How the Economy and Shifting Capital Stack Impacts Hospitality, with Peachtree’s Greg Friedman

Episode Transcript

Greg Friedman: It’s actually probably good for corporate travel because I think a lot of businesses are going to be looking for ways to generate new business. And what’s the best way to generate new business is get on the road and see your customers, although they’re going to be looking for potentially ways to cut back expenses. But most corporate balance sheets are very healthy. So they’re going to be wanting to spend money and get in front of customers and they’re going to be forcing more and more people to return back to the office. And as people return to the office, that gives reasons for why someone should travel. 

Robin Trimingham: Welcome to the Innovative Hotelier podcast by Hotels magazine with weekly thought provoking discussions with the world’s leading hotel and hospitality innovators. Welcome to The Innovative Hotelier brought to you by HOTELS magazine. I’m your host, Robin Trimingham. Interest rates have climbed sharply over the last year. Inflation is running at over 6%. Consumer credit card debt is up sharply, and restarting student loan payments in the US promises to strangle consumer discretionary spending. On the flip side, the stock markets are approaching all time highs. Us employment data has wildly exceeded expectations and talks of an economic soft landing seem wishful thinking on the hotel side. Triple A is projecting a record breaking summer travel season. Luxury properties are booming and traveler demand remains strong despite increasing prices. So what do we make of these conflicting signals? Where is the hospitality market headed generally? And more specifically, how are capital markets responding to these dynamic circumstances and how will the capital stack likely shift for developers in the next year? Join me now for my conversation with Greg Friedman, CEO of the Peachtree Group, as we discuss his outlook for the hospitality sector and the associated capital considerations. F.O.H. is a global food service and hospitality company that manufactures smart commercial grade solutions. Headquartered in Miami, the company designs and manufactures all their restaurant and hotel products. They have showrooms and distribution centers located throughout the globe, and their products are always in stock and ready to ship from any of their distribution centers worldwide. Welcome, Greg. Thanks so much for taking time out of your day to chat with me. 

Greg Friedman: Yeah, thank you. I really appreciate the opportunity to talk with you. 

Robin Trimingham: Well, I think it’s going to be a pretty fascinating discussion. As I was saying before we started all of this, I’m a pretty big fan of your LinkedIn posts, so I know that you have a lot to say about what’s going on at the moment. So just to get us started here, Auburn, I’m going to call this weird moment of uncertainty in the US and other Western economies in that we have economic forecasts ranging from complete doom and gloom to others who are saying we’re going to avoid a recession altogether. Where do you see the US economy headed over the next 12 months and what indicators are you referencing when you give us your opinion? 

Greg Friedman: Sure, it’s a great question. It’s a really tough market to figure out today. I don’t think anyone has conviction necessarily in exactly where everything is going to head just because there are so many moving pieces. And this is a very unprecedented time that we’re going through just given what happened during Covid, the amount of liquidity that was pumped into the system. And now with what the Fed has done just from raising rates so quickly. So it’s causing a lot of atypical events, causing a lot of pain in the market today as well. But with that said, I personally continue to sort of pay attention to the liquidity in the market and how much capital is still in these money market accounts or have flowed into money market accounts. And there’s a record amount of liquidity that’s sit in money market accounts today. The other factor that I’m paying attention to a lot is just the job market. And the job market continues, although it’s soft and a little bit, it continues to remain really strong. And I think there’s just some structural challenges there on the Labor side that’s going to cause the job market to continue to remain strong. And I’m a big believer that ultimately consumer activity drives 65% or more of the economic activity in the country. And so if consumers continue to have relatively healthy balance sheets that continue to be employed, I think that’s going to continue to drive what’s happening from an economic perspective where if their balance sheets start to erode, along with them losing opportunities to be employed or losing opportunities to make income, then obviously that could have a very negative impact on what’s going to happen. 

Greg Friedman: So my view, just based on the strength of the labor market, based on the current balance sheets of most of the consumers and also based on the balance sheets of corporations which continue to remain strong for the most part. Obviously, there’s been some weakening across some of the tech companies and so forth. But for the most part, corporate balance sheets continue to remain strong, too. So when you look at all those factors, I don’t necessarily think we’re not going to have a recession. I do think we’re going to have an economic recession. But personally, I believe it’s going to be relatively shallow. I think the Fed is committed to getting inflation down to 2%. I think it’s going to be very challenging for some of the reasons I just mentioned, just with the labor market, some of the structural challenges there and with the consumer continuing to show signs of resiliency as well as just corporate balance sheets. So I think it’s going to continue to be a very choppy environment, but I don’t think we’re headed towards a hard landing per se. I think we’re going to have a relatively a shallow or soft recession and I think that bodes very well for the hospitality industry. It’s based on the factors I’ve mentioned. 

Robin Trimingham: It’s interesting when you reference the labor market, because I agree there’s something that’s just not, I’m going to say a little bit different about what’s been going on. There seems to be a disconnect between those looking for employment and perhaps jobs available. One of the interesting things about my position is I get to talk to everybody and an interview that I actually just completed earlier the day, one of the things that came up is how quickly AI is changing training and you can install a brand new AI based system and all the training is user friendly and comes with it. So the lag time between hiring and being up to speed and able to do the job is virtually disappearing altogether. It’s kind of cool. You’ve written extensively that hospitality is uniquely positioned to thrive as a real estate investment in a persistently high inflation economy. Can you talk about why you say that’s the case? And I’m also interested is. A point at which sticker shock starts to bite into this and consumer demand drops off. 

Greg Friedman: Yeah, there’s definitely that risk as pricing continues to grow. You could argue that potentially there is some pushback by the consumer. So at some point that is a risk factor. But historically what we’ve found within the hospitality industry, inflation is a good factor for hotels because hotels reprice daily. So it does get the benefit of higher inflation. That’s part of the reason I believe it’s a good thing. I think the other part of the reason why I think elevated inflation because I don’t think we’re going to I don’t think necessarily we’re going to remain at the inflation rates we’ve seen over the last 6 or 9 months and the inflation is coming down. It’s just not coming down quick enough. But I think inflation personally believe inflation is going to be a little bit more elevated than where the Fed would like it to settle. So we end up around that three 3% range, maybe a slightly higher. And that’s actually a really good thing for the hotel business, not only to mention the repricing ability on a daily basis. And so hotels become a really good way to hedge if you’re investing capital. Hotels become a great asset class to hedge your position against inflation. But then the other side of the coin is, if you think about it, historically, inflation is a good indicator of where the ultimately where the ten year Treasury rate and I call the ten year Treasury rate the risk free rate, that’s usually a good indicator of where that ten year Treasury rate or the risk free rate’s going to price at. And so if inflation arguably settles around 3%, you would argue that on average over the last 50 years or so, inflation typically is roughly about 150 bips to 200 bips below where the ten year Treasury rate would be. 

Greg Friedman: So if inflation settles around, say, 3%, that means technically the ten year Treasury rate should be around four and a half to 5%, arguably. And then when you look at historically, the risk premium spread for cap rates. Cap rates tend to be, call it on average about 150 basis points to 280 basis points above the ten year Treasury rate for just middle of the road commercial real estate, which includes hotels and all asset classes. And the reason I mention all this is that ultimately you’re going to continue to see this repricing across all commercial real estate assets because during the pandemic, you notice a lot of asset classes had this huge compression in cap rates. It was interest rates dropped next to zero because of the reverse side of the equation I just mentioned. And so the risk free rate went down to effectively zero during the pandemic. And now all of a sudden you’re dealing with this situation where all these asset classes are going through this repricing. And I think hotels in a say, an elevated inflationary environment because hotels trade at higher cap rates in general, because most hotels typically trade at a 7 to 9% cap rate range. Some hotels trade at higher levels, some hotels trade at lower. But the hotels that we primarily focus on, which is service limited service, extended stay hotels tend to fall in that 7 to 9% range. And so you actually have risk premium spread that equates to the risk that you’re taking to invest in those assets. And so it’s very compelling to be an investor in the hospitality space. 

Greg Friedman: So I think it’s going to definitely thrive as a potential investment vehicle because of those two factors. Just given the fact that it trades at elevated spreads. On the cap rate side, it’s historically traded at that level. It’s continued to trade there and it continues to have that risk premium spread. We have the ability to reprice on the on a daily basis to take advantage of inflation. And probably the third factor that gets probably a little bit overlooked, I think more people are talking about it today is just the lack of new supply because usually when you’re headed into a economic recession, you have a record amount of supply that needs to be absorbed. And that’s what really exacerbates any economic recession. It makes it really painful for not only investors, but for operators in the lodging business this time around. I mean, supply is is growing at roughly about 1%. Historically, demand is growing at about 2%. Demand is surging today just given the recovery in lodging that’s taking place, obviously, and it continues to surge across a lot of these markets that are relying on group business. Corporate demand is starting to come back. Obviously, leisure demand has remained elevated. It’s starting to pull back some. But even with that pullback, hotels continue to have really good headwinds on the demand side and secular trends that I believe that are going to be sticky to favor demand. So you just have really good, I would call it demand fundamentals relative to the supply growth that continues to make lodging a very good investment vehicle for the next 3 to 5 years or longer. 

Robin Trimingham: I follow what you’re saying. I want to ask you about new construction, because some people that you talk to talk about new construction having practically dried up practically in urban areas if we’re in. In a reality where inflation is roughly 3% for the next, say, 18 to 24 months. From your perspective, how is that going to impact new construction in the hospitality sector? 

Greg Friedman: I personally believe it’s going to continue to compress or really make it very challenging for new construction to take place with elevated inflation. Obviously costs more to build, so developers have to be more selective, coupled with the fact that there’s a lack of debt in the market altogether. Most lenders like to finance existing assets. They don’t like to finance construction, so there’s less capital available on the debt side, which ultimately means the lenders that are lending on development deals are lending at lower leverage points. So they’re requiring more equity to go in these projects. But it makes it very challenging for anyone to develop, given the fact that projects are costing more and they’re having to deal with the need for more equity and there’s less lenders even willing to finance. To me, it’s a great thing for developers that can develop and markets that truly need new supply. That’s why from a standpoint of us as an organization, we’re very bullish on continuing to develop hotels today because there are a lot of markets that are underserved from a supply perspective. And so we’re able to in this environment because most groups are unable to develop and so we’re able to take advantage of a lot of markets that historically we wouldn’t have the availability of sites or the availability of brands, given just the lack of developers that can get finance were able to take advantage of it. 

Robin Trimingham: Yeah, I have to say, some categories are really having a moment like extended stay, I understand is one of them that’s just surging at the moment. A lot of these hotel business models, though, were developed under the assumption that there would be low inflation. Do you expect that we’re going to see what some people are going to call fire sales or increasing demand for mezzanine lending or even portfolio collapse, heaven forbid, as the reality sets in that interest rates aren’t coming down anytime soon. 

Greg Friedman: Yeah, I’m a big believer interest rates are going to remain elevated for longer, given the fact that the Fed’s not going to have any reason, just assuming inflation remains where I think it’s going to remain for the next several years, there’s going to be very little catalyst for the Fed to drop rates. And so if interest rates remain higher for longer, I do think it’s going to start and it has started to create some balance sheet distress, I would call it, where groups are dealing with higher interest rates that is impacting their cash flows. And in some cases it’s creating negative leverage or the hotel itself is doing really well. It’s just not producing enough cash flow. So they’re actually they’re actually hitting projections or even exceeding projections in some cases. But no one budgeted for interest rates to be 200, 300% higher than where they had originally did their underwriting. And so that is creating challenges where ultimately, as groups are looking to refinance shorter term loans that they may have received over the last several years when they acquired assets or refinance assets, they’re going to be forced to do these fashion refinances where they’re going to have to bring capital to the table in order to pay down debt. And so I do believe that’s going to cause a huge need for preferred equity for debt to help effectuate some of these refinances or even keep the existing lender in place because the existing lender is going to be hard pressed to renew the loan at loan maturity unless there is a paydown in order to get the property back into compliance on a debt service coverage or fixed charge coverage ratio perspective. 

Greg Friedman: And so I do believe that’s going to cause some distress and there’s going to be a need for more mezzanine and preferred equity. You’re starting to see that across some of the other commercial real estate asset classes like multifamily and industrial and self-storage, because those assets trade at much lower cap rates. So the balance sheet distress has been much more impactful at this point. Hotel is just trading at higher cap rates. And so ultimately they’re at higher debt yields. So they’ve been able to stomach these higher interest rates up until now for the most part. But you are starting to see some examples of groups that are facing this balance sheet distress and being forced to take on either new partners, mezzanine capital, take on preferred equity or even just being forced to sell the asset. And it’s going to create opportunities for groups to buy assets at quite a more fair valuation. 

Robin Trimingham: That kind of leads me to my next question. So you definitely had a LinkedIn post where you talked about this being the golden age of the private lender. And you’ve talked earlier in our conversation today about the millions and billions of dollars that sitting in money markets or earning a nice, cozy 5.5%. How do you convince those people with the safe money in the money market that they really do want to get out of that and invest in real estate for the hotel industry? 

Greg Friedman: Sure. So I think right now being in private credit is a great place to be because ultimately we’re lending at lower leverage points. So ultimately, we’re filling the void that’s been left by a lot of these regional banks, some of the national banks and community banks that are no longer lending, which typically the banking system provides about 40% of the capital needed for for hotel assets, if it’s construction loans, acquisition loans or even refinances, about 40% of the market comes from regulated banks. And due to the fact that banks are not lending at the level that they once lent, you’ve got to CMBS and market that is not as effective or as efficient as it once was either. And that makes up about 30% of the market as well. Private lenders like ourselves under we have Stonehill, which is our private lending platform, and Stonehill is able to thrive in this environment because in a lot of cases we’re able to lend at lower leverage points. So we’re able to do lower loan to value points that typically a traditional bank would be financing the spreads that are elevated, just given the risk in the market for getting paid very well to take on that risk. And so ultimately, for someone that’s out there trying to invest in private credit today, I think they’ll find when they’re investing in private credit in general, they’re getting paid a much higher spread than what they would be able to receive investing that money in a money market account because the money market. 

Greg Friedman: An account today would probably pay a rate that’s around 5%, maybe a little bit less or a little bit higher, depending on how that money market account is structured. So give or take a hundred bips. But ultimately, if you’re investing in private credit today, in general, you’re getting double digit returns. So you’re getting good, I would say on average a good at a minimum 5 to 700 basis points or more risk premium spread to be invested in a debt position. That is, in a lot of cases it’s in a very protected position. I mean, there’s still downside risk and that’s part of the reason you’re getting paid that risk premium spread. But I personally believe it’s a better place to be invested because you’re you’re getting much higher returns on the fixed income side and you’re typically going to be invested over the shorter term because most private lenders are lending over to 2 to 3 year period of time. 

Robin Trimingham: I think you may have answered my next question, but let’s try it from the other side of the street. When you’re the lender and you’re not really making money when you’re sitting on the sidelines, okay, it’s safe in the money market. But how do you assess the risk of not investing? 

Greg Friedman: Yeah, it’s sort of easy to not invest because if you don’t invest, you’re not taking on any risk. And myself as an investor, I’m not afraid to sit on the sidelines because ultimately when you invest, you can also lose money. So you buy, you buy. I’ll use an example. You buy Enron stock in 2000. It’s obviously eventually becomes worthless in 2003 or whatever time period. Right. So if you held on to that stock so you can lose money no matter what you buy. And Enron back in 2000 was a thriving company. And in 2003 or again, whatever time period you want to use or whatever, it ended up becoming insolvent. Eventually it became eventually became insolvent in worth zero. So anytime you make an investment, it could potentially become worth zero. If you make no investment, you obviously lose money. People would argue maybe you’re losing money because of the inflation rate. So if you appropriately hedge yourself by investing in a money market account or in a potentially buying treasuries, and that’s why I’m a big believer you’ve got to look at when when I’m making investments, I look at, okay, well, if I’m going to invest in something very safe and very liquid, if I’m going to, that’s like in today’s environment, the ten year Treasury is roughly three caught, 375. So it’s roughly 3.75%. So I want to see that I can get a return that’s considerably higher than that in order to make an investment. 

Greg Friedman: And when I say I want to get that return, I want to be able to invest where I feel like I have limited downside risk because again, all investments carry downside risk, but also have the ability to get huge upside off of that risk free rate of 3.75%. And so it’s one of those that you’ve got to if you’re investing capital, you’ve got to have conviction that you’re going to be able to generate those returns and also be protected on the downside. But you’ve got to also appreciate and understand that there’s there’s no guarantees you’re going to be able to make money when you invest capital. So unfortunately, you can buy public securities, you can buy you can invest in private, private offerings, and they always carry risk. And that’s why you really got to pay attention to what the actual investment managers are doing in order to protect their position when they’re investing capital. And that’s why us as a firm, when we invest capital, there’s certain underwriting, there’s certain types of markets, certain types of assets that we like to invest into because we believe they carry lower risk and they put us in a position to protect our downside and let you know, let our upside work itself out. 

Robin Trimingham: Well, I have to agree. It’s certainly a time when you really have to do your due diligence and know and understand what you’re getting involved in, particularly if it’s going to be your first foray into a new kind of investing, such as the hospitality hotel industry established in 2002, is a woman owned global food service and hospitality company that manufactures smart, savvy commercial grade products, including plateware, drinkware, flatware. Hotel amenities and more. Driven by innovation F.O.H is dedicated to delivering that wow experience that restaurants and hotels crave all while maintaining a competitive price. All products are fully customizable, and many are also created using sustainable eco friendly materials such as straws and plates made from biodegradable paper and wood and PVC free drinkware. F.O.H has two established brands. Front of the house focused on tabletop and Buffet Solutions and Room 260, which offers hotel products. Check out their collections today at  FOHWorldwide.com. So Peach Tree is about as vertically integrated as it gets. You guys have managed funds, you undertake development and investments. You do mezzanine and bridge lending. You ultimately manage hospitality properties. From a client perspective, what are some of the advantages of that level of vertical integration? 

Greg Friedman: Sure someone that’s doing business with us, like within our lending platform. I think it’s a huge benefit for them just because we really understand the business from all aspects. So for providing a construction loan to someone that’s building a new hotel because we do a lot of construction financing and first mortgage lending where we do construction loans, we do a lot of JV transactions on the development side as well. And so as a partner or us as a lender in those projects, just to use those as examples, we really understand the challenges on the development side. We also understand the operating challenges once the hotel is open because we do develop and we do operate ourselves. And so we become a really good sounding board and we’re able, when things aren’t working out to the way that everyone likes, we’re able to sit down and really look through and help restructure deals to hopefully put the put the asset in a position to be successful. Whereas I think a lot of times if you’re using a traditional lender or a traditional equity source, they may not have a full appreciation for the challenges within the hospitality business, especially because the hospitality business can be very volatile too, especially during any time there’s some type of economic disruption or some type of black swan event that can have huge impact to our business. And I think just our appreciation for it allows for our clients or people who are doing business with to to be able to make it through some very tough situations. And a good example is the pandemic we just went through. 

Greg Friedman: It was a very challenging environment we were able to work through on the debt side with everyone we were able to work through in a lot of cases doing debt deferments because there was no cash flows at the hotel level. So we were able to help restructure the loans to ensure the ultimate success of the various groups that we had lent money to pre-pandemic. That also allowed us in the middle of the pandemic. We were one of the few lenders still lending because we had an appreciation for the business. We also had really good data internally to where the business was headed, so we were able to pivot during the pandemic. And while a lot of traditional lenders and a lot of traditional equity sources were not willing to invest, we were making a lot of new investments, both on the direct lending side where we were financing groups to go out and acquire or refinance assets. We were also buying a lot of debt. We bought over 180 loans during the pandemic. We bought 19 hotel assets during the pandemic as well. So we were able to pivot and make those investments because we had, you know, we truly had an appreciation for the business and the and really had a good had a really good thought for what the the intrinsic value of these underlying assets. And so we felt very comfortable to invest capital and most groups were unwilling to invest capital on the equity side or even willing to make loans to the hospitality space. 

Robin Trimingham: I think you’re making a very interesting point because when you have a business model in which you’re involved in all sides of the hospitality industry, you have a 360 view of the whole thing. And I would imagine that would make you able to do what I’m going to call creative problem solving a lot more easily than some of the other entities that somebody might turn to. But it doesn’t really matter who you are. If you’re borrowing at higher interest rates, then your returns to equity are getting squeezed. And then some deals are just let’s face it, they’re flat out not viable because of the circumstances. So what do you think? What sectors of the hospitality development are going to continue pretty much unabated and what sectors are going to be like? All but stopped. We talked about new construction. Are there any others that you think are going to be impacted at the moment? 

Greg Friedman: Yeah, I think as we speak right now, I think the transaction market is very soft on the equity side. So if you’re looking to acquire or develop just given the challenges, as you just mentioned, higher debt expense, it’s making it very hard to make projects make economic sense for investors to invest into. It’s making it very hard for lenders to lend to a lot of assets. That being said, not all markets, not all deals are equal. So there are deals, there’s acquisition opportunities, there’s development opportunities where it still makes sense even with this higher interest cost. And so you do have to be more selective in this environment. I think when you look across the board, select service, a limited service, hotels, extended stay hotels, personally I think still offer very compelling risk return and investment opportunities. So I think that’s probably the we look at the risk reward. I think that’s it’s very compelling in the select service, limited service and extended stay sector, it’s a little bit more challenging on these larger full service hotels right now just given the higher interest costs and a lot of times. Those assets, depending on the location they may trade at, especially when they’re in dense urban locations or even really any asset that trades at lower cap rates across the hospitality space. It’s definitely putting more pressure because that’s those assets face more negative leverage. So it definitely makes those assets a little bit more challenging. But for the most part, I think select service, limited service, extended stay hotels on the acquisition side continue to be very compelling. But it doesn’t mean that all investments make sense right now because most investments don’t. And that’s why you’re seeing the transaction market really slow down just given the fact that a lot of assets, they’re not at a level where buyers are willing to pay the pricing that sellers need in order to transact or it doesn’t make sense to even develop just given the cost of development layered in with the interest expense. It just ends up diluting returns to a level where you’re not getting paid to take on that risk. 

Robin Trimingham: Yeah, I would imagine you not just have to really do your due diligence. I think you have to really understand forward bookings and what jurisdictions are going to be trending up and can you marry up the two things all at once? Warren Buffett has a famous quote. He says, Be fearful when others are greedy and greedy when others are fearful. So it’s fair to say there’s a fair amount of fear for many in the hospitality sector at the moment. Can you talk about any areas where that fear is justified, and are there any others where you think it’s really time to take action? Seize the day right now? 

Greg Friedman: I think in general in this environment, it’s hard to have a strong conviction one way or the other. I do think it’s a little bit premature to have total fear just because the actual underlying performance across hotels remain very robust. But I do think on the flip side, I think a lot of groups are really betting on the fact that interest rates are going to be lower. So they’re looking at the forward curve and they’re dealing with higher interest costs. I say they’re betting on the fact that interest rates are going to be lower. And I think that’s another area of concern right now where I think groups need to need to really pay attention to that piece. Because if you’re expecting interest rates to decrease in order to make your underwriting work, you may be disappointed and may end up not hitting not only hitting the returns, but you may end up continuing to deal. If you’re in a negative leverage situation, for instance, you may continue to be in a negative leverage situation down the road, which is going to lead to more of that balance sheet distress. What we’re dealing with today. I still think it’s somewhat early just because there’s more questions than answers. But I think ultimately, given the fundamentals and as we talked about earlier today, just looking at what’s happening across the consumer, looking at what’s happening across most corporations and just how we’ve had so much lead time, we’ve just had so much timing ahead of this economic recession that we’re about to go into. 

Greg Friedman: So I think most groups have been able to plan accordingly. I don’t think necessarily there’s a lot to necessarily be fearful of. I think it’s more being in a position to take advantage of opportunities when they do become available and knowing when to be patient as well. And I think today is a perfect example where it does pay to be patient. But I do think certain strategies you can probably invest more capital like for instance, on the private credit side, I think that’s an area where I would not be fearful to go lend into today. Unfortunately, I think a lot of banks are very fearful to make new loans on hotels today given the unknown of the economy and just given what’s happening across all asset classes. So they’ve all pulled back as well as just regulatory pressure. But this is the time environment where I would not be fearful to go lend. I would be very cautious, though, to go out and be buying a lot of hotels or buying a lot of any commercial real estate and taking on that last dollar of risk until there’s more certainty on where where everything’s headed from, not only an inflation perspective, but where the Fed’s going to settle on the interest rate side, I do think we’re headed towards a inflection point on this cycle, and I think that inflection point is going to become a little bit more clearer this summer. 

Greg Friedman: And assuming the Fed doesn’t, assuming they end up not raising rates materially higher than where they are right now, I think that’s going to start to create an environment where you’re going to start seeing a lot more transactions because I think people will be able to be able to fully price where assets should be valued at as they look at where the ten year Treasury rate is probably going to settle out as well as they start to look at where the ultimate cap rates should be to price appropriately all commercial real estate assets, including hotels. And also they will have better visibility into any potential pullback in lodging because you are seeing some pullback in some of these markets that were huge winners during the. Endemic and some of these leisure markets that historically didn’t perform at the level that they performed during the pandemic. Some of those markets are starting to pull back. So would be a little concerned in those leisure markets investing heavily today just based on I expect some of those markets are going to normalize back to where they were pre-pandemic. 

Robin Trimingham: Yeah, it will be interesting to see what the impact of all that surge in staycation was towards the end of the health crisis. You talked about looking for opportunities. How do you go about evaluating whether an investment opportunity is viable? 

Greg Friedman: Great question. We look at it two different ways. We look at it qualitatively and then we look at it quantitatively. So qualitatively we look at investments. We look at the actual submarket, the quality of the asset, the branding. What type of segment does it play into? Is it full service versus service or extended stay? So we look at those type of factors along with what’s actually driving demand and the sustainability of those demand drivers. And then quantitatively, we obviously underwrite the actual performance of the competitive set along with assuming it’s an existing asset along with the historical performance of that specific asset. And so we’re factoring in the ability what that asset has done historically, but also our view of how that asset is going to perform over the next 3 to 5 years as well. And so we’re underwriting those factors when making a decision and we’re balancing out the qualitative side as well as the quantitative side. And if we’re looking to make a loan, we want to see that. Obviously, we want to make sure we’re in a position to get paid back. 

Greg Friedman: So we want to see that the sponsor or the borrower is buying an asset where where we feel like they’re in a very good position on their equity, where they’re going to make good return. And if for the last dollar of a acquisition like so if we’re going out and buying assets or developing assets ourselves on the equity side, we’re going through that same exercise. But in that case, we want to feel have full conviction that we’re not going to take on any risk on the downside because there’s always risk. But we want to make sure our risk is mitigated because we’re in markets that have very sustainable demand drivers. We’re in at a great basis. We have the right brands. We’re looking at those kind of factors, but also making sure the model provides the opportunity to get the returns to compensate for the risk that we’re taking. And assuming all those items lined up, then usually we’re going to go ahead and make an investment into that asset if it’s on the equity side or even the debt side. 

Robin Trimingham: Couple more questions for you here. A lot of hoteliers themselves are really quite optimistic at the moment. They’re talking about how strong the tourist season that we’re embarking on is looking. But I keep looking at the fact that international travel is still not where it once was, particularly in my home jurisdiction. I live and breathe this every day. Do you feel that the hoteliers perspective is by and large justified, or do you feel that they might be missing something here? 

Greg Friedman: I think it’s cautiously justified. So I want to I want to make sure I put that caveat there, but I think it’s cautiously justified. I think you look at forward bookings, everything points to us having a really good summer. So we expect that we’re going to continue across our hotels that we own and operate, which we have about 100 hotels that we own and operate. And then we’ve got over 200 debt positions, primarily first mortgage loans on different hotel assets. And for the most part, everything points to having a really good summer as well as potentially having a really good fall as well. So I think I think hotels are very well positioned, but I do think there’s risk in the marketplace. I do think international travel is starting to come back. It’s just it’s been somewhat slow. I think corporate travel is rebounding as well. And I think as more and more companies reopen their offices, you’re seeing more and more demand come back on the corporate side and you’re continuing to see this this bleisure travel, the blending of business and leisure travel, which I think to some degree it’s making it harder to really quantify if a traveler is. 

Robin Trimingham: The travel or leisure. 

Greg Friedman: Yeah, exactly. So I think there’s a little bit of misunderstandings there. But I think overall the hotel business is very well positioned. I think there’s just really good secular trends in this whole hybrid work model continues just to help drive new demand into lodging. So overall, I think it is justified. The optimism. I do think you got to be somewhat cautious and realize that historically when we go through an economic recession, which I expect will be on one later this year, although I think it’s going to be relatively soft. But historically, every economic recession, you do see a pullback in demand for hotels. I think there are a lot of factors that make this time a little bit different. One being, as we mentioned earlier, just the lack of new supply in the market that needs to be absorbed and the lack of new supply. That’s even on a forward basis. When you look over the next 2 to 3 years, there’s just not a lot of new supply that’s going to start construction. So I think the hotel business is very well positioned there. And so I personally I’m very optimistic that hotels, given that that factor and just along with the huge amount of just pent up demand for travel and you’re seeing this spend of dollars by consumers are going towards experiences and less in services and less towards goods. So I mean, just think all those factors lead to a it should be a very healthy travel for the rest of this year for the consumer as. As well as for even corporate travel. 

Robin Trimingham: Yeah, I think what you’re saying is very insightful because traditionally what happens with the economy and what happens with travel and tourism, they’re at opposite ends of the spectrum. So even if the economy takes a dip, travel’s already been booked and on a lot of leisure cases already paid for. So it happens. And then you have to wait for the economy to pick up before you get another booking surge. So you could well be right about what we’re looking at later down the road. 

Greg Friedman: And I just think people coming out of Covid, I think most consumers, most people recognize that travel, you may not be able to travel in the future because due to unforeseen circumstances like Covid, for instance, where there was mandated lockdowns. And so I do think people really appreciate and value the ability to travel and see the world and see family members and friends. I really do think you’re going to continue to see this outsized flow of dollars from consumers and from other sources where they’re going to choose to spend their dollars on experiences like travel versus going out and spending dollars elsewhere. And so I think it just hospitality puts lodging in a really good place going forward. And I also think a lot of corporations, if we do end up heading into this economic recession that I think will end up in the latter part of this year, it’s actually probably good for corporate travel because I think a lot of businesses are going to be looking for ways to generate new business. And what’s the best way to generate new business is get on the road and see your customers, although they’re going to be looking for potentially ways to cut back expenses. 

Greg Friedman: But most corporate balance sheets are very healthy. So they’re going to be wanting to spend money and get in front of customers and they’re going to be forcing more and more people to return back to the office. And as people return to the office, that gives reasons for why someone should travel. And it’s funny, earlier today I was listening to someone talk about there’s been like a study done. I forget who did the study, but basically they came to the conclusion that Zoom, you can’t innovate over Zoom. Zoom is proven to be a very poor tool to be able to to innovate new ideas, to be able to collaborate. You really do need to be in person. And I think there’s just a lot of tailwinds on the innovation side, too, with AI and everything else that’s going to require people to get into one room together and that’s going to even drive travel. So there’s just a lot of random factors like that that I think benefit travel in general that should give us several good years in front of us of the need for new travel. 

Robin Trimingham: Yeah, I think it’s going to be a very interesting time. Yeah, I’ve got a couple of minutes left here. Question that I ask a lot of people that I chat with. You’ve got a pretty unique perspective on a lot of the hospitality tourism sector because you’re so vertically integrated in what you do. Do you see a common mistake that you feel is currently made by hotel owner-operators? 

Greg Friedman: And you sort of mentioned earlier, is just expecting interest rates to drop? Do you think interest rates are going to stay higher for longer? I think that’s probably the the biggest mistake a lot of groups are making on the investment side when they’re considering investments is just factoring in the fact that rates are going to be higher for longer. And I think just from a standpoint of when you look at operating expenses, obviously operating expenses have come down materially during Covid. They’re now starting to come back as we get fully heading towards full employment across hotels because we continue to not be fully employed and just having an appreciation for the true expense load going forward for all hotels. Although our hotels being select service, limited service and extended stay hotels tend to be less impacted because there’s less labor needs. But we’re all still impacted where that’s going to put pressure on the operating cost side and making sure you factor that into your underwriting on investment. So those are probably two areas that come to mind where groups are probably not fully appreciating or making mistakes. 

Robin Trimingham: Greg, I want to thank you so much for your time today. You’ve certainly given us all quite a lot to think about. You’ve been watching the innovative hotelier. Join us again soon for more up to the minute insights and information specifically for the hotel and hospitality industry. You’ve been listening to the Innovative Hotelier podcast by HOTELS magazine. Join us again soon for more conversations with hospitality industry thought leaders.