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Q&A: Luxury Hotel Segment Poised for Comeback, Says Laurence Geller

Q&A: Luxury Hotel Segment Poised for Comeback, Says Laurence Geller

Who knew Laurence Geller was a geek? The suave, British-born but all-American luxury hotel magnate has a soft spot for industrial engineering. Decades ago, Geller, who is now president and CEO of Strategic Hotels & Resorts, worked for an industrial engineering company that eventually developed a beneficial hotel practice. There he learned the importance of strict controls on labor in all business, especially hotels, and the effect those controls can have on both the bottom line and property values.

“Everything we did was based on principles of industrial engineering,” he says. “I had those ideas knocked into me: empirical analysis and a systematic approach. I’ve applied them through all the five decades I’ve been in the hotel business.”

The collapse of the economy particularly hurt luxury hotel firms like Strategic, which posted a $313 million loss in 2008. Geller marshaled his firm to adopt a series of tough operational and marketing steps to weather the storm.

In particular, Geller and his team of asset managers scrutinized existing labor practices — many of which were ingrained in the cultures of the brands that operate them — at all of the then 19 upper upscale and luxury hotels the real estate investment trust owned.

As a partial response to public market forces, Strategy began to prune its portfolio, selling a Four Seasons in Mexico City and a Renaissance in Paris, and backing out of a deal to buy hotel space under development next to its Fairmont Hotel in Chicago.

While not yet back on firm footing, Strategic has shown improvements in its financial performance and key lodging industry benchmarks. In the first quarter, the firm trimmed its net loss from $43 million in 2009 to $40.3 million this year.

Similarly, funds from operations, a key REIT metric, improved year over year from an $11.5 million loss in 2009 to a $5.4 million loss in the most recent quarter. He forecasts increases in revenue per available room (RevPAR) between 6% and 8% for the second quarter, driven by hikes in the average room rate.

In speaking with analysts last week, Geller stressed operating performance improvements the company tracked through the first quarter. While RevPAR fell 1.6% in January, it flattened in February and rose 3.6% in March. Compression nights, or the number of nights the company achieved above 90% occupancy, grew from 118 across the chain in the first quarter of 2009 to 239 this quarter.

As part of its quarterly earnings release, the firm announced it closed on a $317.8 million, non-recourse mortgage agreement with Metropolitan Life and secured by its Westin St. Francis in San Francisco and Chicago Fairmont properties.

On Monday of this week, Strategic said it will issue a secondary stock offering and use the funds to buy back bonds that come due in 2012. In the offering, the firm will sell as many as 46 million shares of its stock.

Under the deal, two mortgages for $346 million that were due to mature this year and next were replaced with a new loan at 6.09% interest that matures in 2017. As part of the agreement, Strategic paid $26 million on the combined principal of the loans.

How Strategic navigated its way through the recessionary minefield and what the future holds for the REIT were several of many subjects Geller discussed during a lengthy interview in his Chicago office last month.

Watkins: How does this downturn compare with others you’ve experienced?

Geller: I could always see the cyclical resonance between Europe and the U.S. because of the travel patterns, but I’ve never seen a global situation like this. The depth and the speed of it astonished me.

Watkins: How quickly were you able to respond?

Geller: Around the middle of 2007 we announced publicly, and I got excoriated for it, that we were going to implement phase one of our three-phase contingency plan. Our stock price fell to approximately 65 cents, but by 2008 we started working with the hotel chains to start industrial engineering the labor component of our business.

Watkins: Industrial engineering isn’t a common principle in the hotel world. How does it work?

Geller: In all of our hotels, we re-engineered the entire operation: cutting executive committee sizes and consolidating jobs at the managerial level. It sounds very obvious, but for the chains it’s not. They use the executive committee pyramid as their farm system for growth, and the hotel owners pay for it. (To feed their management ranks as chains grow, they often overstaff at properties with middle-management personnel and then promote them as needed to new hotels.)

Watkins: How did you break that news to them?

Geller: We told them there is no growth, not in this country at the high end, so the farm system is no longer necessary. We cut out 20 percent to 22 percent of total hours in hotels, and that goes from the general managers on down. Our goal was to have 25 percent to 35 percent of those hours cut permanently.

Watkins: What does this mean for the bottom line?

Geller: In our type of business we can add 200 to 300 margin points of our gross operating profit (GOP). Put another way, using this kind of technology puts us on par with the airlines on an operational basis and takes us from being a cottage industry to a real industry.

Watkins: That’s operations. What about marketing?

Geller: We realized we couldn’t rely on the old marketing systems, so we put together a guerilla task force, with the rule that failure is in only not trying. The concept was to try every idea we could. We started at the Del (the Del Coronado, the iconic Southern California resort).

The hotel wasn’t bound by chain management, so it was an easy one to start with. We realized we could use Internet technology to instantly market a hotel. For example, at the Del Coronado, we developed a 50-percent-off promotion that generated millions of dollars of revenue very quickly.

Then we tried it at (the Ritz-Carlton) Laguna Niguel, but in a slightly different way. Because it’s a Ritz we couldn’t discount by 50 percent, but we used Internet marketing more aggressively, and in ways we never tried before.

Watkins: Other examples?

Geller: When swine flu hit us in Punta Mita (a Four Seasons hotel in Mexico), we came up with a promotion and Four Seasons let us try it. We wanted to do something to induce trial among non-Four Seasons customers and get them to the hotel. If we can just get a fraction of them to come, we’ve won. We came up with an idea called “One, Two, Three, Four” that had a goal of an extra $3 million in EBITDA over the budget.

The idea was to give $1,234 of resort credit when a guest booked at the hotel for four nights at rack rate. It cost very little to send the messages, and God bless Four Seasons for coming along with us. It netted us around $900,000 of EBITDA. It brought trial and kick-started the hotel.

Watkins: What about your corporate and group business?

Geller: We realized the way you get most corporate customers now is online, so the speed of reaction must be instant. You can’t wait three months to do a print campaign or wait for corporate approval (from the chains). And the print is so expensive. For $25,000, you can get a million names for an e-mail [campaign].

Operationally, we’ve added profit through cost savings in labor. Technology is the enabler. And technology is systemically changing the marketing of hotels at the property level. We’ve seen two fundamental shifts that go dramatically to the profitability of hotels. If you can make more money out of less labor, that’s good and it’s permanent. And if you can get more impressions out of a dollar of marketing money, that’s great, too.

Watkins: What’s your prognosis for a turnaround?

Geller: People are looking for a three- to four-year recovery, but I don’t believe it. I think it will be much sooner. The secret ingredient to all of this is culture. If you genuinely believe in these ideas at the ownership and operational levels, it will get done. If it’s superficial, if people pay lip service to it, only 80 percent of it gets done, and that’s not good enough. We want a performance level of 95 percent against our standards, and 98 percent is our goal. At 80 percent, you can say, ‘Look at how much money we’ve saved.’ But look at how much you could have saved.

Watkins: What makes you think the business will come back quicker than everyone else seems to believe?

Geller: They’re wrong because they misunderstand the American consumer. They misunderstand the entrepreneurial nature of this country. Americans get bored very quickly. They get bored of not growing or not trying. You’ll never change that wonderful aspirational spirit of Americans. That’s the lubricant in an economic recovery that will make the wheels go faster.

We fell harder than anyone at the high end, but in every metric we look at — whether it’s high-end retail sales, first-class airline seats, Sotheby’s and Christie’s auction sales—we see a lot of accelerating strength.

Watkins: What’s your outlook for business?

Geller: The group bookings for the year are up 40 to 50 percent, and RevPAR is also up. For good days, it’s up 12 percent; sometimes it’s flat, and sometimes it’s a little down, but overall RevPAR is much higher. The reason 2011 and 2012 don’t look that busy right now is that people still fear the double-dip recession, and since they have to guarantee the business they’ll wait to book. It’s the same thing I saw in 2002 and 2003, and even during the 1990s.

Watkins: What about transient business?

Geller: For corporate business, we measure two sets of compression nights: 80 percent and 90 percent. The 80 percent compression (nights in which a hotel’s occupancy is above 80 percent) is up about 30 percent or 40 percent, and the 90 percent doubled. At 80 percent, you can change your mix of business, which puts the rate up. At 90 percent, you change the mix and the rate. The best news is the margins are holding beautifully.

Watkins: What’s going to happen in transactions?

Geller: It’s beginning to happen, and the REITs will lead the transactions market because they have the money and the capacity. There will be an acceleration in transactions this year, not because of distress but because we’re at an abnormally low level of transactions. The volume of transactions must come back to a level — not like the boom years — but to some average. There will be consolidation. Transactions will get back to a [more normal] level within a year and a half or two years, depending on the credit markets.

Watkins: Will you be net buyers or sellers?

Geller: We still may try to sell [our properties in] Europe, but London is recovering so quickly we may hold back awhile. It’s a strategic decision because the stock market here doesn’t give much credit for European assets. We have higher taxes and administrative costs. The other side is Europe fell a lot less in our markets, so it can’t recover as much. If I buy in Europe for $100, I’ll have four percent growth. If I buy $100 here, I’ll have 30 percent growth.

We may also be sellers. My number one priority is to fix the balance sheet, which is well on its way. The second priority is to knock off a bunch of the little projects we have in the hotels that we haven’t done. For example, we had some empty space in D.C. (a Four Seasons hotel) that we eventually want to lease out.

We opened a little store in the space. It’s 1,000 square feet and cost $90,000 to create. It does $3,000 a day in sales, and we can make 20 to 30 percent on it. I’ll double the return on our investment in the first year. We’ll do a lot of those. We’re asset managing several hotels at the luxury level for other people, and it’s logical that we might fold some of these properties into our platform.

Watkins: What’s your outlook for supply and demand in the luxury segment?

Geller: There is still undersupply. If it costs you $600,000 per room plus land to build a hotel, which it does at my level, who is going to build? It will be great competitively for us for the next five years at least. It doesn’t mean pricing is infinite because people’s propensity to consume is relative to their corporate needs or personal income.

Eventually you will price to a level where people won’t come, but we’ve got a long way to go to get to that level. You don’t have infinite pricing because of supply and demand characteristics, but you have fairly elastic pricing for the next few years.

Watkins: There is growing concern that the hotel stock is deteriorating because owners aren’t putting money back into their properties. Do you believe that to be the case?

Geller: Many of the chains have given relief on ff&e (furniture, fixtures and equipment), and the banks have allowed the ff&e reserves to be used for this and that.

That’s okay for a year or two, but not for five years. I think private equity has cut back more than the public companies. The [condition of the assets] in the public REITs is probably pretty good, but the stock in the private ones is probably pretty crappy. I don’t think it has deteriorated to a point of drama yet, however.

Watkins: In what condition is Strategic’s portfolio of properties?

Geller: We’ve kept spending. We spent $30 to $40 million a year on our properties, so we didn’t cut back a penny.

Watkins: Where will Strategic be in five years?

Geller: It will either be a similar size with a turnover of assets, or bigger with the addition of some assets. I’m not going to make the mistake of keeping assets too long because in the inevitable cycle you want the fresher assets, not the older ones.

Scale is an issue, so if things go logically we will be larger but not 10 times larger. At that size we can’t lavish the attention on the assets. Take the Del Coronado, for example. It’s a $750 million asset. Most hotel companies aren’t that large. We’ve got to put a lot of attention on the Del. We have land there; we’ve got housing and retail development.

Watkins: What have you learned from the severe downturn in the hotel business during the last couple of years?

Geller: I probably found myself caught up in growth for growth’s sake.

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