Pebblebrook Hotel

zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Raymond Martz, Co-President and Chief Financial Officer. Thank you. You may begin.

Thank you, Donna. And good morning, everyone. Welcome to our third quarter 2023 earnings call and webcast. Joining me today is John Bortz, our Chairman and Chief Executive Officer, and Tom Fisher, our Co-President and Chief Investment Officer. But before we start, a reminder that today's comments are effective only today, October 27, 2023, and our comments may include forward-looking statements under federal securities laws. Actual results could differ materially from our comments. Please refer to our latest SEC filings for a detailed discussion of potential risk factors and our website for reconciliations of non-GAAP financial measures referred to during our call. Now let's turn our attention to our Q3 results. We are pleased to report that despite two negative weather events and continuing entertainment industry strikes in L.A., we were able to achieve same-property hotel EBITDA, adjusted EBITDA, and adjusted FFO at the top end of our outlook due to a continued recovery in corporate group and transient demand across many of our urban markets and solved cost controls in a gradually moderating expense environment. Washington, D.C. led the rebound, with hotel occupancy surging an impressive 13.68%, and RevPAR increasing 21.4%. This was closely followed by San Francisco, which climbed over 10 occupancy points, 72%, with RevPAR up 13.1%. In Los Angeles, where occupancy improved nearly 6 points to a healthy 78%, with RevPAR growing 5%. Significantly, weekday occupancies at our urban hotels, a good bellwether for business travel demand, rose to a solid 75.4%. up from 72.3% in the prior year quarter and a meaningful recovery over last year. Our urban properties also gained from a resurgence in leisure travel, particularly during the summer, bolstered by concerts and other leisure cultural events. Consequently, weekend urban occupancies elevated to an impressive 82.3%, almost surpassing our weekend resort occupancy of 83.9%, which itself is nearly two points higher than the prior year quarter. As a result, rep par at our urban hotels increased by 3% compared to last year's third quarter. This improvement helped to offset moderating room rates and demand for suite and premium room upgrades, particularly in the leisure segment at our resorts. Resort rep par was down 10.2%, with occupancy flat. Resort rates continued to be on average about 40% or $111 higher than those in 2019. The resorts bore the brunt of the two weather impacts, so their results would have been better, otherwise less negative. For the quarter, we recorded a marginal increase of 0.2% for same-property Tolerant Park. While room revenue dipped by 1%, non-room revenue rose by 3%, attributable to the benefit of recovering occupancy levels, a persisting trend across our portfolio, along with continued healthy out-of-room spend by our guests. The third quarter was not without its challenges, though. First, two named storms adversely affected demand on both coasts, triggering cancellations and curtailing bookings from mid-August through mid-September in several key markets. This led to an approximate 90 basis point decline in our repertoire growth and shaved an estimated $2.5 million off our same property EBITDA. Second, West Los Angeles properties continued to feel the impact of their writers and actors strikes, which have notably dampened demand from the entertainment sector. We estimate this caused a 30 basis point decline in REFAR in the quarter and a $0.5 million decrease in same property EBITDA. While the writers have recently settled, the continuing actual strike is expected to curtail demand in the LA market in Q4, which we have estimated and reflected in our Q4 outlook. Finally, the completion of the redevelopment of Solmar into Margaritaville-San Diego gas main corridor, coupled with extensive renovations at the guest houses at Southermost, resulted in an approximate 45 basis point impact to Repar and a $1.4 million reduction in same property EBITDA. These renovation-related disruptions are largely anticipated and aligned with our original Q3 outlook. Despite these hurdles and one-off weather events, overall portfolio occupancy continued its upward trajectory, finishing the quarter at a healthy 75.4%, an increase of 2.5 points over the year-over-year. Our same property EBITDA at $114.3 million hit the upper end of our Q3 outlook, with EBITDA margins at 29.4%, also at the top end of our expectations. These positive achievements were aided by prudent cost management strategies across all operating departments, as well as successful reductions in property taxes at several of our properties. Overall, wage rate pressures and other operating costs have notably eased as the year progressed as compared with the significant strains witnessed throughout 2022. The year-over-year growth rate in our total hotel operating expenses, excluding property taxes, has declined from 27.8% in Q1 to 10.2% in Q2 to 5.4% in Q3. And on a per occupied room basis, they've declined from 7% in Q1 to 5.3% in Q2 and down to 1.8% in Q3. We provided these numbers excluding property taxes since they may vary materially on an unpredictable basis as we are successful in winning reduced assessments and making multi-year true-ups, but these growth rates would have been even lower if we included property taxes. We expect further easing in the growth of more normal course operating expenses, meaning excluding the noise from things like property tax interrupts or property insurance in the fourth quarter, as we are lapping the success we've had restaffing in the last four months of last year. Energy expense growth also moderated to 10.7% in Q3, down from the nearly 14% spike experienced in the first half of the year. This reduction in the growth rate results primarily from our significant investments in energy and water conservation across the portfolio and some moderation in energy rates. However, we continue to have energy contracts we locked in several years ago that will roll over at significantly higher percentage increases. As a result, this will keep our energy cost growth rate from moderating in the next 12 to 18 months. Insurance costs were also ahead when increasing 34.4%, over the prior year quarter. On a monthly breakdown, the REPAR in July dipped by 0.5%. August saw a 1.1% decline, probably due to Tropical Storm Hillary, which made landfall on August 20th, resulting in cancellations and reduced bookings at our 17 hotels in San Diego and Los Angeles. September REPAR ended down 1.7%, probably due to Hurricane Adalia, which made landfall on August 30th, which increased cancellations and negatively impact bookings at our six resorts in the southeast. Our adjusted EBITDA and FFL benefited from business interruption proceeds of $10.9 million for La Playa, slightly exceeding our forecasted $10.5 million. Lower than expected, G&A also contributed to our positive variances versus our outlook. During the third quarter, we deployed $33.1 million in capital investments across our portfolio, with a significant portion related to two major redevelopments, the newly transformed Margaritaville San Diego gas plant, which occurred on August 15th, and the $12.5 million redevelopment and substantial repositioning of the four guesthouses comprising 50 guestrooms and suites at Southernmost Resort in Key West. Renovations of the guesthouses at Southernmost are on track for completion in November. The public space renovations at Estancia La Jolla are scheduled to commence in November, with completion expected in early Q2. This marks the final phase of a 15 month long comprehensive redevelopment and reposition of LaSancia, which began with a full guest room renovation. And our last major redevelopment project for 2023 involves the sweeping transformation of Newport Harbor Island Resort, which is set to commence on November 13th with the closure of this property. We aim to complete this redevelopment in Q2 next year, before the resource peak season. We remain on track to invest $145 to $155 million in the portfolio for the year, and we're pleased to report that the bulk of revenue disruptions and overall investment dollars associated with our strategic capital redevelopment projects are in the rear view mirror. We remain bullish about the substantial upside these repositioned properties will generate in both market share and cash flow in the foreseeable future. Shifting focus to Apply Beach Club Resort and Club in Naples, substantial strides continue to be made in the resort's ongoing repair and refurbishment. The 40-room Bay Tower and 70-room Gulf Tower, which encompasses the resort's key amenities like the lobby, restaurant, and club, are substantially complete and full operational. Apply is beginning to look like an upscale resort again. Rebuilding work on the 79-room beach house is now well along with clearly an end in sight. We currently are forecasting this final portion of this resort to be substantially complete and reopen in the first quarter next year. This represents a delay from our prior year-end estimate due primarily to delays in permitting with the county. Impressively, despite the absence of a full-fledged resort experience and the inevitable noise and disruption from very visible ongoing construction, The 110 guest rooms currently available across the two operational towers achieved a notable 50% occupancy rate, an average daily rate of $389 during the third quarter. It's the seasonally slowest period and a striking 60% uptick over 2019 rates. For context, it's important to note that before the devastation brought by Hurricane Ian, we projected La Playa to contribute over $4 million in EBITDA for Q3, as opposed to the $0.2 million loss it actually incurred. This underscores the impact the loss of the resort had on our financial results. And as a reminder, we currently exclude La Playa from our same property operating results. Regarding our Q4 outlook, we have not incorporated any additional business interruption or BI proceeds related to Q3 losses. Instead, for La Playa, we anticipate that BI proceeds for lost income for both Q3 and Q4 of the current year will occur in 2024. As of the end of the third quarter, we have recorded approximately $33 million in BI-related revenues. As part of our strategic capital reallocation strategy, we have entered into a contract to sell Hotel Zoe Fishman's Wharf for $68.5 million with a sale targeted for completion in Q4. Assuming a successful closing, this will bring our total asset sales for the year to six properties, generating $300.8 million in gross proceeds year-to-date. All divested properties have been urban properties in line with our overarching strategy to rebalance the leisure and business segments of our portfolio for optimal long-term risk-adjusted returns. John will speak more about this strategy in his remarks. And on the capital allocation front, we did not purchase any common shares during Q3. However, we reduced our total debt and increased our cash position by replacing a $161.5 million loan secured by a Margaritaville-Highwood Beach resort with a new secure loan of $140 million. This loan carries a three-year term extendable by two one-year options with a rate fixed at 7% for the ensuing four-plus years. Regarding our balance sheet and liquidity position, we have over $829 million of liquidity comprised of $191.6 million in cash and $637 million available on our unsecured line. The weighted average cost of our debt is 4.4%, with 78% of it currently with fixed rates and 92% unsecured. Our increasing cash reserves and unsecured credit facility, augmented by additional asset sales, provide us with more than sufficient liquidity to navigate our upcoming debt maturities over the next 12 to 24 months. And with that comprehensive update, I'll turn the call over to John. John?

Thanks, Ray. I'd like to touch on three topics this morning. First, our observations on industry trends. Second, I intend to discuss our ongoing strategic capital allocation program and our continuing pivot from a heavy urban and business travel focused investment company to a more balanced portfolio, more evenly split between business and leisure and between urban and resort. And then third, I'll talk about our outlook for the fourth quarter. In terms of industry trends, it's fair to say the industry has seen a flattening out of the recovery in demand on an overall basis. In fact, the industry was unable to successfully absorb even the smallest amount of supply growth in Q3, with overall industry occupancy declining, albeit slightly, in every month in Q3, a trend that continues from Q2. We were surprised that this trend did not reverse in Q3. However, the revenge travel related to outbound international and cruising this year seems to have overwhelmed improving demand in business travel and international inbound travels. We believe business travel, both group and transient, continues to gradually recover. Leisure, on the other hand, has declined slightly, as international outbound travel and cruising rebounded to above pre-pandemic levels. And international inbound travel, especially leisure, has only gradually returned. The leisure softness has primarily been reflected at resorts, while urban weekend occupancies have continued to recover. We believe next year leisure will normalize at higher levels of domestic travel As we lap this revenge travel, an international inbound continues its gradual recovery. The resurgence in business travel we've seen is evident by the improving occupancies in the urban and top 25 markets, specifically during weekdays. This trend is particularly strong in the luxury and upper upscale segments, hotels which are predominantly located in major cities. The STR data for Q3 shows a consistent softening of occupancies at the mid to lower end of the spectrum. We've not seen any evidence of trading down in the industry. In fact, the STR numbers show the weakest demand and worst performing properties are at the bottom end of the quality and price spectrum, with the economy hotel category performing the worst. Geographically, in general, the previously slower-to-recover markets, such as Chicago, San Francisco, Washington, D.C., and New York, are now experiencing stronger demand growth, and the earlier-to-recover markets, such as Miami, Tampa, Orlando, and Atlanta, are witnessing weaker demand growth. The top 25 markets continue to see increasing demand and occupancies while other markets continue to see declining demand and occupancies. Amidst this industry-wide stabilization of demand, ADRs in Q3 also displayed a moderating growth rate, though ADRs in September and so far in October have bumped up from the low points in July and August. None of these trends come as a surprise, and we don't expect much change in these industry trends for the rest of the year, However, we do expect a modest boost in October's performance due to the favorable calendar of the Jewish holidays this year falling completely in September. Of course, given the Fed's efforts to bring down inflation and slow the growth of the economy, we shouldn't be surprised if we see a slowdown or recession sometime in the next 12 months. Now I'd like to move on to a brief discussion of our capital investment strategies and our overall pivot to a more evenly balanced business and leisure demand mix. Our reduction in urban properties has been going on since 2016 when we began to sell out of New York. Prior to the LaSalle transaction in late 2018, we sold a total of seven properties for gross proceeds of $592 million, and all of them were urban. Acquiring LaSalle added six unique resorts, all with significant repositioning upside. Simultaneously with the corporate transaction, we also disposed of five of LaSalle's urban properties for total gross proceeds of $821 million. Since then, we've sold 24 additional properties, including the upcoming sale of Hotel Zoe in San Francisco, all urban, generating gross proceeds of an additional $1.725 billion. In total, we've sold 36 urban properties since 2016 for over 3.4, I'm sorry, for over $3.1 billion. In 2021 and 2022, we acquired five leisure-focused resort properties and two guest houses in Key West which were added to Southernmost Resort for a total of $822 million. Jekyll Island, Estancia, La Jolla, Newport Harbor Island, and the two guest houses have and are undergoing extensive upgrades, repositionings, and operator changes that will drive significant upside going forward. This is on top of the very substantial investments in our other resorts, including Skamania Lodge, Chaminade, Mission Bay Resort, the Marker Key West, Southernmost Resort, Lobert's Del Mar, and La Playa in Naples. And we believe all of these resorts, due to the investments we've made in upgrading them and re-merchandising them, will continue to gain market share, thereby enhancing cash flow. So from 2016 to today, we went from two resorts to 13 resorts, which also helped us increase the leisure mix within our portfolio. Today, we believe the business leisure mix in our portfolio is roughly 50-50, and assuming we sell additional urban properties over the next couple of years, we expect the leisure portion to edge slightly higher. We don't think it will move a lot, as many of the urban properties we've sold or are selling, such as those in San Francisco, Portland, Seattle, and Washington, D.C., have a strong leisure mix as these markets are very attractive to leisure travelers. Moreover, most of the resorts we've been acquiring have very large business group components, while their business and corporate transit mix tends to be more limited. This helps explain the actual increase in our group mix overall in our portfolio as this pivot has continued. We believe this roughly 50-50 mix between business and leisure will serve us well in the years to come, as we believe the slowest to recover segment will continue to be business transit travel, and we believe that secular trends favor leisure travel as well as group, particularly group in resort locations with significant outdoor meeting and event space and numerous amenities, activities, and experiences. As we move forward, we continue to focus on taking advantage of the public private arbitrage opportunity that exists today. We're selling urban properties in slower to recover markets with lower cash flows and within our individual property NAV ranges, and then using those proceeds to reduce our net debt and repurchase our common and preferred shares at very significant discounts to the NAV of the company. Since the pandemic began, we've sold 14 properties, including the upcoming sale of Hotel Zoe in San Francisco, for gross proceeds of $881.8 million at an average trailing 12-month NOI cap rate of 0.5% and a trailing 12-month EBITDA multiple of 105.8 times. We've generally sold our lowest quality properties in the slowest recovering urban markets thus improving the quality and growth prospects of our remaining portfolio. We've sold five properties in San Francisco, two in Portland, two in Seattle, one in Nashville, one in New York, one in Coral Gables, one in Philadelphia, and a small retail property in Chicago. We believe strongly that taking advantage of this significant financial arbitrage opportunity which is being funded by the sales of urban properties in slower to recover markets at attractive relative pricing, is by far our best capital investment strategy. The opportunity available in the past year, including right now, represents a far better value creation opportunity for our shareholders than either using all of the proceeds to pay down our debt, which we believe is at a modest level, or holding cash to take advantage of undefined opportunities in the acquisition market at an undefined time in the future. We just don't believe any opportunities in the future will be more attractive or available at a bigger discount than buying our current properties at a 25% to 30% discount to their estimated current gross values and a 50% plus discount to the overall value of the company. Now let me turn to our view of the near term. As we look at the fourth quarter, October started out well with healthy business and leisure travel. October is also benefiting from both Jewish holidays falling into September this year versus them being split between September and October last year. This, of course, helps the performance of the entire industry. In addition, we have some favorable convention calendars in the fourth quarter in San Diego, San Francisco, Washington, D.C., and Boston, which benefit a significant portion of our portfolio. This is evident in the year-over-year pace for our fourth quarter, which shows robust growth in both group and transient business. Specifically, compared to a year ago, we have a 9.6% increase in room nights on the books at a 2.9% higher ADR, resulting in total revenues on the books substantially higher, up 12.8%. Breaking it down further, Our group business on the books is particularly strong, with a healthy 10.3% year-over-year increase in room nights, a very strong 7.5% increase in group ADR, and 18.6% growth in total group revenue. Transient is not as strong, but is still very favorable, with room nights and revenues up 9.1% and rates flat year-over-year. As a note of caution, about how our pace may ultimately translate into our performance, we need only to look at this past quarter. We had a great pace advantage going into the third quarter, but we experienced a deficit in pickup in the quarter for the quarter. We feel comfortable in saying that we believe this doesn't represent a slowdown in business activity, but a normalization in booking patterns. We believe that more business is being put on the books further out, consistent with more normal pre-pandemic patterns, as business and leisure customers have increasingly felt more confident booking further out as their comfort level grows with pandemic-related concerns increasingly in the rearview mirror. In Q3, we booked almost $10 million, or 8.2% less in room revenues, for the third quarter than we did a year ago. So our 5.5% revenue advantage turned into a 1% deficit by the time the quarter ended. We expected this normalization of booking patterns as evidenced by our down 2% to plus 1% outlook. What we didn't forecast was the impact from the negative weather patterns. So while we're very pleased and encouraged by the fact we're almost $14 million ahead of the rooms revenue that was on the books for the fourth quarter at the same time last year, we expect a significant reduction in the pace advantage over the course of the quarter. As a result, our outlook for Q4 REVPAR versus last year is forecasting growth ranging from 1% to 4%, which certainly compares favorably to our Q3 actual results. As has been the case all year, we expect the bulk of this growth will be driven by increased occupancy. Our outlook for total revenues for Q4 is for growth of about 1.5% to 4.5%, or approximately 50 basis points higher than our outlook for rooms revenue growth. So that completes our prepared remarks. We'd now like to turn to your questions. Donna, you may now proceed with the Q&A.