With new development challenged, conversions are today’s growth vehicle. Four case studies offer different approaches to striking deals.

Hyatt Hotels Corp. was willing and able to de-flag another hotel in St. Louis to win the contract for a big trophy hotel acquired by Chartres Lodging Group.

For the foreseeable future, conversions will be the predominant development vehicle for franchisors, management companies and owner-operators. As credit remains tight, brand developers are spending much more of their time chasing lenders who are reclaiming suffering assets, as well as debt and equity players taking advantage of discounted acquisition opportunities. In each case, the new landlord needs to quickly maximize revenue by competing more effectively and attracting new sources, usually via the benefit of a more robust reservation system. Nine times out of 10, that means flying a new flag.

Brands competing for the best opportunities are cutting deals left and right by being more flexible with property improvement plans (PIPs) to aid owner ROI, offering ramp-up time with some fees until cash flows improve and providing key money to help reposition properties in serious disrepair. For owners, choosing a new brand is largely market-driven, says Steve Rushmore, founder of HVS International, the Mineola, New York-based consulting giant. “The question is: What is the best brand currently not in the market that will bring in the highest RevPAR?”

Non-chain operators have also identified this opportunity, preferring to “white-label” their management expertise and let the asset speak for itself under a new, improved direction. “In many cases, this is, perhaps, neither a conversion nor reinvention—simply a rather late acceptance of what should have been done some time ago to maintain market share,” says Philip Bacon, managing director of HVS Madrid. “It is likely that in some cases, things were going OK and there appeared to be no need to fix anything until it was too late.”

In either case, conversions offer realistic ways to reinvent hotels struggling during this downturn. In this report, HOTELS looks at recent conversions completed by Hyatt Hotels Corp., Accor, Starwood Hotels & Resorts and Hilton Worldwide. Brand leaders talk about deal structures and their outlooks for further conversions going forward. We also talk to property owners about the challenges of completing these specific deals, as well as their expected ROIs.

Hyatt Regency St. Louis at The Arch

The 910-room Hyatt Regency St. Louis at The Arch had its grand reopening in July after a US$62 million, top-to-bottom renovation by owner The Chartres Lodging Group, San Francisco. This former Adam’s Mark property was acquired in February 2008 as part of a portfolio deal, and Chartres chose Hyatt because it was willing to de-flag another Hyatt in St. Louis and bring that existing customer base to the new hotel, according to Maki Bara, managing partner and a co-founder at Chartres. “Hyatt had presence in the market, which was the most important reason we chose them,” she says.

It also helped, Bara says, that Hyatt was willing to provide key money to help with the costs of the renovation and was more flexible on its brand standards. But what made a big difference, she says, is that “Hyatt married its buttoned-up corporate culture with an entrepreneurial spirit that resonated with our nimble platform.”

Bara was swayed by what she calls Hyatt’s cutting-edge cost-savings initiatives. “All brands are looking at making things more efficient while maintaining standards, but Hyatt was on the cutting edge with things like housekeeping standards that didn’t require a full clean everyday,” she says. “They looked at everything and didn’t say they had to do things the way they are always done.”

Throughout the renovation, both the owner and manager focused primarily on ROI more than cost savings, in some cases adding scope to the project while looking to save elsewhere. For example, they used US$750,000 to turn an underutilized rooftop pool and racquetball court space that targeted cheaper weekend business into and indoor/outdoor meeting and social banquet space. “We got a great write-up on weddings and are seeing great ROI,” Bara says. “Elsewhere, Hyatt gave us a waiver on the wall-covering PIP, and our designers found a cheaper way to make the wall coverings pop.”

Some challenges of the conversion cited by Bara were the result of being a bit hasty during the design process and the economic timing of leasing out some of the F&B space. At the end of the day, however, “We came up with great product that pleased all and everyone felt they had their stamp on,” she says

Measuring the results of the conversion has been tough, especially considering market conditions. “Compared to our pro forma, we are way off,” Bara admits. “But compared to pre-renovation, we are definitely higher, and bookings are what we have to look at. We have been completely renovated for less than a year and groups want to see final product. When we look into the future, booking pace rates are much higher than the pre-renovation pace, which is promising.” Bara adds that the hotel is trading 10% to 15% higher in rate and 15% to 20% higher in RevPAR post renovation. “We are still below target, but if you look at booking pace, you can double these numbers looking at future bookings,” she adds.

From Hyatt’s perspective, its strong group base had to be attractive to the new owner of a large hotel with significant meeting space. “The way you have to fill those rooms is by ensuring you have a strong group mix, and Hyatt brings that to the table. That was appealing to ownership,” says Gary Dollens, Hyatt’s global head of franchise and select brands. It also did not hurt Hyatt’s case that it had already proved its group prowess to Chartres in a previous Adam’s Mark conversion in Jacksonville, Florida.

Looking ahead, Dollens says Hyatt has good opportunity to compete for conversions, especially because it just got into the franchise business on the full-service side of the business. “We don’t want to convert just any hotel and put a Hyatt name on it. It is important that any hotel represents the brand the way we believe it should,” he says.

That being said, Hyatt recently converted the independent Ivy Hotel in San Diego to its new upscale Andaz brand. “We have a specific operating model in the public space, so to do a conversion we must be sure the model works,” Dollens says. “PIP dollars will need to go against that, and the same applies to our other brands.”

Hyatt is upfront about its ability to provide key money and mezzanine loans to offset some capital needs of the PIPs. Hyatt also tries to be sensitive to time factors and needs to ensure owners more immediately focus on things that impact guests, Dollens says. “We try to be considerate of the capital outlay and allow it to come in overtime, letting the owner use cash flow from property as part of the renovation,” he says. “We can also look at ramping fees in the first year or two until a property is fully renovated, knowing the first few years can be a struggle until the economy recovers.”

What might help Hyatt in the near term is its lack of global distribution. “We have fewer hotels than the other big brands, which creates a lot of opportunity for growth,” says Michael Coolidge, vice president of real estate and development. “We can focus on the best assets that fit our requirements.”

Dating back to 1878, Doubletree by Hilton Dunblane Hydro is located on 10 acres (4 ha) of landscaped grounds.Doubletree by Hilton Dunblane Hydro

Following a £12 million refurbishment, a property dating back to 1878 was re-branded in September as Doubletree by Hilton Dunblane Hydro in Dunblane, Scotland. In concert with Hilton’s development team in the UK, property owner The Ability Group transformed all aspects of the hotel, including guestrooms, public areas, bars, restaurants, meeting rooms and conference facilities.

“The owner thought he spotted great value in Dunblane and was determined to bring the property back to its former glory,” says Ian Carter, Hilton’s president of global operations and interim head of development. “It is a great spa location with 100 years of history. We went through the PIP with every room and agreed together (with the owner) what should happen. Hilton’s tech services came up with joint report with Ability, and the conversion took 18 months from start to finish. We had to operate through the conversion, which was tricky with rooms out of action. But everyone was aligned on the vision and willing to go through the hassle.”

Physically, the hotel was taken back to the wiring, which certainly creates a disruption. “We overcame that by allowing sufficient time and by the quality of tech services and the owner’s team,” Carter says.

When asked what sort of incentives Hilton offered to finalize the deal, Andreas Panayiotou, chairman of The Ability Group, one of the UK’s largest private residential landlords, says: “Obviously this is confidential, but what I can say is that this is not solely financially driven; it is more about long-term relationships, professionalism and brand recognition.” He adds that Hilton’s global distribution and marketing programs also helped seal the deal.

This hotel marks Hilton’s sixth Doubletree development in the UK, but even having had a history working with The Ability Group, Carter says Hilton was far from the only brand represented at the deal table. However, having advised The Ability Group on its first hotel acquisition in Cambridge, which is now outperforming the market by 50%, according to Carter, might have swung the Dunblane deal in Hilton’s direction. “The Cambridge hotel (a former Queen’s Moat House) was already running strong when we came in, which really proved we could add value,” Carter says. In fact, the Cambridge hotel has traded so well that Panayiotou is looking at adding a 53-key extension.

Whether or not the Dunblane conversion is as successful as Cambridge remains to be seen, says Nick Smart, vice president of development for Hilton in the UK. “We are establishing a new business mix in a tough environment. We have to do it, and the owner believes we are capable. A lot of time and money was focused on conference and banquet facilities, which is a part of the business that has a longer lead time. It will be about a year before we see the proof in the pudding.”

Not unlike its competition, Hilton sees conversions as the way forward in the near term and will try to be as flexible as possible to compete for deals. “There are brand standards that are core to our brands—some physical and some service delivery,” Carter says. “That being said, Dunblane was not a standard Doubletree, and what we try to do is be flexible in context of the country we are converting in.”

Doubletree sits well as a conversion model due to it flexibility, as Carter says Hilton does not insist on any certain amount of meeting space. “Capital expenditure costs can be lower and returns higher for owners,” he adds.

Conversion opportunities started to become more plentiful starting in the middle of last year, Carter reports. “We converted more full-service hotels last year than previous years despite the softening. We expect that to increase again this year,” he says. “Of the 200 expected openings this year, a higher percentage will be conversions, largely driven by deals outside the United States.”

Carter also sees strong conversion opportunities in the UK, as well as some in Italy and Eastern Europe. In the UK, Hilton has done 24 deals in last 25 months, with about half being conversions, Smart says. “Now we are seeing even more acceleration to conversions based on market conditions,” Smart says. “There is a flight to quality and brands, which is driven by banks and funders who are encouraging owners to adopt brands.”

In Asia, Carter points to China, Thailand and Malaysia—and, to a lesser extent, Australia. “Even in the Middle East, opportunities are emerging, and we will see more as distressed assets come to market,” he says.

Lastly, Smart says he is looking at office schemes that have run into trouble, particularly in London. “It is a sign of where we are in cycle when we get a chance to look at office conversions to economy hotels, as normally we don’t get a look,” Smart says. “We are looking at four or five office conversions that are secondary office markets but prime for hotels.”

Le Méridien Chambers renovation was a natural fit for the stylish brand and owner.Le Méridien Chambers

In February after six months of discussions, the independent, 60-guestroom Chambers hotel in Minneapolis was converted to Le Méridien Chambers, increasing the Starwood Hotels & Resorts brand’s footprint to 10 hotels in North America.

Hotel owner Ralph Burnet, who also owns W Minneapolis–The Foshay, located two blocks away from what was the independently operated Chambers, recognized the potential synergies of using Starwood to manage both hotels, making it an easy decision to convert to the Le Méridien brand.

Starwood looked at the style, art, architecture, design and cuisine—all focal points of the David Rockwell-designed Chambers, recognizing the potential for it to become a North America flagship for a brand trying to position itself as a creative hub in vibrant cities around the world.

For Burnet, the cost of the conversion was about US$400,000, with the biggest expense coming from having to change the locks. At the end of the day, Burnet expects to save “seven figures” annually by having Starwood take over management, not to mention the already noticeable difference its reservation engine is bringing to the bottom line. Within the first three weeks of the conversion, rates were up at least 10%, and reservations were picking up with the Starwood loyalty program making a big difference, according to Burnet.

There was no huge punch list of change orders to make it brand-specific, and Burnet was even able to keep some existing inventory with the Chambers logo, such as robes. “We had to add the hardware for the brand’s signature scent at the entrance and changed the feel of the art in the lobby a bit,” says Burnet, who has more than 200 original pieces of art in the hotel. “Other than that, the signage changed, and we had to change from hard keys to magnetic keys for security and brand standard, which was fine with me.

“We had two management companies within two blocks,” Burnet says. “There was two of everything—sales, accounting, etc. That was a big motivator to make the change.”

Starwood did not offer any incentives to make the deal, and Burnet now has a contract similar to what he has at the W. “I was comfortable with that and didn’t consider anyone else. I am thrilled with Starwood, and the GM has been outstanding, now overseeing both properties.”

For Starwood, the development and conversion mantra is “right partner, right property and right places,” says Paul Sacco, senior vice president of development, North America. “We have that in spades with Ralph. He understands and appreciates branding, particularly our brands, which is a crucial component for any conversion.”

Moving forward, Starwood has a similar point of view to the other big players—be quick and flexible in response to potential opportunities, and focus on ROI for owner-developers with realistic PIP expectations. “We are proactive not with just owners, but with lenders, consultants and brokers telling the story for all of our brands so everyone understands the messaging behind them,” Sacco says.

While the Chambers conversion provided a management opportunity, Sacco sees a mix of managed and franchise deals with the same ingredients applying for both. “There is a large, growing base of franchise owners in the U.S., but we still see a lot of activity similar to The Chambers. We own, franchise and operate hotels and want to have a healthy mix of all components—largely franchised and managed. You will see us do both in 2010.”

Grand Mercure Hadleys will have 200 guestrooms when its new tower opens.Grand Mercure Hadleys

Michael Doherty, owner of the historic Hadleys Hotel in Hobart, Tasmania, has gone to great lengths to commence work on a A$30 million expansion, which includes a new hotel apartment tower with 128 luxury suites and several new food and beverage outlets. It took six years to get this proposal through all approval stages because of the original hotel’s heritage status and Hobart’s very strict requirements when it comes to new developments. With such an investment of time and resources and at such a scale, Doherty decided he had to convert from a small Australia brand and take on a global brand. He chose Accor’s Grand Mercure, its specialist apartment brand in Asia Pacific, which took over management some two years ago.

Previously branded a Doherty hotel, the upscale Grand Mercure expansion is one of the largest private developments undertaken in Australia’s state of Tasmania. The project is scheduled for completion by the end of 2010 and will feature a grand ballroom, which will increase the meeting capacity of the hotel from 250 delegates to 600.

The work is taking place on an adjacent site to the existing hotel and will remain faithful to the historic style of the hotel. The addition will complement an earlier renovation of the existing building, which saw the exterior fully restored and refurbishment of all rooms and public areas, undertaken by Doherty Hotel Group. Doherty purchased the hotel in 1999 after the circa-1830s landmark fell into disrepair in the 1980s.

“We had run the hotel for 10 years, and that was fine when it was a boutique hotel with limited facilities, but we are going from a 70-room hotel to a 200-room hotel with nine F&B outlets, so it will be a substantially different operation,” says Doherty, managing director of Doherty Hotels. “The new hotel will target a global corporate market, and, therefore, it was important to get a company with widespread brand recognition and the professional skills to attract and build that market.”

Doherty had established a relationship with Accor at another property in Ballarat, Australia, so it was the first option. “They have considerable experience with the development of such projects, and while we are fully experienced in the building and construction aspects of the property, Accor is able to provide all the requisite support for fit-out and interior design and then the operation of the hotel.”

Putting a big brand’s name on the project also helped with the financing, according to Doherty. “Financiers were looking for us to engage a professional management company who could take the project to the next level. It certainly made the financiers more comfortable, which was an essential ingredient in the development,” he says.

According to Simon McGrath, vice president of Accor Australia, conversions are a key growth avenue for its brands. “Our extensive portfolio of brands enables us to target many properties across all market segments, thus we can often successfully pitch both a value-add proposition and a strong brand fit to a wide range of properties,” McGrath says. “The final assessment criteria are potentially barriers to entry, and expenditure that is required to ensure brand compliance. We look for partners who believe in reinvesting back into their properties.”

McGrath says franchise opportunities on the Australian continent outnumber potential management deals 5-to-1, adding the costs involved for either agreement in Australia are among the lowest fees in the world, due to the intense competition within the market and the market’s desire to achieve maximum returns. “The market here is extremely attuned to securing the best possible commercial outcome in a tight and restricted market,” McGrath says. “Hence, an enticing commercial package must always be carefully considered with our desire to increase market share and maintain performance.”

While it is not generally looking to inject capital into new deals, McGrath says Accor is generally flexible when it comes to the commercial structure of its agreements. “The key criteria is whether or not we can add value,” he says. “If we feel that we can, then Accor is happy to negotiate a commercial structure that reflects the owners’ concerns, so long as we secure such things as tenure and capital expenditure back into the property.”

(Source :hotelsmag)