What makes sense today for Arbor Lodging

CHICAGO – The principals at vertically integrated owner-operator Arbor Lodging have learned to be nimble and shift their focus to match market conditions. Built in Chicago over the past 19 years by Vamsi Bonthala, previously a private equity attorney in New York at Kirkland & Ellis, and Sheenal Patel, who was at Related Cos. in real estate finance, they will pivot to create value either as asset buyers, sellers, debt providers or as an emerging third-party manager.

With 34 owned and managed branded hotels (4,800 rooms) in their portfolio and one acquisition close to closing, today they are putting their emphasis on debt market opportunities as well as their fledgling third-party business, particularly in Mexico, because buying assets is simply too challenging.

In fact, Bonthala told Hotel Investment Today that Arbor Lodging is a net seller, not necessarily because they want to be, but because some of their smaller, lower performing assets in the sub-$25 million range with little opportunity to enhance value have seen some decent buyer interest. “These are regional and local buyers that have a different angle on the operations model. They have access to different types of financing from local banks and their return thresholds are just different,” Bonthala said. “If it’s accretive and we’re able to sell it at what we think is a really attractive cap rate or basis we have been selling.”

Arbor Lodging's Hotel Phillips in Kansas City, Missouri

Arbor Lodging recently had a larger asset that they took to market and ended up refinancing it instead because the buyer pool was more institutional, and they hit a ceiling on the valuation they could get to. “We just did not think that made sense given that it was a well performing, cash flowing asset,” Bonthala said.

Debt business

Where Arbor Lodging is growing their business over the past two years and finding attractive returns is on the debt side as higher interest rates reopened a window to get back into the space. They have been active on senior, preferred and mezzanine debt for U.S. hotels.

They have a joint venture with a large, global credit fund for larger transactions, having done a loan for $60 million-plus and just signing a term sheet on a $100 million loan.

The bigger debt need has been on the sub-$10 million preferred pieces, Bonthala said, where Arbor Lodging uses more in-house capital and/or brings in a few investors to get total returns in the mid-teens. “We’ve been doing those in conjunction with major senior lenders, some of the most active in the industry,” Bonthala explained. “We’re taking mezzanine pieces and underwriting with them. We’re giving them that extra level of conviction on the underwriting and the asset, and we certainly like that side of the business.”

Third-party opportunities

Arbor Lodging is also putting a lot of resources into growing its third-party management business. It has five contracts right now and three in the pipeline. They also hired former Aimbridge Senior Vice President of Operations Neil DeGuia, among others, to become more aggressive on the third-party side.

We care a lot more about in place cash flow. We are not leaning into big value-add plays and big upside stories in the way we could a few years ago. I’d rather look at all of those as getting lucky on the potential upside than being a core part of the business plan.

Vamsi Bonthala

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Arbor Lodging also likes the university hotel niche for third-party business and is working with a school to develop their hotel and will stay on as the operator.

The other pure management opportunity is in Mexico, where Arbor has had an office for three years, built a team, integrated the business with U.S. operations and is an approved manager for the major brands.

They were recently selected for their first third-party contract in Cabo San Lucas, Mexico, and Bonthala said a few more deals are “pretty close.”

“We are building some relationships in CALA with a goal at some point of being able to invest in the region, as well,” Bonthala added. “Our CALA expansion is really important to us. We’ve spent a lot of time trying to be thoughtful about that. We’re lucky that we’ve been able to find some good resources, good opportunities, and I think sky’s the limit down there.”

About cash flow

Looking ahead, as Arbor Lodging looks at new opportunities, especially on the acquisition side, Bonthala said they think a lot harder today about what an asset is worth and what they can pay for it because the flow through is just not the same as it was five years ago.

He points to all the increases in operating expenses, insurance, taxes, etc. that gives them pause and causes them to spend a lot more time thinking about the ways that they can employ different strategies, especially to streamline expenses.

“We also have to be really thoughtful about where we think we can push rate because if you are in a market that has seen supply growth and you’re in a certain asset class that has more challenges and we are way more sensitive to what we think an asset is worth,” he said. “We care a lot more about in place cash flow. We are not leaning into big value-add plays and big upside stories in the way we could a few years ago. I’d rather look at all of those as getting lucky on the potential upside than being a core part of the business plan.”

Arbor Lodging would also like to look at more independent hotels because, Bonthala said, there’s much more freedom to explore creative solutions to address expense creep.

“Some of the branded hotels that could have worked for us in the past are a challenge now because we know we have brand standards that are going to be keeping us restricted,” he said. “We know there’s significant CapEx requirements on us, and when you layer all of that in, we’re just not getting the prices that sellers are willing to sell at. Whereas with independent hotels, we can be super creative on the expense side and on the revenue side.”

And speaking of creativity, Arbor Lodging has started a new division called Arbor Management Solutions, providing accounting services to other third-party management companies because of the challenges and expenses surrounding keeping good people.

“We have a couple of contracts and it’s growing,” Bonthala said. “The nice thing about that business is clients are calling us.”