Unlike other commercial real estate asset types, the hotel industry is unique in that most hotel investors are purchasing both the land, property, and the business which operates therein. Managing a physical asset is much different than operating a hospitality business.
For this reason, many hotel investors will hire third party firms to operate the hotel on their behalf. Indeed, a real estate company must have specialized skills in order to operate a hotel business effectively – something that Wolfgramm Capital has now been doing for more than 25 years.
In this article, we compare how a typical hotel investment firm works and then compare it to the Wolfgramm Capital model. In both cases, the firm is engaged in acquisitions, underwriting and due diligence, raising capital, asset management, and property management. However, the Wolfgramm model brings the lion’s share of these activities in house as a way of achieving operational efficiencies that, ultimately, help to bolster the returns of our investors.
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A Typical Investment Firm Works Like This:
1. Identify Potential Acquisitions
The typical hotel investment firm will generally use publicly available tools and resources to source their deals. For instance, they will sign up to be on the email listserv of the major brokerage firms like CBRE, JLL and Crexi which will send them listings for hotels for sale as they come to market.
In some cases, there may be two or three dozen properties featured each day. The typical investment firm will then filter their search results based on their specific investment criteria; e.g. by location, hotel type, or number of keys. As things meet their criteria, they will then follow-up with those brokers to learn more about the opportunity.
Another strategy that hotel investment firms often use is working with a “finder” – someone who acts like a broker but whose responsibility is only to find hotel properties that meet the investors’ criteria. They are not negotiating the deal, but rather, acting as the middleman between the broker and the prospective buyer. In exchange for the legwork they do to find the deal, the finder will then take a 3 or 5% fee calculated based on the final purchase price.
2. Underwriting and Due Diligence
After finding a hotel deal that meets their general criteria, a typical firm will then enter into the due diligence period. Most firms, Wolfgramm included, will conduct their underwriting and due diligence in-house.
- Financial
The average hotel investment firm will have at least one or two analysts in-house whose sole responsibility is to underwrite deals. There are some exceptions, of course. Institutional investors like Blackstone have entire teams dedicated to financial underwriting, in most cases, there will be specialists assigned to each CRE product type.
In either case, these analysts will comb through STR reports, the premier source of hotel industry data. They will examine the hotel’s current financials, trailing financials, and areas for growth and improvement. They will craft a financial model that can include variable factors, like debt, and then they will run a sensitivity analysis to determine whether this property should be considered for further due diligence.
While financial underwriting generally happens in-house, there are rare occasions where a less experienced hotel investor will hire a property manager to collect and analyze the financial data on their behalf.
- Insurance
The typical hotel investment firm will either assume the in-place insurance when acquiring a property, or they will obtain a new policy using the bare minimum information.
The standard process involves filling out a property condition report that describes when the property was built and its general style, the type and age of the roof and other building systems, number of keys, number of employees, whether it is in a flood zone, etc. This data allows insurance companies to calculate a policy based on their standard rates, and then the typical hotel operator will evaluate two or three options before selecting one.
In short, there is nothing scientific about how most hotel operators select their insurance – which, as you will see, is very different than how Wolfgramm Capital obtains its insurance policies.
- Legal
The typical hotel investment firm will not have in-house legal. They will outsource their legal work to a third-party firm that specializes in structuring and negotiating hotel sales. In many cases, outsourcing legal work is more cost effective than having an attorney on their payroll. This is especially true if the firm is only engaged in one or two hotel transactions per year; there is generally not sufficient scale to warrant having in-house counsel.
- Third Party Reports
Third party reports are almost always conducted by independent experts, at the typical hotel investment firm as well as Wolfgramm Capital. This includes the Phase I environmental study, geotechnical and seismic studies, civil engineering, the property condition report, and appraisals. This is to ensure that there is no bias in the report that benefits either the buyer or seller. Most lenders require these studies to be handled by third parties in almost all cases.
3. Raising Capital
The typical hotel investment firm will have someone dedicated to raising capital, usually a third-party debt and equity broker who works for a larger brokerage shop. The broker shops the deal around to various audiences depending on the size of the deal. For larger deals, they might start with institutional investors, funds, or family offices. Working with a debt/equity broker on a larger capital raise can make a lot of sense.
However, on smaller deals, the hotel investment firm might give the broker a simple pitch deck that the broker then shops around far and wide. Their goal is to raise as much capital, from whatever sources, over a 30-60 day window. They will approach investment groups on Facebook, LinkedIn, WhatsApp, and other social media platforms. The brokers are often paid between 2-5% of the capital raised and some may also receive up to 20-25% percent of the sponsor’s carried interest.
This approach can be problematic. Third-party capital raisers, while they have their place, simply cannot be as involved or have the familiarity with the deal needed to build that trust and relationship. The more attenuated the relationship, the worse it ends up being for all parties involved.
4. Asset Management
An asset manager for hotel properties plays a crucial role in optimizing the performance and value of the hotel assets on behalf of the hotel investment group. The typical hotel operator will outsource this function to a third-party who visits the hotel on a quarterly basis. During that visit, the asset manager will walk the property to determine what type of capital expenditures are needed.
More often, though, firms will simply overlook asset management until they decide to go sell it, at which time they will be faced with significant – and costly – deferred maintenance that impacts the property’s value.
- Periodic Renovations
It is very common for hotel operators to outsource room renovations. This is partially because renovations are not needed that often. Someone with a smaller portfolio may only need to do renovations every five to seven years, and therefore, having someone devoted to this on the payroll would not be cost effective.
Instead, they hire an owner’s project manager (OPM) who can oversee the construction and trade professionals on the company’s behalf. An OPM’s ability to manage the budget and identify cost savings is generally limited versus someone whose sole responsibility it is to manage hotel renovations on a daily basis. Moreover, they do not have the same financial incentive to negotiate lower rates for contractors, materials, or supplies – most owners simply accept the budget as presented and execute the renovations accordingly.
- Risk Mitigation
Asset managers typically play a large role in assessing and managing the risks associated with hotel ownership and operation, such as identifying potential threats to the property’s value and implementing strategies to mitigate risks, such as changes in market conditions or regulatory issues. Hotel investment firms who rely on third parties – or who do not engage asset managers at all – are often putting their investment at risk.
5. Property Management
Most hotel operators hire a third-party property manager. In some cases, this is required. For instance, the luxury hotel brands of Hilton or Marriott, require you to use their third-party property management firms to ensure top-notch, consistent service.
However, limited service and other hotel assets are not mandated to use a specific property manager. Instead, we see many firms hire a third-party operator who oversees all staff and day-to-day operations on the investment group’s behalf.
There are some instances where this makes sense, particularly if someone has no experience owning and operating hotels. In these situations, the level of control that the owner maintains over the property management company and the incentive structure utilizes is critically important. At the end of the day, you are entrusting this firm with the profitability of your hotel asset.
Wolfgramm Capital Works Like This:
1. Identify Potential Acquisitions
One thing that Wolfgramm Capital does differently is that, when looking for hotels to purchase, we rarely if ever use third party “finders”. We have used this approach before and in our experience, these finders seldom add value to the process. They often have sharp elbows, where they create more space between the buyer and seller, which leads to delays in sharing information and moving things forward. Moreover, because finders are paid around 2 or 3% of the sales prices, they are only paid if a deal closes. Therefore, there is some concern about the information they do share and whether any details are skewed for the sake of getting the deal done.
In our experience, the acquisitions process moves forward more seamlessly when we are in direct communication with the seller. This allows us to build rapport with the seller, which is especially beneficial if that seller has multiple properties that they want to sell over time. Once they see that we are a good partner, they will generally give us a first look at future properties that we can then negotiate directly.
In some cases, we will work with property management companies who bring us deals to consider. The property management company is different from a finder, in that they are not paid a commission on the deal. Instead, they bring us a deal in good faith hoping that we will use their firm to manage the property after taking over ownership. The same is true for attorneys and asset managers who often bring us hotels to consider.
Otherwise, we identify all of our potential acquisitions in-house using our existing team. Again, many come to us off-market given our reputation for being a well-capitalized and solid operator. This puts us in a position to negotiate the best terms since we are not competing for listings that have been circulated to the masses. Indeed, most of our deals come to us off-market and are negotiated entirely outside of the brokerage realm. This strategy works: over the past 18 months, we have closed over $150 million in deals that we sourced directly.
2. Underwriting and Due Diligence
As is the case with most hotel investment firms, Wolfgramm Capital manages the entire underwriting and due diligence process in-house – with the exception of third-party reports, which are conducted by independent expert practitioners.
Below is a look at what the underwriting and due diligence process entails at Wolfgramm Capital.
- Financial
Any time we look at a potential acquisition, we begin by taking a detailed look at both in-place and trailing financials. We look at how the hotel has been doing for at least the past three to five years, the current budget, size and cost of current payroll, anticipated capital expenses, and more.
Then we build a financial model that includes what we expect to get for debt terms, so we can better understand our projected debt service coverage ratio, loan to cost, loan to value, and other metrics. Then, our team of analysts sharpens their pencils to see where we might find cost savings – either by bringing some functions in-house or by improved operations. In some scenarios, the current owner projects costs to rise by 3%, 5%, or even 10% but, after digging in, we find cost savings that help to improve the projected returns.
The importance of building one’s own underwriting model cannot be overstated enough. Too often, a traditional hotel investment firm will rely on a model template that they found online. While this may be a good starting point, rarely do these templates capture the nuances of the company’s business model. Worse, these templates can have errors in their formulas that result in inaccurate projections that undermine the true pro forma.
For example, a pro forma might assume that the company is making capital calls bi-annually for the next six months when the business plan does not require capital calls. Or it might assume that a condo building is pre-sold within the first six months, when market factors suggest 24-months to be more realistic. Disconnects like these can make, or – more often – break a deal. By the time someone realizes that the underwriting is flawed, their earnest money might already be gone.
Managing our underwriting in-house ensures that our model is updated in real time. For instance, we may add a preferred equity piece to the capital stack instead of the common equity originally anticipated. We can make these adjustments quickly and accurately given that our analysts are working so closely with our capital markets team.
- Insurance
Unlike a typical hotel investment firm, which may just assume the in-place insurance when they acquire a property, we leave no stone unturned when looking for the best insurance for our hotels. Shopping around for insurance can translate into hundreds of thousands of dollars in enterprise value.
However, we do not simply request quotes from multiple insurance firms. We take this process one step further.
In our experience, insurance companies are very data-driven. We use this to our advantage by providing robust data sets that show how we are minimizing risk to the insurance company and making claims less likely.
For example, we have installed water sensors at all our hotels that notify us in the event of a small leak. Leaks are inevitable, and having a leak is not inherently problematic. The problem is when that slow leak goes undetected for several months, creating significant damage in the process. Walls might start caving in, mold has spread, and costly renovations might then be necessary – a cost that the insurance company will generally have to absorb.
By installing water sensors, we can show the insurance company that we have tools and systems in place to minimize damage.
We also have our staff go through robust training. This helps ensure they are in compliance with all rules and regulations, but also helps with things like worker’s comp claims. For instance, a common worker’s comp claim is when a hotel cleaner slips and falls while standing on a tub or toilet to clean something. We mitigate this risk by providing proper tools (e.g., extending brushes and step stools) and providing training that explicitly highlights the risks associated with standing on fixtures – especially wet fixtures, like bathtub surrounds. We record this training and provide guidance in our employee handbook. That way, if a slip and fall claim occurs, we can show how we have protected ourselves.
We even provide specialized training, such as how to spot human trafficking, which helps reduce our risk and liability in the event of a claim.
This combination of shopping around for policies, plus providing data and robust training, is truly unique within the hotel industry. The strategy is effective. We save tens of thousands of dollars per property on our insurance policies alone.
Lastly, whenever possible, we cluster hotels and find policies that cover five or six hotels at a time. Many insurance companies will provide discounted policies when they are guaranteed volume, so we use this as another bargaining tool.
- Legal
Wolfgramm Capital benefits from having in-house counsel that can devote their time to any and all legal questions around a potential acquisition. In fact, we have two in-house attorneys: our Chief Legal Officer and a General Counsel. The Chief Legal Officer focuses more on business strategy whereas the General Counsel is more focused on contracts. Insurance claims, and company operating policies.
Having in-house counsel has been a significant benefit to the firm. Given our size and scale, employing attorneys directly proves to be a cost-saving mechanism vs. outsourcing to a third-party who would bill on an hourly basis. Moreover, our attorneys bring tremendous institutional knowledge that is retained from deal to deal. They are keenly aware of what the firm cares about most (and what we don’t), the terms we can give on (vs. those we can’t), how the investment fund works and its mandates, and more. If we were to outsource legal, the on-boarding process would be both time consuming and expensive.
Our in-house legal team also carefully monitors the regulatory environment to ensure we remain in compliance. For example, if a lawsuit finds a hotel liable for X, Y, or Z, our attorneys will examine the case carefully to ensure that we take proactive measures to prevent ourselves from being sued for similar reasons.
On rare occasions, we will pull in third-party legal support to supplement our own attorney’s capacity. This is typically only necessary when we have a unique property or situation that requires specialized experience. For example, we once had to bring in an attorney who could help us navigate questions around international law. In other instances, we might bring on a local attorney who has very specific permitting experience if we are constructing a new hotel property that requires zoning relief or if we are trying to navigate a complicated easement agreement.
- Third Party Reports
At Wolfgramm Capital, we also outsource third party reports. In fact, this is one of the only elements of our due diligence process that we do not handle internally. However, there is good reason for this: to be considered above-board, third-party reports like appraisals and environmental/geotechnical reports, must be managed by an independent firm who has no vested interest in the deal.
Join the waitlist for our next investment opportunity and learn more about our unique approach to hotel investing.
3. Raising Capital
At Wolgramm Capital, all our capital raising is done in-house. This is true for both debt and equity. We have tried and true lenders who we consult with for debt, and long-term equity partners who routinely reinvest with us.
When we need to fill a debt or equity gap, we run that process using our internal team of partners who are recognizable people within the company and who investors know they can call upon during the lifetime of the investment period.
We believe that having personal relationships with our investors is critical. This way, if something with a deal changes – say, for instance, new information is discovered during due diligence that proves to be costly – our investors will know and trust our ability to navigate these obstacles.
4. Asset Management
Asset management is front and center for Wolfgramm Capital. It is a function that we believe must live in-house. The asset manager works closely with the property management team but has distinct roles and responsibilities.
Our asset managers walk our hotel properties at least monthly, taking pictures and detailed notes along the way. They look at the property condition, inside and out, including landscaping and room conditions. They evaluate the condition of building systems to ensure optimal performance.
At Wolfgramm, our asset managers are also investors and owners of the company. Therefore, they pay even closer attention to repair vs. replacement considerations – decisions that ultimately impact the bottom line. We strive to make as many improvements with our current staff and property management teams as possible before outsourcing and incurring additional costs.
Periodic Renovations
Given the scale of Wolfgramm’s portfolio, we oversee hotel renovations in-house. While each individual hotel may only need renovations every five to seven years, we have enough hotels that this equates to at least one hotel needing to be renovated every year or two. Our renovations are also wholesale, including replacing every couch, bed, bed skirt, headboard, lamp, night shade, dresser – you name it, we upgrade it. With a portfolio of 1,500 to 2,000 hotel rooms, this means that we are almost always replacing something on a regular basis.
Our ability to manage this in-house also has cost savings. Our asset managers are forward-looking and can pre-order items in bulk. We can purchase directly from the manufacturers overseas, rather than purchasing from retailers here locally. For instance, we found one bed that we could purchase from $50 if we bought it from the manufacturer directly; that same bed cost $600 in a retail store here in the U.S. Multiply this across hundreds of hotel rooms and the cost savings are in the tens of thousands.
This entire process is managed by our in-house head of construction and renovation, Curt Stidham, an integral member of our team who has done more than $1 billion worth of construction projects in his career. We rely on him to determine which renovations can be handled internally versus those that need to be outsourced to general contractors or other third parties.
He also helps to negotiate change orders by keenly reviewing costs and bringing in other suppliers who can give us better rates on materials or supplies. For example, we recently received a change order from a contractor worth $600,000 where costs were driven by an uptick in the price of concrete. We were able to connect the contractor with another supplier and ultimately brought that cost down to less than $200,000 – a two-thirds cost savings.
Risk Mitigation
Our asset managers are also heavily involved in executing the business strategy, and for that reason, are tasked with implementing various risk mitigation strategies. They are involved in setting the goals, defining the investment strategy, and making decisions that enhance the financial performance and value of the property over time.
They are responsible for analyzing financial performance, monitoring key performance indicators, and making strategic financial decisions.
To that end, our asset managers assess and manage the risks associated with hotel ownership, including market risks, economic trends, and operational challenges. They then implement strategies to mitigate these risks and protect our firm’s investments.
Outsourcing to a third-party asset manager is simply not as impactful as bringing this role in house where you have a person – or team of people – who are fully integrated with the rest of the team and have a strong understanding of ways to enhance the property’s performance. For example, our asset managers will work closely with the legal team to review all existing contracts and insurance policies to ensure we are both well protected and have advantageous terms.
5. Property Management
After experiencing some of the pitfalls associated with third-party property management, Wolfgramm started our own property management company that has since been approved by Marriott, Hilton, and IHG. Bringing our property management and operations in-house allows us to retain greater control over staffing, revenue, and general hotel operations. We are able to monitor costs closely and make operational improvements that benefit the bottom line.
Self-operating our hotels has also proved to be beneficial with our capital partners. Many investors take comfort in knowing that we manage our own properties and have detailed systems and policies in place to do so effectively.
Conclusion
In conclusion, the comparison between the operational models of a typical hotel investment firm and Wolfgramm Capital underscores our distinctive approach, emphasizing a commitment to in-house expertise and integrated management strategies. While both models engage in similar activities, Wolfgramm distinguishes itself through a comprehensive in-house execution of these processes.
Wolfgramm Capital's operational model is characterized by a fusion of expertise, proactive risk management, and a commitment to control critical aspects of the investment process. This comprehensive and integrated approach allows us to optimize returns for investors while positioning ourselves as one of the nation’s premier and most trusted hotel investment firms.
