David McCaslin provides an owner-centric diagnostic for finding hidden upside and deconstructing market complexities to rev up IRR.
PHILADELPHIA – Newly named Capstar Advisors partner David McCaslin predicts the big winners in today’s market will be lone-wolf investors who look for opportunities where others don’t. And he’s not just talking development targets.
From fresh additions to the capital stack such as Property Assessed Clean Energy (PACE) loans and equity kickers to tighter due diligence for conversions and more emphasis on the terminal value of a deal, hospitality investors are going to have to move out of their comfort zones to make the most of this market’s upside in his view.
“You can wait until the market normalizes, use the same structures everyone uses and pay what everyone else pays for a deal. If you’re willing to be a commodity investor, that’s fine,” McCaslin said in an interview with Hotel Investment Today. “Markets change, and you have to determine where you’re comfortable taking risks if you want higher returns. Investors typically tend to make more money over the long term by being slightly contrarian."
The way this development and operations veteran defines contrarian makes the implications of that observation far more complex than they seem at first. What he’s describing is a strategic approach that not only targets opportunities in markets and asset classes that aren’t on anyone’s hot lists, but an approach to investing that questions every aspect of the current conventional wisdom to find the logical holes that reveal opportunities and unlock value that may benefit the individual firm’s goals.
“This is not a one-size-fits-all investment environment,” he said. “Take debt. It’s not that you necessarily won’t get debt. It’s just hard to get it. Will you take less than an optimal amount of debt to do a deal you really believe in? Can you layer in more debt two to three years into the hold period? Will you look beyond traditional structures? Not every investor will have the same answers. So, you can’t just look up and say you can’t get debt. You can. But you have to be willing to consider a broader range of tools and terms to get it."
McCaslin shared in-depth tips on his tactics for 2023-24 and where investors might be missing some chances to outperform.
Hotel Investment Today (HIT): Before we start into strategy, the obvious question is what’s it like to be working with Paul Whetsell again?
David McCaslin (DM): It’s great. It doesn’t really feel like 'work.' I helped Paul found what became CapStar Hotel Company in 1987 and became its COO. We were able to continue to innovate, not only as owners/operators but as a platform. Our 1998 merger with American General Hospitality and the split of our operating company as a separate division made us the industry’s first paper-clipped REIT. The opportunity to apply that kind of thinking to this market alongside Paul at CapStar Advisors was too good an opportunity to pass up.
HIT: What’s the deal pace look like and how are you going to make those deals pencil?
DM: The pressure now is to do a deal or to get something done. But you’re going to have to be confident that deal will succeed. You're paying substantially more in interest rates and the bid-ask gap is still fairly wide. That’s why the types of deals getting done are changing somewhat. You're going to have less current cash flow, which puts a lot more emphasis on the terminal value of the deal. And that, in turn, will reflect how much you believe in that project and your ability to create value. It's harder to get current year cash-on-cash returns today. I also think the traditional ratio of debt to equity may change for deals that are not core or core-plus. So, I don’t think that means deals will come to a standstill, but I do think it means that the preponderance of the returns will come on the back end.
I don’t think that means deals will come to a standstill, but I do think it means that the preponderance of the returns will come on the back end.
David McCaslin
HIT: What kinds of deals will come to market?
DM: For the big players, the M&A activity and mergers we’ve been seeing this year will continue, as will brand launches. That’s been going on for a while and I expect it to continue. You’ll see some small portfolios coming on the block–maybe due to a situation in which a small company wants to sell out or a large company wants to sell enough assets to achieve some other balance sheet goals.
HIT: With the Federal Reserve pressuring banks to get or keep their own houses in order, will we finally see some distressed inventory for sale?
DM: There are not a lot of weak owners today. Most of the owners, whether they're high net people or institutions, have better balance sheets. Clearly there will be exceptions but this is not an 'I’m out of cash and I have to sell' scenario. Most owners are holding on in the hope that values will go up – though I’m not seeing that they’ve gone down yet.
The decision to sell will be driven more by strategic or portfolio management priorities. A company may put a small portfolio up for sale because they want to change their capital stack or pay down debt. Maybe the firm is out of their fund life for an asset or a portfolio or the loan is reaching maturity. Maybe the franchisee agreement is coming up for renewal. These would be more common reasons to sell.
HIT: Development discussions are dominated by conversion opportunities, especially for office buildings. What’s your read on that?
DM: I'm a little unclear in my own head how many conversions will occur. That’s not because there isn't pressure on the office space. But if you believe that shuttered offices are creating hotel conversion opportunities, you also have to acknowledge there are fewer offices for people to work at or travel to for meetings. We’ve already seen that business travel might have a small dent in it. Then, why would you add substantially more supply given the market profile? I’m not saying all conversions are bad investments. I’m just not sure that you're going to see a mass movement of offices being repurposed as hotels. In my view, it’s more realistic that you’ll see offices being recycled into residential real estate. Perhaps hotels could be part of that mix.
HIT: Where is the smart money headed?
DM: It’s hard to say where there’s a ton of opportunity. Generally, I would tell investors to look at things other people aren’t looking at. Not all of them will be good, but that's where I think you're going to find some things that are positive.
What I would say is that the industry tends to chase the same things. Now, that means the Southeast is hot; Texas is sort of hot and the rest of the country is not so hot. There is certainly a class of investors that have made several cycles of investments in urban real estate that believe that urban will still really come back.
I have a couple of theses I’d like to explore. I think we’re going to see a boom in group and convention business related to the increase in remote or hybrid work environments.
We’re already seeing some evidence of that. A year and a half ago, warm weather convention hotels were an unloved asset class. They’re performing well now, and there’s not much new supply under way.
What I do believe is it's tougher to be in the middle. These companies have to move up or specialize because, realistically, they can’t do dozens of things, stay in the middle and continue to do well.
David McCaslin
HIT: What are some of the more innovative tactics to get a “yes” from lenders to get these deals done?
DM: Property Assessed Clean Energy (PACE) loans aren’t widely understood, but I think they’re going to get a second look. They’re only available in 37 states and they haven’t been stress-tested yet. Nor are they a panacea. What you may see is people considering them as they try to breach the bid-ask spread.
Equity kickers are more accepted. They’ve been around in mezzanine positions for a long time. I wouldn’t be surprised if you see some components of this as people put deals together now. Some in the financial services industry may greenlight deals that give borrowers more certainty on short-term cash flow in return for lowered expectations on other terms because the firm can keep the loan as is or put it into slices and sell it off once the deal is done.
HIT: Will there be enough opportunity to go around?
DM: I'm a believer that there's a lot of room for targeted players in specialty niches. And then I think there is a need for larger players that do a little bit of everything.
What I do believe is it's tougher to be in the middle. These companies have to move up or specialize because, realistically, they can’t do dozens of things, stay in the middle and continue to do well. Investors and developers have to pick a size, scale and strategic direction or dominate within a niche as one of the top two or three undisputed leaders within that niche.