Pebblebrook Hotel Trust's CEO Presents at Citi Global Property CEO Conference (Transcript)

Mar. 4.14 | About: Pebblebrook Hotel (PEB)

Pebblebrook Hotel Trust (NYSE:PEB)

Citigroup Global Property CEO Conference Call

March 4, 2014 8:50 AM ET

Executives

Jon E. Bortz – Chairman, President and Chief Executive Officer

Unidentified Analyst

Welcome to the 8:50 session of the 2014 Citi Global Property’s CEO Conference. This session is for investing clients only, if media or other individuals are online, please disconnect now. Disclosures available up here and on the webcast on the disclosure tab. We’re very pleased to have with us Pebblebrook Hotel’s and CEO, Jon Bortz.

Jon I’ll turn it over to you for any introductory remarks you have and then we’ll go straight to Q&A.

Jon E. Bortz

Right, thanks Josh.

Unidentified Analyst

You’d have to push the green button and then light will go on, there we go.

Jon E. Bortz

There we go, welcome everybody. Thanks for coming today, I’m going to keep my opening remarks limited, because this is really I think most useful for Q&A. I will just start by saying we’re in a good place in the industry right now. Demand continues to outpace supply, we continue to grow our occupancy and it give us very healthy, pricing power in the industry and with revenues growing faster than expenses we’re seeing growth in margins and faster growth in same property EBITDA.

For Pebblebrook, I think we have the particular benefit of having made capital allocation decisions that have led us to a concentration on the West Coast markets, and have for less supply growth at this point and really for the next several years. And those assets are, those markets are performing significantly better than the vast majority of East Coast and other markets in the United States. And so, we’re very excited about the opportunity that we have with our portfolio with the upside from the renovations that we typically do after we acquire assets and of course.

I’m sure everyone knows that everything the entire company exist just in the last four years and everything we’ve bought, since we went public in December of 2009. So, there is a lot of upside from those renovations typically takes two to three years for those properties to be able to take full advantage of the improvements that we’ve made. And we still have quite a long list of the best practice implementation opportunities that will continue to help our margins and allow us to drive some of the highest organic growth in the industry.

So, with that Josh I’ll turn it back over you to see what’s on your mind?

Question-and-Answer Session

Unidentified Analyst

Maybe spend some time on New York. The market in general and also the Affinia collection and sort of what you’ve done with it and growth trajectory you see?

Jon E. Bortz

Sure, so New York for us through – we have a joint venture with our partner we have a half interest in six hotels in Midtown, five on the East side and one on the west side [indiscernible] to Madison Square Garden. New York for us the attractiveness of the investment was one, it’s a diversified group of high-quality assets in the market. So, we didn’t have any concentration issues we’re making a very large investment in just one hotel in order to get a nice position in New York. But two these hotels are pretty unique in that, I think the average room size was about 500 feet and which is of course a relatively modest size apartment in New York for four, five people.

And these are in many cases hotels like the Dumont and Affinia Gardens and Affinia 50 were all-suite hotels, including suites upwards of a 1,000 or more square feet in many cases. So, part of the opportunity we saw when we’ve bought this was in ability to go into those hotels and reconfigure some of those large suites to create greater room count.

And when we were buying the portfolio Denihan was – had already completed or within the process of completing doing that at the Manhattan, which was adding 90 rooms to the hotel. So which was about 18% additional inventory and then we’ve just completed a complete renovation and repositioning at the Affinia 50 where we added 20% more rooms through reconfiguration.

And at the same time we reposition the quality of the hotel about half a dime and higher through what ultimately is a $19 million renovation. So, individually within the portfolio, we have significant upside from the Affinia Manhattan and from the Affinia 50, which have been completely renovated in the last two years. And then the Affinia Benjamin where we did a rooms refresh last summer.

The rest of the hotel should roughly follow the market would be our perspective with some additional opportunity to do the same things at actually three of the properties, the Benjamin, the Dumont and the gardens at some point in the future when we can reconfigure and add keys. I think in terms of the overall New York market, we've talked really now for two years I think about the fact that New York has a lot of supply that’s coming to the market its running right now, it’s running at about a 5% increase on a monthly basis.

We think it will average about 7% supply growth this year and we think next year it looks like 5% to 7% and what we've told people is we don’t think that level of over supply really subsides this cycle, unless the capital markets turn-off or unless New York stops observing the hotel rooms. In either case New York is likely to be an underperformer through the rest of this cycle.

It doesn’t mean it’s a bad market it just means it’s probably low to mid-single digits in terms of RevPAR growth.

Unidentified Analyst

So when you think about doing the additional renovation projects you’ve mentioned that the other three Affinia hotels. In your mind what drives the timing of that and whether we move forward with that or whether not to move forward with it.

Jon E. Bortz

I think it – part of it has to do with what else is going on in the company. And do we want to go through the very significant disruption for a benefit that’s going to take another three to five years. And so it maybe something we say what its better to do that, that’s beginning of the cycle or at the very end of the cycle to be prepared for the beginning of the next up cycle then it is to do it in the middle of this cycle.

Unidentified Analyst

And can you remind us, this is the only joint venture I think that you probably maybe ever done on this public company.

Jon E. Bortz

Where we did want to add LaSalle when I was there we had a joint venture for the Marriott, the large Marriott Hotel with Carville, that we ultimately sold to DiamondRock and then we actually entered into a joint venture with LaSalle Investment Management to build a portfolio of hotels. But it was late in the cycle and both partners ultimately agreed that it was probably better to wait which was a really good decision.

Unidentified Analyst

Is there an opportunity and I just forgot the details, but is there an opportunity, if you have entry to consolidate the joint venture, the Affinia joint venture. And is that even something that you would want to do?

Jon E. Bortz

Yes, there is – there we went into the partnership with no intention what’s so ever and no lever to pull in order to increase our ownership in the joint venture. Our partner has owned these assets for multiple generations. They seem to have an interest in continuing to do that. And we’re very comfortable being in a 50-50 proposition with the group that shares our culture and our values and our vision for these assets.

So, we do have an ability and as we’ve talked about in the past to after five years of the joint venture to put any or all or any portion of the portfolio up for sale 100%. And so, that we certainly have an ability to gain liquidity in the venture should we want to do that and do that retail and not at a discounted basis from, and not the interest.

Unidentified Analyst

Remember, when you I think and correct me, if I am wrong but I think when you first launched Pebblebrook, you kind of you’re investing in some markets that you thought were real long-term markets for the company and then you characterize I think some markets as having a good yields but maybe were a shorter holds period. And I think maybe Minneapolis and there are probably some others. I guess we’re already with some of those, where as you’re thinking on some of those assets that you had thought where maybe shorter holds?

Jon E. Bortz

Yes, the only thing that’s changed and your characterization is correct is that when we were on a road show, we talked about really perpetual markets once we hope to buy in and hold for ever like Washington, or New York or Boston, or San Francisco, L.A. et cetera. And then cyclical markets those that lack the same barriers to entry as the core perpetual markets as we define them. And those would include Minneapolis, would probably include Buckhead, perhaps Miami, perhaps Philadelphia. And so, as you know we haven’t sold anything yet.

We’re closely monitoring the supply and the economies of those markets and we will ultimately likelihood sell those assets overtime depending upon the particular situation of those markets.

Unidentified Analyst

Are you seeing things in those in any those markets is supply becoming an issue or do you see any those markets is the cycle kind of going to point where things starting to happen that make you nervous.

Jon E. Bortz

Yes, it’s interesting that the take a market like Buckhead, which I think a lot of people when we acquired the Intercontinental down there in 2010. First of all Atlanta has a real estate investment market, I think has a pretty checkered reputation maybe that’s being polite. But certainly a lack of barriers to entry in general in the Atlanta marketplace, well not the same in Buckhead, which is a highest barrier to entry market which has had negative net supply in the market over the last fourteen years.

And yes it gets influenced to some extent by other surrounding markets like Midtown, but yet still operates at a much better level in a much greater safety level than some of the other markets. Interestingly there is nothing under construction in Buckhead and there are a few peeps in the last few months about people talking about doing a hotel or two. But nothing that’s very far down the road as far as we can tell. Minneapolis is probably just starting to perk in terms of discussion and in fact I think one select service hotel that’s under construction at Downtown.

And that should give us an idea that you know things are beginning to move in that direction and we should be giving some thought to disposition in that market in the not too distant future, certainly over the next several years.

Unidentified Analyst

Can you spend some time on the west coast, west coast real – I think across the sectors, west coast has been extremely strong because of the markets, your portfolio and then also kind of which cities are doing the best, I think San Diego for some reasons is not doing as well as some of the other markets but can you spend some time on the west coast?

Jon E. Bortz

Sure, I have heard it said west coast is the best coast. So I think that’s true today. And I think in terms of economic regions, the brain markets if you will are the ones that are flourishing along the two coasts and East coast would be Boston and west coast would include really Seattle, Portland, San Francisco and somewhat debate the brain concept in LA but there is a lot of creativity going on in entertainment and content business today and clearly a lot of technological changes and disruption going on. What we have seen and continue to see and you probably hear this in other real estate categories it’s difficult to build. It takes longer, it’s more expensive, its riskier, you’re not always sure, you’re going to get approved.

A lot of these markets are really not particularly real estate development friendly and are very much dominated by communities and neighbors who want to protect their air and their space and their light and the character of their existing neighborhood. So supply does get added in those markets, it always does. People are creative and people can be very aggressive, but it takes longer and it is more expensive. And it tends to come much later in the cycle which is the case in the hotel business compared to the east coast markets.

And that means that you got a longer runway for growth and ultimately a higher values and there are great cities in general for existing owners, they are very challenging cities for people who want to develop new product. When we think about those five markets, and you notice I didn’t include San Diego, necessarily in the brain market although certainly in La Jolla and in the there is a very, very large biomedical concentration in suburban San Diego not really Downtown.

Downtown is really a primarily a leisure and a convention market and it’s – we like to say it’s the weather stupid although that that could apply to a lot of the west coast markets. And so all of the markets have been very strong but for San Diego which will shortly catch up and it’s – it’s a – the weakness is primarily than based upon conventional calendar and perhaps even more or so the politics that have gone on in the city with clearly a Mayor who ultimately resigned – who not only had some personal issues but had some extreme issues related to how the dollars that were raised for marketing of San Diego by the hotel association should be used for other purposes.

And so those funds were held and the staff, large staff selling both the convention business and San Diego would let go. And that’s all being rebuilt now with the election of a new Mayor who is much more business focused and then San Diego have a convention center added or expansion added either 17 or 18 which is all financed at this point. And again was held up by our friendly prior Mayor who had his own view of – of how that money ought to be used.

So I think when we think about the west coast whether it is San Francisco or Seattle or Portland which is a little below the radar for a lots of folks, it really is benefiting from the strength of the technology industry, the biomedical industry, the education industry. And the west coast continues to benefit from the weather. So…

Unidentified Analyst

You mentioned San Diego you think its going to catch up soon is that – if there is a conventional calendar get better in 2016?

Jon E. Bortz

Yes. And it’s a funny market; the convention market is never bad in San Diego. I mean they run almost a capacity every year, and their half year is down 50,000 room nights which is probably less than 10% of their business. And so a part of it some times depends upon what kind of conventions are there, I mean are you talking about nurses or are you talking about orthopedic surgeons, or are you talking about fireman or you are talking about lawyers because a lot of these associations obviously people are paying their own way and the rate differential can be very material in the marketplace.

So San Diego will continue to benefit from the convention center, the business is better in 2015 and 2016 and then it’s likely to pick up significantly with the expansion which has what occurred last time in San Diego when – when the center got expanded.

Unidentified Analyst

So we all none of the hotel REITs self manage, but your model is probably the closest to the self managing because of kind of your intensive asset management and how involves you all with everything of the property level and just looking at this map you have kind of developed a nice cluster of hotels in San Francisco, is there any way that you can kind of I guess what you’re doing with the Affinia collection are there kind of platform synergies or cost savings or things that you can do better having five hotels in a submarket and potentially more?

Jon E. Bortz

There is a limited amount, you can do again when you are not operating and the kinds of things that you’re talking about even in the Affinia collection are very limited. So I think the concept of that is I wish there were more opportunity there, there really isn’t, the benefit to us is knowledge. We have obviously a lot of knowledge and information about what’s going on San Francisco. We’re in the different parts of this city, Fisherman's Wharf, we’re in Union Square, and we’re in SoMa.

The second thing is our teams all talk to each other regardless of who they work for technically in terms of the operating company. We share information. We own the hotels. We can price them together if we like. We can do whatever we want from that perspective. So some of that goes on we do have a part with Kimpton, there is sharing of revenue management were appropriate they are sharing of some other from sales and marketing.

And then Kimpton has a larger part for city wise and some of the larger marketing efforts for all of their properties in San Francisco that all of us participate in. The other thing is there is obviously a lot of sharing of information that goes on with the other owners in the marketplace. So, I think from does it benefit us having five properties in a market versus one, sure, that is probably more so from information and knowledge of the market then it is from any lower cost from operating perspective.

Unidentified Analyst

At the Investor Day, you had a lot of case studies on the acquisitions that you have done that and most of them have performed really, really well and exceeded your underwriting but you also mentioned the Mondrian and Bethesda is the being the two that kind of missed their underwriting for various reasons. And the Bethesda we’re – it’s probably more of a market issue can you talk a little bit about the Mondrian, what you’re doing there? What the growth strategy is?

Jon E. Bortz

Sure, well we make plenty of mistakes so we tried to keep them small and not do the same ones over and over again. In the case of the Mondrian part of our shortfall in performance was self induced if you will we’ve made some long-term decisions related to the property, that are really heard in the short-term and does include things like when we’re buying the property Morgan’s had been moving forward on a redevelopment and renovation of Skybar and the deck in the pool, in the backyard. And there was no way to stop that at that point.

So, we move forward with that and it was very disruptive Skybar in the pool were closed for three months and that impacted our rooms business as you could imagine because not have a pool in LA particularly with the scene that we get there at the hotel what was painful, we then made some further decisions related to reconfiguring the lobby moving the bar to the opposite side moving the check-in to the opposite side basically swapping their positions.

And then putting windows, new windows in – on the Skybar side of the building because of the noise that comes up and the compliance we have, those two things impacted our business and then we ultimately decided to close down Asia to Cuba and seek out a tenant and a new concept to replace that. And so we were closed from a restaurant perspective for four months and that had an impact on the business as well. So as we say we have caused a lot of the pain that we ourselves are experiencing in terms of performance.

And then we have been disappointed with the leadership team and the efforts on the part of Morgan’s overall. And I think everybody knows what’s been going on at Morgan’s and one might say they are distracted from the everyday operations of their hotels and we have experienced that over the last couple of years. And so we think we’re in a really good place right now to recover what we have lost from those self inflicted pain and we think that Morgan’s hopefully is in a little better place themselves in terms of getting their act together to – to focus much more so on the business and working in a collaborative way with us which is really a key part of our success as you explained is that we’re very actively involved in the operations. We bring a lot to the table in terms of very broad perspective as well as best practices and it’s paid off for us over the years.

Unidentified Analyst

Can you talk a little bit about the acquisition pipeline and just how you see 2014 playing out, which markets you think they are the best opportunities and also competition I think the last several years a lot of the other public REIT have kind of started to ship their portfolio more towards smaller independently managed hotels, which probably creates more completion for you?

Jon E. Bortz

Sure. So let me give you the list of what we’re buying. So when we look at the market today, I would say it’s shaping up much like last year, I think the first half of the year likely to be lighter from an industry perspective. There is less on the market meetings we had at Dallas, where we often see or get teased about assets that are going to be offered for sale was light. Again more or so in the gate way cities, I think there is a lot of available in secondary and tertiary markets.

And so I think you know as have talked about you know acquisitions at this point are relatively small part of our growth. It really is about internal organic growth most of which is already where the investments have already been made and where we have repositioned the assets and we really have another three years to reap the benefits of those renovations.

From a competition perspective much more competitive. The debt markets have ensured that we’ve talked for years about the fact that inevitably comes, there is more leverage available it’s inexpensive, brings out the private equity players, brings out the operators who bring in financial partners who can use leverage at a much higher level to financially engineer the levered returns that they need to be competitive. The REITs continue to be competitive, we all continue to loose deals from time-to-time to some of our peers.

And we will continue to be very disciplined and very conservative in a way we underwrite, we like to have a bunch of cushion in our numbers because we make plenty of mistakes along the way and if we have those cushions, particularly as it relates to not underwriting asset management enhancements and best practice implementation, if we’d rather by less on that basis then buy more where we’ve already built those things into our underwriting.

So, it doesn’t mean it, those won’t worked out okay, but again we’re about mitigating risk and that’s how we get better returns in the long-term by not taking that risk and so, you shouldn’t expect us to be a big acquirer this year. And this could very well be the last year we are in an acquirer in any material way. As we see the market shift competition become greater.

And you’re in the mid part of the cycle so, I think we have quite a number of really good years left and we certainly are going to have demand exceeds supply for at least next two years if not three, nevertheless as we look out we get more conservative when we underwriting and it really comes down to this we don’t know when this cycle ends. But we know as each year goes by, we are one year closer to it. And that just means there is more risk and either you should get more return or you have to be more conservative in your underwriting and when we do that we lose and that’s okay, that’s the way it should be.

Unidentified Analyst

Are you surprised that markets like New York and D.C. that are weaker fundamentally that assets are basically being priced, similarly to how they are on the west coast obviously the fundamental picture is much, much better?

Jon E. Bortz

We have been surprised of that for the last three years, so yeah. I mean, I think what’s interesting and arguably explainable, there is a lot of money that comes into the country looking for safety. New York, D.C. the places they heard of, in particular from Europe and the Middle East much more so then maybe some of the west coast cities. And so, if you’re looking for safety it’s a good place to be I mean New York is arguably one of the three greatest cities in the world. And certainly from an institutional investment perspective has historically have been very attractive. It doesn’t mean it hasn’t been volatile. And I think sometimes that’s forgotten. New York is a higher fixed cost market than many other markets are but because of the liquidity in the market and the interest almost for ever in New York and DC real estate, maybe there is a very good reason for those assets the trade of those similar valuations, just not for us.

Unidentified Analyst

I know it’s tough to comment on someone else’s underwriting, but as your sense that capital is just willing to accept a lower return because they want to be in those markets for all the reasons you’ve said. Or do you get the sense that capital has a different fundamental view of what the growth is going to be, maybe not this year, but two to three years out versus maybe what you would underwrite?

Jon E. Bortz

Yes, I don’t really know I mean I think the interesting thing about the hotels versus other space is we can all have a totally different view of the next five years. We can all have a different vision for an asset, we can all – have planned to do different things with an asset and basically create a totally different five year set of numbers. And, the way we view the world doesn’t make it right, it’s just a way we view it. And what we’re comfortable with, and the way we like to look at risk and return.

So, and it’s really hard for me to speak for others it’s very different than groups looking at the same grocery anchored shopping center or power center that’s got 10 years or 15 years leases. I mean the differential in the potential returns is probably, fairly narrow in those cases, but in the hotel business you can look out five years and we can have millions of dollars of difference in EBITDA forecast, that based upon our different views and what we’re going do with an asset.

Unidentified Analyst

Okay, before we wrap up three rapid fire questions for you. What do you think industry RevPAR will be in 2015?

Jon E. Bortz

6%.

Unidentified Analyst

What – if you could snap your fingers and sell a portion of your portfolio today without any tax issues or reinvestment consequences, what portion of the portfolio would that be in percentage terms and I guess really the question is what do you consider to be kind of non-core or non-perpetual?

Jon E. Bortz

I mean, I think it’s fairly clear as we’ve talked about the markets which markets for us are likely to be the cyclical markets. But I wouldn’t want to comment any further on that.

Unidentified Analyst

Do you think one year from now, hotel cap rates are higher or lower than they are today?

Jon E. Bortz

Neither.

Unidentified Analyst

All right, thank you.

Jon E. Bortz

Yes, thank you.

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