Diamondrock Hospitality Company

Good day and thank you for standing by. Welcome to Diamond Rock Hospitality first quarter 2021 earnings release. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question, simply press star one on your telephone. Please see advice that today's conference is being recorded. If you require any further assistance, please press star zero. I will now hand the conference over to your speaker today. Brown and Queen. Please go ahead.

Good morning, everyone. Welcome to Diamond Rock's first quarter 2021 earnings call. Before we begin, please note that many of the comments made on today's call are considered to be forward-looking statements under federal securities laws. As described in our filings with the SEC, these statements are subject to numerous risks and uncertainties that could cause future results to differ materially from those implied by our comments today. In addition, on today's call, we will discuss certain non-GAAP financial information. A reconciliation of this information to the most directly comparable GAAP financial measure can be found in our earnings press release. With that, I'm pleased to turn the call over to Mark Brugger, our President and Chief Executive Officer.

Good morning, and welcome to our earnings call. One year ago, almost to the day, we hosted our first earnings call near the inception of the pandemic. And here we are now rapidly returning to profitability. What a difference a year makes. With over 55% of adults in the U.S. having received at least one vaccine shot, we fully expect a strong return of travel demand throughout the balance of the year and setting up for a major increase in all segments of hotel demand in 2022. For Dimerock, let me highlight three areas where we have made significant progress since our last call. One, hotel profits are up. In fact, portfolio GOP was positive every month in the quarter. Hotel NOI and EBITDA were nearly break-even in February and clearly profitable in March. In April, RevPAR for our open hotels increased an amazing 1,113 percent. Two, reduced burn rate was impressive. Our low monthly AFFO burn rate was 44 percent lower than our closest peers at only $914 per key. And three, we executed on strategic dispositions. We transacted on Frenchman's Reef, and we signed a contract to sell to Lexington. Collectively, these dispositions will accelerate our transition towards a predominantly experiential drive-to resort and urban lifestyle hotel portfolio. In looking at the first quarter, Dimerock had total revenues of $72.9 million. Total portfolio occupancy for the quarter, including closed hotels, jumped five percentage points, compared to the prior quarter to 26.9%. Due to a favorable portfolio mix and strong asset management, hotel adjusted EBITDA loss was held to only $2.6 million, which was a 65.8% improvement over the prior quarter. Adjusted EBITDA for the company contracted only $9.6 million, a 35% improvement over the prior quarter. In March, we experienced Red Park growth of 11% and generated positive hotel adjusted EBITDA of $4 million. Digging deeper into first quarter results, you will see that collectively our open hotels were profitable over the entire quarter, generating $21.5 million of GOP and $6.7 million of hotel-adjusted EBITDA. Our resorts were on fire. They generated $18.1 million of hotel-adjusted EBITDA profit at a 35% margin, which was $938 billion basis points higher than in the first quarter of 2020, and remarkably, 84 basis points ahead of even 2019. Conversely, our urban hotels were responsible for a $20.6 million hotel EBITDA loss in the quarter, of which $9.3 million was attributable to our four closed hotels. It is important to note that we had 26 hotels comprising 75% of our rooms open throughout the first quarter. Subsequent to quarter end, we reopened our Chicago Marriott and Hilton Garden in Times Square. At this point, we have only two closed hotels, the Lexington and the Courtyard Fifth Avenue. Turning to demand segments. All segments improved sequentially in the first quarter. Leisure was the star, and Dimerock's unique focus on experiential drive-to resorts and urban lifestyle hotels has been a source of strength. In the first quarter, leisure revenue increased 31% from the fourth quarter of 2020, driven by a 16% increase in room rates. Looking ahead, we expect similar strong demand patterns to persist this summer. Turning to the group segment, we are seeing clear and proven activity and are optimistic that these trends will continue in the second half of 2021. While group room revenue is just 8 percent of our total room revenues in the quarter, we did see group revenue increase an impressive 65 percent from the fourth quarter. Group booking activity continues to accelerate. In the first quarter, we had 7,200 leads, representing 1.2 million room nights. This is a 65% increase in leads, with a corresponding 71% increase in room nights compared to the fourth quarter. As a point of comparison, lead volumes for Dimerock are at 61% of pre-pandemic levels and well ahead of the Cvent industry average of 55%. Overall, we are very encouraged that group demand is rebuilding and, as we will discuss later, we believe Dimerock is uniquely positioned to benefit in 2022. Business transient demand is still a small contributor, but like group, it is unquestionably moving in the right direction. In the first quarter, our business transient room volume was up 25 percent sequentially from the fourth quarter. We expect business transient demand will be much stronger by the fourth quarter, but until then, improvement will be gradual and likely follow return to office plans. There are numerous encouraging data points. Companies like Apple, Bank of America, and Amazon expect to bring employees back to the office over the coming months. Moreover, heavy travel buyers such as Deloitte have approved their 5,000 partners for travel, and Boston Consulting, Accenture, and PwC Company are either resuming travel or expected to revise travel policies in May. Now, I'd like to focus on the success Diamond Rock had in cost-containment and opportunistically maximizing profitability. This was a result of a lot of hard work on the part of our asset managers and operators. On the revenue side, the team did a great job finding new revenue streams. Standout areas included resort fees, parking income, rental income, and the gift shop or business center. Collectively, These four areas comprise over 80% of other income, and these revenues are down only 4% compared to the prior year at our open hotels. Cost controls were tight. Overall, rooms, cost-prooccupied room, or CPOR, improved to $59 from $69 in the prior year, a 14%. which helped drive our rooms department margin to 72.6%, a strong 450 basis point improvement. This excellent CPOR improvement was driven by greater efficiency with total man hours worked per occupied room improving 6.5% at our open hotels as compared to 2020. As a result, total labor costs at our open hotels improved 280 basis points from the comparable period. We had similar success in food and beverage. Total covers increased 19% over the fourth quarter. Even with this increased business, we were able to reduce associated labor, food, and beverage costs. The result is that in the first quarter, our restaurant, room service, and lounge outlets collectively generated $1.5 million more profit than the fourth quarter, with a flow-through of over 40%. As we emerge from the crisis, we are confident that we will be able to have stronger, stabilized profit margins for the entire portfolio. We believe we can do that without harming the guest experience. In fact, despite our tight cost controls, our TripAdvisor scores continued to edge higher for our hotels. And to illustrate the point about being able to deliver even better margins, our resorts generated Q1 EBITDA margins that were 84 basis points higher than 2019, and that's on lower revenue. Let me highlight a few outstanding performances in the quarter. The Vail Marriott really delivered. with margins improving 390 basis points to produce over $6 million of EBITDA. La Berge de Sedona saw a 25% increase in REBPAR, driven exclusively by big rate growth. Total REBPAR surpassed $800 per night, and EBITDA margins increased a whopping 1,250 basis points in the quarter. And our Key West Resorts, remain consistent great performers. Combined total rev par for Barbary Beach and Havana Cabana was up 5.1% over 2019, driving a better than 300 basis point increase in combined EBITDA margins. Now let's transition to talk about our capital investments into the hotels. Our focus remains prioritizing projects that can take advantage of the reduced disruption and produce high returns. We spent $12 million on capital expenditures in the first quarter, with the bulk of that on the repositionings of the lodge at Sonoma and our Vail Resort. We project our total capital spend in 2021 will be around $55 million. Before I turn the call over to Jeff, I want to talk about our focus on ESG. Of particular note, the steps Dime Rock has taken over the past few quarters to refresh the board. I want to extend my gratitude to our two retiring directors, Maureen McAvey and Gil Ray. We have benefited from their hard work and guidance for many, many years. I also want to take this opportunity to welcome to the board our newest director, Tabassum Zalatrawala. She comes with a wealth of construction and design experience. that I know will be additive to Diamond Rock. In late 2020, we also added Mike Hartmeyer to the board. Mike brings extensive M&A and investment banking experience to the boardroom. Strong governance is a cornerstone of our ESG initiatives, and the board refreshment ensures that we maintain a fresh and diverse perspective as we move the company forward. Jeff?

Thanks, Mark. Let me begin by focusing on one of our great strengths, the balance sheet. The balance sheet is in great shape. We finished the quarter with $437 million of total liquidity, comprised of $100 million in corporate cash on hand, $300 million of capacity on a revolver, and $37 million in working capital at the property level. Our debt is strategically split between mortgage and corporate debt. We have $594 million of non-recourse mortgage debt at a weighted average rate of 4.2%, and $500 million of bank debt comprised of $400 million in unsecured term loans and $100 million on the unsecured revolving credit facility bearing interest at a blended 3.5% rate. Additionally, our debt is well-laddered. Just 4% of our total debt matures before the end of 2022, that is, the mortgage on the Salt Lake City Marriott. While we're on Salt Lake City, after several attempts, we were successful in obtaining a long-term extension of the ground lease for the Salt Lake City Marriott. We extended the ground lease by 50 years from the 35 years remaining for a new total term of 85 years. This will substantially enhance the value of the hotel while giving us the flexibility to obtain new financing or sell the hotel if the timing were right. We have $112 million of capacity under our ATM unchanged from the fourth quarter. To preserve the availability of the program, we will renew our ATM before it expires in the third quarter. Let me turn to our cash burn rate, a point of pride for Diamond Rock given the current challenges. We beat our internal expectations. During the quarter, our monthly cash burn for Hotel NOI and Corporate G&A combined averaged $3.7 million per month, blowing past the prior loss estimate of $8 to $8.5 million we provided in February. The total burn rate for the company was $13.9 million and included about $5.6 million per month for debt service and preferred dividends, as well as $4.6 million per month for average capital expenditures. This also was well ahead of prior guidance of $17.5 to $18 million per month Looking to Q2, we expect the total company burn rate will range between $11 and $13 million per month, and it is likely to turn positive in the back half of the year. Okay, with a great balance sheet and improving cash flow, let's talk about Diamond Rock's plans to transition to offense. We have enormous capacity to acquire new hotels. We have several buckets that provide this dry powder. Before I get into those, I would like to point out that unlike some of our peers, Our bank covenants do not limit our ability to raise junior capital. The first bucket of investment capacity stems from the $200 million of junior capital we raised last year. The second bucket is net proceeds from asset sales. We have approximately $220 million sold or under contract, and the bank facility allows us to redeploy over $500 million of dispositions into new acquisitions. So between these two buckets, we have the potential for over $700 million of new acquisitions without ever going back to the equity markets. I'd also note that our bank agreements provide a final bucket of $105 million for ROI projects, ground lease buyouts, and other such investments. In total, this is substantial capacity relative to the size of our portfolio. Before I hand the call back to Mark, I want to point out another area where we have exceeded our expectations. The portfolio was near break-even hotel EBITDA in February on a 65% decline in REVPAR. Early in the pandemic, we estimated we'd break even at a 57% decline in REVPAR. All else equal, we've learned we break even at occupancy about 800 basis points lower than originally believed. The team is really hitting on all cylinders. With that, I will turn the call back over to Mark.

Thanks, Jeff. Before we take your questions, I want to touch on our recent transactions and our outlook. The two announced transactions strongly demonstrate that we are strategically repositioning the portfolio to lean in to our long-held thesis that experiential hotels and drive-to resorts will outperform over the next decade. First, the pending sale of the Lexington Hotel will reduce our overall urban exposure Specifically, it will reduce our New York City exposure by more than 50 percent. The hotel is under contract for $185 million, which represents a 6.3 percent cap rate on 2019 NOI and a 5.8 percent cap rate on 2018 NOI. We received a non-refundable $5 million deposit, and the transaction is expected to close before the end of the third quarter. In short, this sale allows us to right-size our New York City exposure at an attractive price. The second transaction involves the Frenchman's Reef development in the USVI. On April 30th, we successfully completed a transaction in which we received $35 million in cash plus a contingent participation in the hotel's future profits. This profit participation has the potential to be worth tens of millions of dollars if things go right. As many of you know, Frenchman's has been a long saga. The hotel was essentially destroyed by sequential hurricanes in 2017, and after a long battle with the insurance company, we received nearly $240 million in insurance proceeds. This transaction does a number of positive things for us. It eliminates all future funding obligations, thus freeing up more than $200 million of investment capacity for acquisitions with more immediate returns. Two, it allows us to receive cash now as well as part of the upside. And three, it eliminates the company's Caribbean hurricane risk, thereby making Diamond Rock an even better risk-adjusted investment option. These two transactions really help to fuel our ability to go on the offensive. We intend to target opportunities consistent with our experiential drive-to resort and urban lifestyle focus. We have a particular focus on hotels that are synergistic with our existing hotels in markets like Sonoma, Vail, Lake Tahoe, and Sedona. Stay tuned as the year goes on. Let's talk about the outlook. Overall, we feel very good about the setup for Dimerock. Our portfolio is well positioned to capture the continuing robust leisure demand, as well as the coming rebound in group and business transient activity. Importantly, profitability at our hotels is rapidly returning. Based on our current forecast, our second quarter hotel EBITDA is likely to come in near break even. This significantly surpasses our prior expectation provided back in February. As we look out to the third quarter, we believe that we can be profitable at the hotel EBITDA and corporate EBITDA level as long as the recovery in group and business transient continues. Turning to 2022, the setup for Dimerock's group business is very encouraging. Recall that prior to the onset of the pandemic, Damarac had a very strong 2020 group pace. Much of that has been pushed into 2022. In fact, recent lead generation for 2022 continues to accelerate, and citywide room nights on the books in our biggest group markets, Boston, Chicago, and D.C., are already up 8.6% over 2019. It is still early. but we are very optimistic that our group pace for 2022 could really distinguish us next year. Also, we expect 2022 results will be substantially benefited by our high ROI projects. We now have seven repositions either underway or under evaluation for this year, including the up-brandings at Vail, Cherry Creek, and Sonoma. We hope to reveal more repositioning stories as the year progresses. Finding these value creation opportunities is truly an obsession at Diamond Rock. This concludes our prepared remarks. We are excited about our future and emerging from the crisis as an even better and more dynamic company. We have a great portfolio, a great balance sheet, and a great team to be able to deliver outstanding shareholder returns. With that, we'd be happy to answer any of your questions.

Thank you. And as a reminder, ladies and gentlemen, that is star one to get in the queue. To withdraw your questions, simply press the hash key. Please stand by while we compile the Q&A roster. Our first question is from Smith Rose with Citi. Your question, please.

Thanks. Good morning. I just want to ask you a little bit about, um, sort of two things that you think about, um, the, the pace of the recovery. And the first was, um, you know, maybe what are you seeing on the, on the labor cost side, um, and on the ability to, to refill, um, jobs and get people to come back. And the second is as you're booking, um, more on the corporate side, and I guess particularly corporate groups, do you hear or get sort of feedback that corporates are looking to, um, reduce overall expenditures or, you know, having enjoyed, you know, sort of essentially no travel budgets, you know, what's your sense of their willingness to kind of start ramping those back up? Thanks.

Sure. Hey, Spitz. It's Mark this morning. So those are both excellent questions. On the labor front, yeah, I think what we're seeing across, if you looked at the jobs report even this morning, the bulk of the pickup was in hospitality and leisure-oriented jobs. So, yeah, there's a rush on for rehiring folks There is a big pool of people out there that were, you know, unfortunately laid off in this, but some have found other jobs and other works. Some people have issues where they need to stay home and care for children and other issues, you know, in this pandemic as we emerge out of it. So we're having different experiences in different markets. We pride ourselves that generally we are excellent employers. But, you know, I would say it's a mixed bag depending on the market and how tight the labor markets are there. We are having to incentivize in some markets to get employees to come back. But we have a good handle on it. And remember, a lot of our markets were a very good job. So if you take New York City, for instance, where the overall package for a housekeeper is something like $80,000. With all the benefits so you compare that versus the alternatives. It's still a very attractive job But you know, we're clearly like a like our other other folks in the industry and markets like Florida It's very challenging to get workers, but we're on it and we think we have good action plan to your second question on corporate rates so far that with the with the what called the frequent travelers to consultants and banks stuff the the rates for a Going into next year, I think, are going to hold relatively steady, still very early. So, so far, it's been a mantra of kind of holding to pre-pandemic rates, and we think that that's going to continue. Travel budgets haven't been adjusted, but I think as we move into really the fall and post-Labor Day, we'll see a need for corporate America to get back on the road. So it's a little early to tell what's going to go on there with the customers. Everyone's looking at this. Everyone's trying to figure it out right now. But I think we subscribe to the school that people are going to need to get on the road to do business. It's been, you know, it's been over a year. I'd say my personal anecdote, I've done five business lunches in the last probably two weeks for folks that I would normally see, you know, poorly. But they're, as people are getting vaccinated, they're getting back on the road because they need to see their customers. So I think, you know, I think rates are going to hold relatively flat to pre-pandemic levels on the business corporate side. We'll have some people up to adjust for. And then we'll, I think, you know, this fall we'll really see folks get back out there and companies need to adjust their travel budgets according to the necessity of running their businesses.

Okay. Thanks for the comment.

Thank you. Our next question comes from Rich Hightower with Evercore. Your question, please.

Hi. Good morning, everybody. Mark, it may have been on my side, but I think you cut out a little bit earlier when you were describing the portfolio concentration in urban upon sale of the LEX. And maybe if you don't mind, just carry that through to what the shape of the entire portfolio might be, what the splits are across the different segments. I guess pro forma for both the LEX and Frenchman's, if you don't mind.

Sure. So post those two transactions, we're about 40%, I'll call it, through drive-to resorts and lifestyle-type markets. And our goal, strategic goal, as we've stated for the last several years, is to get over 50% and probably drive closer to 60% ultimately. So freeing up the Frenchman's capital, although certainly that location and that market has a lot of merit, We think freeing up that $200 million and then another $105 million in work will really help accelerate our ability to distinguish ourselves and execute on that strategy.

Okay. Yeah, and then just to kind of pick up on that idea, you know, it seems like in certain leisure-heavy markets, even today, and I'm thinking maybe of Key West as a good example, you know, you're running at or above pre-COVID run rates in many cases, and so... as you are underwriting some of those future deals along those lines and in that particular segment, you know, what are Diamond Rock's underwriting expectations generally in terms of the progression back to peak, above prior peak, you know, over what time? And then how would you estimate that the market is similarly underwriting?

So I guess it's a nuanced answer because everything every market and every resort's a little bit different. So to kind of give you two different ways we're looking at the world. So I guess overall, we believe that we are on the cusp of a continued leisure outperformance, right? If you look at the personal savings rate and the desire of people to get out there and the sharing of experiences over social media, we just think it all adds up to kind of new levels of leisure travel. Next. several years. So we subscribe to that overarching trend and we believe the data backs that up. In different hotels, it's going to perform differently. You know, if you look at our Fort Lauderdale Westin, for instance, terrific on the beachfront, terrific hotel, 400 rooms, but it's got a great group platform as well. So that one we would expect is below prior peak numbers. We expect as group kind of layers in there to boost the transient that we'll see that really accelerated. We would underwrite an asset assuming that the group comes back in there. Therefore, we could push the transient rate because we could squeeze those rooms down. In a, you know, let's say 150-room hotel in Key West, we think it's pretty durable there. We would expect that to continue, so we wouldn't expect that to pull back. Now, we wouldn't expect the same kind of year-over-year growth that we've experienced in the last 24 months. But we think those markets are very durable and that the leisure trend, the overall kind of wave, if you will, based on the data, will continue. So we'd be pretty encouraged. Clearly, the market is valuing durable income and leisure assets more, right? They've proven through the last two cycles to be the most durable investment option. So when you think about discount rates, they should bear a lower discount rate. So we remain, you know, kind of optimistic and I think the overall market, you know, we all have a lot of similar data. We probably have a little bit more conviction than some. But, you know, it's shown that those are more valuable assets and the market's pricing them accordingly.

Okay. Thanks for the thoughts.

Thank you. Our next question comes from Dori Keston with Wells Fargo. Your question, please.

Thanks. Good morning, guys. Can you walk us through the process you went through on Frenchman's, what the level of interest was to partner with you versus acquiring the asset and just how you were thinking about valuation?

Sure. Great question. So we engaged a global brokerage firm to go out and do a global marketing campaign. We received a, I'll tell you, a higher level of interest than we expected. We had 10 offers. We went out and said we're flexible. We want to get the resort rebuilt. We believe it's a great asset. We'd like to stay in for some of the upside, but eliminate the funding obligations. It's kind of the criteria. We received 10, I believe 10 written offers from various groups, from developers to household name private equity firms, There was a high level of interest. We did a series of rounds of bids, and the credibility and enthusiasm of ultimately the winning bidder stood out. They shared our vision for the asset. They were committed to getting it restarted very quickly. We believe they have the ability to execute well in their relationships with the local government. to get it done. So, you know, based on certainty, execution, and alignment, it made the most sense to go with this particular offer. We think it's going to be a good deal for them. For us, we think it's a good deal. Basically, if you kind of think about the math, basically with the $240 million of insurance proceeds and the $35 million we received on April 30th, we get close to back to the value that we had in 2017. And then the profit participation, you know, is all upside from there. And that's likely, you know, things go right, that's likely to be worth a substantial amount of money. So we think the result's good. We think it's a good deal for a buyer. We think it's a very good deal strategically for us. And freeing up that capital to reinvest now we think will really pay off for our shareholders.

Okay. Thank you.

Thank you. Our next question comes from Chris war on car with Deutsche Bank. Your question, please.

Hey, good morning, guys. Mark sounds like you're definitely pivoting more into more acquisitions of leisure oriented stuff and give you credit for kind of being early on that many years ago. But But the question is, obviously, there's there's a lot of capital out there right looking for similar stuff and not all of it is necessarily as smart or as disciplined as you all are. So how are you going to find these acquisitions? Is it something that just has to have a value-add asset management opportunity on the back end or something else?

Yeah, I think we have three advantages in the marketplace. So it's relationships, expertise, and synergies. So on relationships, as you know, we've been talking about this thesis for several years. And so our internal investment team and really the whole management team has relationships with many, many owners of these kind of assets we've been talking to for years. So we've built relationships, we've built contacts, we've built trust. So we think we probably have broader, deeper relationships in these kind of assets than any other public lodging retail. So relationships are important, especially since we're trying to do off-market transactions. And then we have expertise. So we've been doing more of these. Our team and our asset managers are very adept at finding other revenue streams and understanding the revenue upside in these kind of assets. And so I think that gives us a real edge in our ability to underwrite them and ultimately execute on them once we buy them. And I'd say the third advantage we have is synergies, because we are in many of these micro-markets, whether that's Vale or Sedona or Sonoma, or Lake Tahoe, you know, the ability to have relationships with other markets, but also when we can find an asset to buy, hopefully off-market in there, we have synergies, right? We can have one GM over both properties. We can cut out, you know, one director of revenue, one salesperson. You know, there's just a lot of synergies, especially when you're talking about smaller assets. Those synergies can be very powerful and have the return profile. So we think those relationships, expertise, and synergies give Dimerock an edge as we execute over the next couple of years.

Okay. Very helpful. Thanks, Mark. Sure.

Our next question comes from Michael Bellisario with Baird. Your question, please.

Good morning, everyone. Mark, just back to the Lex. What are the risks to closing this deal or getting it across the finish line? It seems like a longer than normal closing period you guys have lined up.

Sure. So it's a well-known and well-financed buyer. It's a $5 billion non-refundable deposit. They're actually going to post a second deposit in the coming weeks to increase that amount. And the timing, the... Timing is due to the way their endowment funds are coming in. So they're all set. We had to line up the closing sequentially with the way their funding works. So I have high confidence they're going to close. Nothing in life is guaranteed, but we have the substantial deposit. They're enthusiastic about the deal. They've raised money around a New York thesis They're enthusiastic and big believers in the rebound in New York City. That's kind of what they're investing for. So we think this asset lines up very well with what their vision thesis is. So we feel good about it, but the only contingency is that they have a non-refundable deposit. That's kind of the confidence builder, and we know it's consistent with how they've raised their money, and we know it's a very credible buyer.

Got it. And then just the timing of the sale, I know you've been pursuing it for a while, but how much of your motivation here is asset-specific versus any change you might have in your broader view of New York City going forward over the next three to five years?

Yeah, I mean, New York City is still the number one city in the United States. It's got a lot going for it. We just think there's a lack of visibility right now. You could certainly argue the bull and bear case in New York City, we believe. There are about 20,000 hotel rooms under construction in the market right now. It's the top two supply market in the U.S. But there's a number of reasons, particularly in the Midtown East, to be encouraged and excited. So we think that just this opportunity allowed us to reduce our new exposure. We remain with three select service hotels, which we think is a smart place to play that market. It allows us to accelerate our overall strategic goals of getting into more drop-to resorts So, you know, it just seemed like the right time to pivot in the marketplace. Given the lack of clarity, we are maintaining an allocation to New York. It's just a lower allocation as we move forward.

Got it. And then just one more quick one for me on Frenchmans. Maybe could you provide any details on what needs to occur there for you to be in the money on the earn out in terms of hurdles? And then what's your base case for timing of this potential payout?

Yeah, I mean, there's a lot of factors that go into it. So, there's the construction costs and the basis and the asset. There'll be the ramp-up timeline. I think we have the similar underwriting as the partner on this or the person who bought it. So, probably, if I had to guess, and this would be a guess, it would be about four or five years until they move to kind of realize all their equity value on the asset. And the way the accounting works is we revalue it every quarter, and the more we think it's certain, the more likely we are to start recognizing the gain as we move forward. There's hurdle rates, and it's an IRR hurdle rate to them, and there's a very complicated waterfall where we get 100% at one level and then we get 20% after a certain other threshold, but we have a series of confidentiality agreements around the particulars of that.

helpful thank you our next question comes from the line of anthony powell with barclays your question please hi good morning uh so the resort performance was great uh but the urban hotels you know continued to burn cash i guess and you look forward to the summer and the fall What's the prospect for those hotels to get back to break-even? Can they get back to break-even with just leisure demand as cities reopen, or do you really need that BTN group to come back for them just to get to break-even?

Hey, Anthony, this is Jeff. It's going to vary a little bit by hotel and by market, but I would tell you that we are seeing increasing occupancy on the weekends in our urban hotels throughout first quarter, and it looks like that's Continuing in the second quarter, I do think ultimately to drive meaningfully profitable in the back half of the year, you are going to need to see some level of BT and group come back in the third and fourth quarter is really what our expectation is.

Got it. And maybe shifting gears to acquisitions, you've talked more about buying other hotels in your current market, which is a bit new. Just curious, more disclosure on that, and would you consider getting into different, I guess, micro-resort markets or graduate resort markets in the future?

Yeah, this is Mark. So on the acquisition, it's obviously we have a leg up in the existing markets where we like them. That's why we bought hotels in those particular micro-markets. We think we have a leg up with the synergies, and we have deeper relationships in those markets. What we've targeted overall I was just going back and looking at our strategy deck on external growth. We have about 50 micro markets targeted throughout the U.S. And so it's other markets like Jackson Hole and things that you would think have similar characteristics to the markets we're in now. So, no, we're not wedded only to the markets we're in. We are actively working on a number of other opportunities. We are concentrated. If you looked at kind of our deal sheet, it is primarily off-market deals. We do think the pricing has gotten ahead of itself on some of these fully marketed deals. So we're spending the bulk, you know, 80% of our energy on off-market deals. Not that we couldn't do a marketed deal and maybe have a different twist, but primarily our energies are dedicated to off-market transactions. Troy, do you have anything to add to that?

Yeah, no, I agree with that market. We do have some advantages on markets we're already in, but we're always scouring for sort of the next growth market that we think has maybe some built-in barriers for development and that we're seeing characteristics of increased demand. So I don't like to talk too much publicly about markets we're looking at, but I think those are the characteristics.

And what are the seller motivations in these markets, especially for off-market transactions? I mean, theoretically, they can market and get higher returns. higher pricing. So why are these transactions being held off market?

Yeah, sometimes they've been held in families for a long time. They look at possibly kind of tax consequences of holding longer. Every one of these deals sort of has different types of characteristics, diverse partnerships, things of that nature.

Yeah, I'm trying to think right now, Anthony, the Two of the deals that pop up that we're looking at, it's partnerships where you have a sensitivity between one partner who probably is more inclined to sell and another who is not, where there's complications. So doing a tailored deal that meets their needs very quietly is often better for them to execute than to do something that may fail if they do a fully marketed deal and may create more noise, if you will, that they don't want. Understood. Thanks.

Thank you. Our next question comes from Flores Van Dink. With a compass point. Your question, please.

Morning, guys. Thanks for taking my question. I wanted to talk about, obviously, the sale of the LEX is going to increase your resort exposure. It sounds like the acquisitions you're contemplating are going to increase your resort exposure. Do you have a percentage of your portfolio that you want to be? Will you be a pure play? I mean, are you considering potentially exiting out of your remaining urban hotels as well?

That's a good question. We're currently at 40% of our call resort lifestyle drive-to markets. We'd like to get that certainly to 50%, which I think we could do relatively easy with the capacity we have now. And ultimately, we probably end up between 50 and 60. We think that will distinguish us among all the other investment choices. But we do like the three legs of the lodging stool. We do like having BT and some group in there because over an extended cycle, things do move at different times. So we would never want to be, I think, vulnerable to some of those movements. So we'll keep a diversified portfolio. But clearly, when investors are thinking about their options, we want to distinguish ourselves by having more of these drive-to and leisure markets. And then the other factor that we're really focused on is having an unencumbered by management portfolio. So today, with the exception of two hotels, basically we have terminable at-will agreements in all of our properties for management. That gives us the ability to execute better on asset management. We think it gives us higher exit value or lower cap rates. And I think some of the results on the success of our asset managers are very talented. but they have more control over the properties where they can, they have terminal management agreements. Those managers will do what we think is in the best interest of the property and we have great alignment. Often with the brand management, they do what they think is best. Sometimes we agree and sometimes we don't, but it's certainly harder to get them to do everything that you think is the right thing to do for the property.

Thanks, Mark. Maybe one follow-up. In terms of, you know, you're sort of, you're stabilized EBITDA, I know nobody's giving guidance right now for this year or for next year, but the cost reductions that everybody talked about and that you alluded to, are you thinking somewhere between 1% and 2% of your cost base should be eliminated once everything settles down?

Hey, Floris. This is Jeff. I think the way we've been thinking about it is the transaction we did with Marriott that converted our hotels from managed to franchised is unique to us of about 50 basis points improvement in our EBITDA margins on a 2019 pro forma basis. And then beyond that, I think, you know, as Mark made a comment in his remarks, that When we look at our open hotels, or I believe our resort hotels in this quarter versus 2019, on lower revenue, we had about 80 basis points better margins. So I think we look at those as indications about where cost reductions and margin improvement can go in the future. And like I said, it's sort of 50 basis points on top of whatever the industry can generate at the hotel level. One point I would make is that I recognize on our call and other calls people have asked about labor. I actually think there's an opportunity to the extent there are in some markets or in some situations. Shortages of labor, it does give rise to the opportunity to redo the labor model in those situations, whether it's increased usage of digital check-in or, again, changing customer behavior around room cleaning and things of that nature. So I think we're encouraged on that front.

Thanks, Jeff.

Thank you. Our next question comes from Chris Darling with Green Street. Your question, please.

Thanks. Good morning, everyone. So I want to go back to New York for a minute. And I'm wondering if you have a view on the city's proposed zoning amendment that would require a special permit to construct a new hotel in the city. And were that to pass, I'm wondering if that changes sort of your long-term thinking about your remaining hotels in the market.

Yeah, it's a great question. So, you know, let's look at the facts. So the M1 zones were rezoned with a similar special permit requirement. And I think since that passed, That's two years ago. There's been virtually no new building permits pulled within those zones. So if they adopt something similar for the entire city, which is the proposal and legislation that's moving through right now, we would expect that it would have a significant impact on supply. After all the stuff that's permitted, it gets done. So you're talking about 20,000 rooms under construction, plus there's a lot of other permits that could be pulled before the new law would go in. I think it means that the long-term prospects for New York look brighter because of the kind of supply constraint from new legislation, but that's not going to impact the supply over the next 36 months. So they'll still need to pull through that. But I think it's very easy to build a more bullish case for New York over the five- to ten-year horizon, certainly the ten-year horizon. But they'll have to work through the existing supply that's under construction now.

Yeah, I appreciate the comment. Thank you. Our next question comes from Austin Warchnitz with KeyBank. Your question, please.

Great. Thanks, guys. Good morning. I'm curious how deep the pool of qualified bidders for the Lexington was maybe versus other periods that you've shopped a hotel. And are you able to move forward with an acquisition today or would you have to wait until the Lexington closed just based on what's in your amendment to your credit agreement.

So, Jeff, maybe you want to answer the capacity question, and Troy, we'll shift over to you to talk about the marketing process and what you think about the level of interest in New York assets at the moment.

Sure, yeah. Often, to answer your question, I mean, we do have capacity. Obviously, it's a function of the asset size that we would be considering, but we do have the capacity to move ahead with an acquisition before the before the Lexington were to close.

Troy? Yep. So we, like with Frenchman's, we engaged an international broker and did a full marketing on Lexington back in the fall and early winter this year. And we had some good interest. I'd say there was a half dozen sort of qualified bids that we worked our way through to get to this one. I mean, there's not there was not sort of an oversubscription to New York acquisitions in the middle of the pandemic. But we were pretty pleased with the number of interest in this particular property. So I think it was a good execution.

Got it. Appreciate that. And then just on ADR. So I'm curious how you think ADR trends over the next several quarters, as these additional hotels reopen, because You guys did see a modest increase in ADR versus last year and 2019 for the overall portfolio, even though when you kind of look at the individual buckets of the 26 open hotels and the four that were closed or partially open for the period were down versus those two periods on a standalone basis. So I guess there's a little bit of a mix factor that's going on right now. So how do we think about that trend over the next few quarters?

Tommy, you want to talk about break trends that you're seeing at the property?

Sure. I think when we look at, obviously, the big driver over the next several quarters will be group and corporate BT as that comes back. Our group pace for 2022, our ADR is up to prior year and we're actually measuring off of 2019 where we were in 19 going into 20, just like where we are now in 21 going into 22. The citywide pace is very strong. across our major markets. In Boston, once again, it's almost in line with where we were in 19 going into 20, which was a record year at about almost 380,000 rooms. And at that point in 19, we had 400,000 in. So we're close. Chicago is flat to what it was in 2021 compared to 19 going into 20. So those are two really good indicators. And that'll help if those conventions actualize, that'll help the demand and lift up transient in those markets. It's really going to be a function of the corporate business coming back and maintaining those rates, which we believe we can, and right now our rate is up for 2022. And then really the leisure stuff, the transient leisure stuff, it's going to be case-by-case, market-by-market. We have some unique tools and pricing strategies and the way we look at rate efficiency is in those markets by room type, by lead time, by category, by segment, we understand the buying behavior, and then we actively target markets that are looking based on the data. So I think the leisure side is going to continue to do well. And even if it pulls back a little bit, we're confident that to maintain rates, we'll maintain rates. So I think we're in a good position to see rate to see rate growth. The one thing that we can't really understand is the corporate business transient in the urban markets. Once again, the technology, the trip bans of the world, as rates go down in those markets, the computer obviously can just switch rates. And so all it takes is a few bad apples in a market to start dragging those rates down on the big accounts. So that'll be what we'll be monitoring and looking at and how to defend against that. Just make sure we're We're focused on static rates versus dynamic rates in markets that are oversupplied and maybe are softer so that we can maintain a base on rate. And then everything else, there's no advantage to discounting rates. So I think we're paying attention to it. We have some really good tools that we use, and we provide a lot of guidance so that we're confident we can maintain rates.

Thanks, Tom. A couple other comments. So I think we're seeing good rate integrity with our corporate accounts. There is going to be some mix issues as we get back to high-activity levels where we can really control the mix shift within the properties. And so you'll see that as the mix gets better, as we move through the next 12 months, that'll help the rates. In the short term, though, I would note we are focused primarily on profit here. So we'll be reopening some of our closed hotels, which we've done over the last couple weeks. So that'll lower ADR because of the mix in reopened hotels. This still means more profit, and we're all about profit and getting to higher levels of dollars coming to the bottom line.

Got it. All very helpful. Thank you.

Thank you. Our next question comes from Patrick Scholes with Truist Securities. Your question, please.

Hi. Good morning. Earlier you had mentioned an action plan to – Hire employees. Does that action plan include raising wages? Thank you. And then I have another question.

Yeah, Patrick, this is Mark. And yeah, in some markets, it's going to be some wage adjustments. You know, there's only so much we can afford in our model. So we think the labor pool in many markets is still good. In some markets, it's very tight. In some markets, we've had to provide incentives to get people to come back. You know, I would imagine in this fall, as the unemployment rate call super enhancements burn off after September. That's when our demand should really be surging. So there'll be some overlap and kind of improving incentives for people to get back to work just when we're going to really them in the fall. Yeah, but we pulled out, you know, we're being creative, we're pulling out the stops. But there is some wage pressure in certain markets.

Okay, thank you. And then, I guess, since COVID began last March, what would you say is your accumulated deferred capex to this point. Thank you.

Yeah, Patrick, so the good news for Dimerock is we went in with a mostly renovated portfolio. So if you look at our percentage of revenue over the prior three and five-year periods versus the pure set, it was running between 12% to 14%. So we invested heavily in our portfolio. We had very, very little well-called deferred maintenance going into this. And then we continue to invest in the repositioning of our properties. Some rooms' re-dos that would have happened got pushed a year or two, but for better or worse, there wasn't a lot of wear and tear on some of our urban hotels over the last 12 months. So that makes sense and really didn't lead to any accumulation of deferred maintenance. And then if you look at our five-year CapEx plan, Going forward, it's pretty normal levels. There's not a deferred. These properties were in good shape going into this event. Okay.

Good to hear. Thank you.

Thank you. And our last question comes from Bill Crow with Raymond James. Your question, please.

Good morning, guys. If I go back to the labor question and, Jeff, your discussion about the ability to kind of redefine what labor is needed in hotels. Isn't there a caveat to this discussion that you can do that as long as the guests don't start to complain? We heard yesterday on another call that the guest satisfaction scores are starting to reflect some of the labor shortages in the hotels. How do you think about balancing the staffing model with what guests are used to?

Bill, we're super focused on guest satisfaction. And if you look at our TripAdvisor scores for overall portfolio, they've actually increased despite tight cost controls year to date. So we're encouraged by that. I think it depends a little bit on the kind of hotel and the kind of business you have, about your ability to satisfy your customers, even with more restrained labor models. But we're very focused on that. I think it's more problematic for different assets than we generally own. But we're We're feeling good that our operators, worked with our asset management teams, have been able to raise TripAdvisor scores despite very tight labor models. Tom, do you have an additional color you'd like to add?

Hey, Bill. I would say that the heavy focus really, look, we're going to, we have to, the people that actually are doing the work, we have to adjust and adapt and create incentives. The goal is to create incentives that reward behavior. and not just elevate everyone's wage, right? Try to create incentives for when the business is good. And when the business gets a little soft, that comes down. So we're looking at basically incentives across all, you know, in all those markets. And then I think the bigger thing that we've seen is FTE creep, fixed FTE creep. We've established baselines for the portfolio at occupancy levels, right? So we looked at every type of fixed position. If it's a greeter, a supervisor, a manager, you know, back of the house, accounting, administrative, those are all, in my mind, fixed FTEs. In our mind, they're fixed FTEs. So we've created benchmarks for all of our hotels, and then we're tracking those every month. And we're making sure that the positions that add value and improve customer experience and touch the customer, those ones are the ones that go back first and drive revenue. And the ones that maybe aren't as necessary and they just kind of FTE creeps over the last, you know, four or five years, those are the ones that we're going to really pull back on. And that's the focal point. That's a big part of it. You know, truthfully, the people that do the work, you know, we can't, we have to, you know, there's no way around getting rid of those people. They're critical to our success and to the guest experience.

Okay. Thank you all. Thanks, Bill.

Thank you. And this concludes our Q&A session for today. I will turn the call back to Mark Brugger for his final remarks.

Thank you, everyone. We appreciate your continued interest in Dimerock, and we look forward to updating you on our next quarterly call. Have a great day.

Thank you. And this concludes today's conference call. Thank you for your participation, and you may now disconnect.