when economic turbulence has grounded much of the hospitality investment industry, Verakin Capital blew past a major milestone with investments in a trio of properties in various stages of development. Rupesh Patel, partner in this real estate investment, development and co-investment group, credits relationships that carry over from his 16-year leadership of Zenique Hotels (where he continues to serve as managing partner), a focus on collaborative investing alongside like-minded partners and a knack for creating adaptive new twists on business fundamentals as the primary catalysts for the 16-month-old firm’s growth to over $380 million in assets near the end of Q1 2023.
In an interview with Hotel Investment Today, Patel walked through the opportunistic R&D that makes projects like these pencil out against a backdrop of constant headwinds from interest rate hikes, inflationary cost increases and a looming recession and what the pipeline looks like for the rest of the year.
How Verakin gets capital
Patel acknowledges that Verakin has had an enviable advantage in terms of access to financing. The halo effect of Zenique combined with a strong track record achieved on its solo projects and with partners not only earned buy-in from lenders but also attracted co-investors.
For example, in the three deals announced in Q1, Verakin is the lead developer on a 117-room Courtyard by Marriott in Pittsburg, California. However, it is co-investing with RevPAR Companies, a privately owned hotel investment management and development company based in Durham, North Carolina, and Emerge Hospitality Group, a family-owned and -operated hotel ownership/development/management company headquartered in Cleveland, on the 181-room Moxy Downtown – Centennial Olympic Park in Atlanta, and the 223-room dual-branded Hampton Inn/Home 2 – River North Downtown in Nashville.
That model has spurred growth through pooled resources, combined expertise and significant risk mitigation, according to this second-generation hotelier. But more importantly in today’s debt market, it allows Verakin to use traditional financing structures with no debt-service-boosting strings attached and get a hearing from relationship lenders.
“Our projects are all institutional-quality assets with institutional brands in grade A markets, which attracts all parties,” he said. “The projects we are investing in are projected to yield strong returns, and with diligent underwriting, risks are mitigated to our highest capabilities.”
So, yes, Verakin can get financing, but even the best relationship isn’t going to reset pricing or interest rates to pre-pandemic levels. “Interest rate increases have made it more difficult to make projects and acquisitions pencil, mainly because sellers are expecting price points from a year or more ago,” Patel said. “Increased interest rates should compress cap rates; however, in hotels that is not always the case as cap rates tend to remain fairly stable. Without price decreases with interest rate increases, it makes yielding similar returns to a couple years ago more difficult. Because of this, we remain disciplined on investing in markets and assets that have strong historical performance and high ADRs”.
What’s on Verakin’s 2023 deal radar
Patel anticipates one additional development project this year and will continue to shop acquisition opportunities. Strictly opportunistic, this firm’s development strategy isn’t about pins on maps. “We do not have specific hot markets we investigate; we look in a wide range of locations. The key to our investment decisions is on the projected performance of the investments, brands and price,” he said, an approach proven by a portfolio that reaches from the Pacific Northwest to the southeastern United States.
A new factor Verakin is weighing is development of ancillary uses adjacent to its hotels. “In some cases, we may purchase more land than we need for a hotel and develop other uses such as restaurant or retail which can service our hotel guests. In other cases we may lease those units or sell those units to reduce our overall capital exposure within the hotel investments,” Patel said.
Early due diligence, buy-out grow development ROI
Although Verakin invests in acquisitions as well as newbuilds, Patel sees ground-up development as essential to growing a robust portfolio in the current marketplace. As of April 2023, the company had $180 million worth of hotel assets and 759 rooms under development.
“We believe newer hotels with strong brands are going to withstand market pressures while older hotels will get the brunt of the [negative] impact,” Patel said.
However, investors are going to need to make some cost-effective adjustments to offset “drastic changes” due to supply chain issue and cost escalation for materials and labor.
“We have been buying out projects far earlier in the process than before as well as conducting diligent value engineering very early in the process,” Patel said. “We’re working to uncover cost savings and efficiencies during the planning phases to save time and money upfront.”
Development of the Pittsburg Courtyard by Marriott shows how that works. “We are at 97% buyout and are only at the slab-on-grade phase of the project. We did this to ensure we have the labor and pricing for materials locked in to avoid increases down the line,” Patel said.
We’re working to uncover cost savings and efficiencies during the planning phases to save time and money upfront.
Rupesh Patel
He added that today, projects take ample manpower to work with local municipalities, overcome obstacles that they have never seen before and stay on track as much as possible. "When delays occur, we find areas where we can make up that time which requires vast coordination with all parties,” Patel said.
Finding the "best" course depends on the line item, according to Patel. “Certain equipment, such as electrical transformers and interrupters, has nearly two-year lead times. Thus, we had to pay expedited fees in order to open on time. The alternative to waiting would displace a tremendous amount of revenue,” he said. “The cost increase is justified in this case but does require additional capital. Furthermore, elevators continue to be an issue with lead times with all manufacturers. Due to this, we must have our submittals to elevators companies very early in the project to ensure we have the unit installed and inspected on time.”
How homework closes bid-ask gap
With “ample capital” chasing a short supply of hotel deals, Patel described the bidding process for acquisitions as extremely competitive. He acknowledged that, since every prospective buyer has its own metrics, Verakin will get outbid for some solid projects. But he’s not about to throw away discipline for sake of the deal pace. He pointed out other ways to make the numbers work.
“Navigating the permitting process and negotiating construction bids are among the biggest challenges in acquisition,” he said. “To counter the wide bid-ask range, we dig deep into each sub’s history to ensure they are capable of completing the project on time and on budget, with high quality. Branding decisions are made based on what is already in the market and what we feel the demographic would be attracted to. We have always played in the select-service sector with strong brands such as Hilton and Marriott. Research and our own experience have shown us that these segments have durable consumer demand that generates good performance.”
Patel expressed no interest in returning to the sidelines, even with overall projections for a fairly lackluster investment outlook. “In times of distress, there is always opportunity,” he said. “We have been able to lean on our lending and construction partners from many years on our vision; thus, earning their buy in to work with us.”