Teague Talks with Jonathan P. Stanner, President & CEO of Summit Hotel Properties

Round two. I know. I actually went back and watched round one, by the way. I should have done that. It was really good. I don't know why I sound so shocked. It was really good. You did a much better job than I did. You were very articulate, very intelligent, sounded really smart. A shocking performance.

I'm wonderful. How are you? And thank you for having me. Happy Fourth. Did you do anything fun? Have you traveled anywhere? What'd you do?

Yeah, yeah, yeah. I probably, I guess we last saw each other in New York. It feels like a lifetime ago, but it was probably only a month ago. But you know, NYU, the NYU NAREIT week is a busy week and a hectic week for us, but it seems like a really long time ago at this point. So what are you hearing? What are you seeing out there? What are you learning in the public traded space? What are you seeing?

Yeah, look, that's right. The anecdote I've used over and over is our RevPAR in Minneapolis. We have two hotels in downtown Minneapolis, and in the first quarter we were up 16% year over year. We ran 45% occupancy for the quarter. I'm not proud of that occupancy, but it does highlight that there's just a lot of embedded growth in some of these markets that have been much slower to recover. When you contrast that with what's happened in the resort and leisure space, people are talking about resort and leisure softness in a way that you can only measure year over year versus rates that we saw in '22 and '23, which were atypical. They're still 30-40% often times above where we were versus 2019. I really wish we could come up with another word other than 'normalization' because it's become so overused, but I do think that's what you're seeing from a leisure perspective. You're just seeing rates that reflect people going back to more normal historical travel trends. Not everybody has to drive to the beach in Florida to vacation. You can go on cruises, you can go to Europe, you can do all these things that really weren't an option in 2021 and 2020.

Yeah, look, I think the team did, particularly in the first quarter, a remarkable job. On 1.5% RevPAR growth, all of which, as you alluded to, was our rates were actually flat to modestly down in the first quarter. Our expenses on a per occupied room growth basis were actually negative year over year. So to get 90 basis points of margin expansion off of that type of top-line growth, I would say is atypical. I think where we see the opportunity from an expense perspective, one is again, you are seeing wage pressure abate to some extent. We had multiple years of well above inflationary growth from a wage perspective, particularly hourly wages. That has moderated significantly. And then we've become reliant, our portfolio specifically and I think the industry broadly has become more reliant on contract labor, which is more expensive and less efficient. I think the opportunity set has been actually to hire more full-time employees. So we used to measure FTE counts and say, 'Gosh, I'm so happy we're only at 75 or 80% of 2019 levels.' I'm actually excited when I see that number tick up a little bit because it means we're replacing contract labor. I don't think we ever go back to 2019 levels from an FTE count perspective. I think we've created some efficiencies in this business that will benefit the operational efficiencies of our hotels over the longer term. But I do think there's a real opportunity to replace contract labor and then to reduce the amount of turnover. Every macro indication suggests that the labor market continues to soften. It's softening from a really, really firm position, so there's a long way to go. But that's the opportunity set. Despite the fact that RevPAR growth may not be as high on an absolute basis as we'd like, we do have opportunities on the expense side going forward. I think we're just at the beginning of that. It's still hard out there. I think if you lined up our operating team and said, 'Tell me what your biggest challenge is,' I think labor would still be number one on their list.

Yeah, we've sold. We've been a net seller. Over the last 12 months, we've sold nine assets for about $130 million. We've been pretty strategic and very targeted in what we sold. We sold that on a blended basis at about a 5.5% all-in cap rate. We don't have a lot of it, but we really targeted some of the legacy lower RevPAR, lower margin, higher CapEx needs assets where we could find a local owner-operator that was a per-pound or per-key buyer that was a little less focused on the going-in cap rate. It did a couple things for us. One, it cleaned up some of the lower end of our portfolio. But it also eliminated about $45 million of near-term CapEx spend. I think if you look for a common thread or a common theme across what we sold, it's really that one of the underappreciated stories in our industry is this business just hasn't had the CapEx spend put into it that it needs to. At some point, there's a day of reckoning for that, and we're trying to be very thoughtful around where we're spending our CapEx dollars. The cost of renovations for these types of hotels are 25-30% or even more higher than they were in '19, and we're dealing with revenues that are slightly ahead but not meaningfully ahead on a nominal basis where they were in '19. So when you think about your CapEx obligations as a percentage of revenue or EBITDA, it's just a bigger obligation than it has been historically. So we're trying again to be very thoughtful around where we spend those CapEx dollars. That has been again a common thread amongst what we've sold. We'd like to get back to a point where we can be acquisitive. I think that when the Summit stock story has worked the best, it has been when we've had a cost of capital to raise equity and go buy assets. Like our peers, we haven't been in that position for some period of time. I do think it's a real big part of the value creation thesis of what we do. I think we're great at identifying acquisition opportunities. I think we're really good at putting business plans in place and then going out and executing them. We've got a good track record. If you look at the billion dollars of assets we bought since the pandemic, they've performed very well despite the fact that market conditions have softened to some degree over the last six to 12 months.

Yeah, look, I wish I had a perfect answer to that. I think part of it is going to be public market sentiment for us has to change, for the industry has to change. I think the industry's facing two things, particularly in a public context. You're facing monetary policy uncertainty and you're facing fundamental uncertainty. The combination of those two things has created an environment where sentiment towards public lodging stocks has been really fairly negative for the last 12 months. We have a history of this. This has happened over and over in our industry. It always turns. When it turns, I wish I knew. I don't really know. I do think we'll start to get some better clarity around the direction of our monetary policy later in the year. I think it'll be helpful to get through the election. But I think at some point, there's a rerating for all the public company stocks to look something more like an early cycle type of multiple. I think the multi-year, longer-term outlook for the business is really pretty positive. There's very little supply growth. I think there's very favorable secular demand shifts that are helping lodging broadly. People want to travel. That's a very good thing for hotels. We've seen really no signs of those trends abating. And I think you're still at different phases of the recovery when you look specifically at business travel, where I think there's still room to grow. That doesn't resonate with public company investors right now. They care about what July the week of July 15th RevPAR is, not what 2025 or '26 RevPAR is. History would suggest that that will change over time.

Yeah, look, I think it depends. I don't think there's a blanket answer to that. We've had to be really thoughtful around how we allocate our free cash flow dollars, whether it's acquisitions, dividend increases, or renovations. We could spend every last dime of our free cash flow this year and the next couple of years just renovating assets. The nine assets that we sold, it just didn't make sense. We found a buyer who would take a different view on the capital requirements for the hotels. We think that there was a better use of our capital elsewhere. In many instances, that's renovating a hotel that probably has a better growth profile. So I do think you've got to be very cognizant of what the market dynamics are and be thoughtful around which assets you're renovating and which assets you're not renovating and what the scopes of those renovations look like. But again, while in the near term it's a little bit painful, I do think longer term it's going to create buying opportunities for those of us that are better capitalized. There's only so long you can kick the can without renovating and seeing a real material impact on your top-line results.

And again, it's worked for us because we did have a handful of these smaller assets where the check size was pretty manageable. You could get a local lender to finance it. The improvements you've seen in CMBS market have certainly helped from an institutional perspective, but debt is still expensive. So that's really the needle that we've tried to thread, to be able to find the smaller local owner-operator that is going to self-manage and feels like there's upside from taking out an institutional manager. And frankly, probably he's just going to spend less on the renovation than a more institutional owner would.

Yeah, look, I think you need to see the cost of debt come down. When you look at the really smart big capital allocators across the space, across industries, across the capital structure, I still think the incremental dollar is going to credit. The spreads you can get on what isn't pretty good debt yield, last dollar LTV is pretty attractive when you're talking teens-type debt in place at current interest rates, decent debt yields. It's hard to go out and buy five cap assets when you can allocate your money there. I still think that's where the incremental dollar is going from some of the more diversified institutional investors.

Yeah, look, lower interest rates helps for a whole lot of reasons. I don't know how much we can hang our hat on that happening later in the year. I know the curve is certainly suggesting we're going to get a couple of cuts by the end of the year. I hope it's true. But I think we felt coming into the year that rates were going to be higher for longer, and that has played out. We don't typically try to bet on the yield curve. We did swap a bunch of debt early in the year because we just never bought off on this yield curve that implied six rate cuts for the back half of the year. That has played out. I do think you're seeing signs of a slowing economy broadly speaking. The macro data that's coming out is suggesting that, as you would expect. The higher rate environment that we've had for the last 18 to 24 months is slowing the economy down. Hopefully, it's putting the Fed in a position where, whether or not they cut, they're at least able to start to signal that we're on the path to those cuts. We thought we were there back in December last year when the Fed pivot talk started. It turned out to be a little bit of a false start. Hopefully, we can get back to that point. The dynamics around the election may change the timing of that to some extent, but I do think that certainty around monetary policy is every bit as important as the actual direction. Hopefully, we get some positive news on both over the next six months or so.

Yeah, look, I think it's part of why you see these broad disconnects in the public markets in terms of where the stocks trade relative to NAV. I think there's a heightened sense of concern amongst investors on the health of the consumer. You can point to credit card delinquencies or excess savings from COVID that have gone away. You can point to some things that give you concern for the outlook of the consumer. I don't think you've seen it show up in consumer spending, and I don't think you've seen it show up in hotel demand. You certainly haven't seen it show up in broad travel statistics. TSA is setting records over the Fourth of July for people traveling. So you do worry about that. But I look at a couple things that I think help mitigate lodging versus a broadly softening economy. One is there's just no supply. We haven't been in this environment. We've been in this environment now for a couple years, but if you go back to the three or four years pre-pandemic, the industry supply was growing 4 or 5%. We're going to have four or five, maybe more, years of 1% or less supply growth. So I think that helps to a certain extent. As I said earlier, I think travel continues to be a tailwind. For all the consternation about consumer spending, I've yet to come across the consumer that says, 'You know what, we're going to cut our summer vacation this year.' I just think it's a priority in a way that it hasn't always been a priority. It's more of a priority than it has been perhaps in the past.

Expensive. You guys are too expensive. Why hasn't there been more? Well, look, I think the stocks... I think if you got all my peers on this call, they'd all say their stock's cheap. I don't think anybody loves the valuation of the business, and that's part of it. What's a little bit different is these companies are all well capitalized. People are lowly leveraged. They have a lot of liquidity. Similar to what's happened in the asset-level transaction market, nobody has to sell. And it's expensive. The checks for most of these businesses are a billion dollars plus, and there's still a limited buyer pool that can write that check. They're still very dependent on the credit markets. To lever it at the levels that the most likely buyers lever it at, the all-in rates on hotel debt still can be 8 or 9%. So I think it's really hard to make the LBO privatization math work in this environment, particularly when the views broadly are that there are pretty steep discounts to NAV. That being said, we get asked this question in almost every panel we do: whether we think there's going to be more or fewer public lodging REITs in 6, 12, 18, 24 months. I continue to say fewer. I do think you will see privatizations or mergers in some of these businesses. I don't know that it's today for all the reasons we just talked about, but I do think as you start to see rates come down and the credit markets recover, I don't think there is the resistance to selling that may have otherwise been the perception pre-pandemic.

Yeah, look, I just don't think that the social issues are the impediment that folks want to blame on. I think the impediments are capital markets impediments today, and to some extent some fundamental uncertainty, but more the former than the latter.

Yeah, I think everybody would say that. We certainly believe that. Some of it again is this exposure to markets that we think have a long recovery leg coming to them. But yeah, we absolutely believe that.

Yeah, look, I think you're going to see more of the same. From an operations perspective, I think you're going to see better performance in urban markets. I think you're going to see better performance midweek than you are on the weekends. I think you're going to continue to see pure-play leisure, pure-play resorts lag. I think people are going to talk about how soft it is, and I'm going to say it again: I think it's normalization, not real absolute secular demand trends that are softening from a leisure perspective. So I think we're going to kind of continue to churn along. From an industry perspective, like you, we all see the Smith Travel numbers. Outside of the disruption around June, I think the industry continues to plod along with, as I said, urban markets and suburban markets outperforming and midweek business outperforming the weekend business. That's my expectation for the balance of the year. I don't have a date when I think the transaction spigot turns on. I do think it turns on, and I say that with probably more conviction today than I've said it over the last 12 months. I'm starting to think a lot of it's going to be facilitated by seller capitulation. I just think you're starting to hear more sellers who, one, the ability to kick the can has been there, but it doesn't go on forever. It may be less of a lender issue and it may be more of a brand standard issue or a PIP or renovation issue. I think if you get a little bit of tailwinds from the capital markets, I think you'll see a lot of folks just say, 'I've waited it out. My time is now.' So does that happen in the next six months? I don't really know. Again, I think getting clarity on the direction of monetary policy and getting past the election both will be positives for the industry.

Yeah, look, broadly speaking, you have been right. I remember having this conversation with you probably 12 and 24 months ago, and I was surprised. I was like, 'Well, yeah, of course the broker wants to sell today. Come on.' And I know that's been your stance. And look, you were right. I don't know. I think for us, as we look at it, we look at it very much on an individual asset level. So there are still some assets in our portfolio where I think the strike today makes sense, particularly if I've got a renovation coming due over the next 12 months. There are also some assets in our portfolio where I could probably sell them and I'd hate the price, and I think I'm better off in some of these markets that I just talked to you about. You shouldn't expect us to go double down in Baltimore or Minneapolis or Louisville. I think even you would tell me you probably don't want to sell those today because the buyer you're going to get is a distressed buyer buying off of highly impaired cash flows, at least temporarily impaired cash flows. I think I'm better off letting the cash flows of those hotels recover, which is happening now, and selling into a little bit better capital markets environment. But I think the point you highlight that's been absolutely true is I think as an industry, we've been hanging on to a better capital markets environment being around the corner for 12 months, and it hasn't materialized. I do think it will happen, but I think part of why sellers start to capitulate is because it just hasn't materialized. At some point, transactions need to happen.

Yeah, well, good. Look, I think obviously it's an encouraging stat. I think that's exactly right. I think people get a little too fixated on distress and when are we going to see distress, and less focused on when are we going to see highly motivated sellers. I think the environment for having a lot of highly motivated sellers is certainly going to be there. I think we're there. It's again, 'I don't want to, but they're trading.' Hey, we don't see it turn around anytime quickly, so let's make the tough decisions and move on.

My pleasure. I don't know, but we need to get together soon. This is always fun. I always appreciate you hosting me. Or am I hosting you? I can't remember. I think it's probably my turn, so Austin it is.

Yeah, perfect. And then a two-hour baseball game where we don't sit down. That's right. It's great. Let's do this.

Appreciate it. Thanks, D. Thanks, brother. Bye.