Sunstone Hotel Investors, Inc.

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Sunstone Hotel Investors' Third Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. I would like to remind everyone that this conference is being recorded today, November 8, 2022, at 12 p.m. Eastern Time. I will now turn the presentation over to Mr. Aaron Reyes, Chief Financial Officer. Please go ahead, sir.

Thank you, Operator, and good morning, everyone. Before we begin, I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties, including those described in our prospectuses, 10Qs, 10Ks, and other filings with the SEC, which could cause actual results to differ materially from those projected. We caution you to consider these factors in evaluating our forward-looking statements. We also note that this call may contain non-GAAP financial information, including adjusted EBIT.RE, adjusted FFO, and property-level adjusted EBIT.RE. We are providing that information as a supplement to information prepared in accordance with generally accepted accounting principles. On today's call, references to our comparable portfolio will mean our 13 hotel portfolio. which includes the confidant Miami Beach, but excludes Montage Healdsburg and Four Seasons Resort Napa Valley. Additional details on our third quarter performance have been provided in our earnings release and supplemental, which are available on our website. With us on the call today are Brian Giglia, Chief Executive Officer, Robert Springer, President and Chief Investment Officer, and Chris Ostapovich, Chief Operating Officer. Brian will start us off with some commentary on our third quarter operations and recent trends. Afterward, Robert will discuss our recent capital investments. And last, I will provide a summary of our current liquidity position, recap our third quarter earnings results, and provide some additional context as to how we are thinking about earnings for the remainder of the year. After our remarks, the team will be available to answer your questions. With that, I would like to turn the call over to Brian.

Please go ahead. Thank you, Erin, and good morning, everyone. We are pleased with our portfolio's performance in the third quarter as robust leisure demand in the final months of the summer transitioned to encouraging signs of increased corporate and group travel as we head into the fall. The quarter represents the strongest relative performance that we have seen since the onset of the pandemic with comparable rooms rev par in September and total rev par for the quarter both coming in above pre-pandemic levels. Once again, our operators were able to aggressively push pricing, which contributed to comparable average daily rate of $288, an 11% increase from last year and a 16% increase as compared to 2019. While we saw meaningful year-over-year rate growth across our portfolio, the greatest increase was at our urban and group-oriented hotels, which grew rates 20% in the quarter as compared to the prior year. San Francisco led the portfolio in rate growth, and we are encouraged by the recent trends we are seeing there, especially with our recently completed rooms renovation. San Francisco also saw a meaningful increase in occupancy as corporate and group customers returned to the market. While the market has a way to go to return to 2019 levels, 69% RevPar growth compared to 2021 is a positive step in the right direction, and we expect that to continue into the fourth quarter. Our resort portfolio once again performed well and managed to further grow rate above what was a very impressive 2021 performance. Our two premier wine country assets continued to season, and they generated a combined third quarter ADR of over $1,500, the highest combined quarterly rates we have seen since our acquisition. Including these two hotels, our total portfolio generated a third quarter rev par of $223, made up of occupancy of 71% at a $312 average daily rate. Non-room revenues came in strong during the quarter, benefiting from increased group business and related banquet spend. In our comparable portfolio, we once again saw significant contribution from food and beverage revenue, which exceeded 2019 levels. Banquet and AV sales per group room was $207 for the comparable portfolio in Q3 compared to $176 in 2019, up 17%. Our outlet spend continues to build, growing sequentially quarter over quarter maintaining the positive trend we've seen all year. The strength in group activity has been encouraging with several of our larger hotels exceeding pre-pandemic levels. Following a strong Q2, Renaissance Orlando had an even better group performance in the third quarter with group room nights 12% higher, rates 13% higher, and catering contribution 11% higher than the same quarter in 2019. Similarly, at Waialea Beach Resort, group business in the third quarter generated a significant premium to 2019 with banquet spend per group room night 31% higher. Hyatt Regency San Francisco, which has been slower to recover than many of our hotels, had more than nine times the group volume in-house compared to last year, accompanied by catering contributions up 76% year over year and 14% higher than in 2019. We also saw meaningful increases in destination and facility fee revenue, a product of increasing occupancy levels and rolling out these programs to more of our hotels. Cancellation fees in Q3 came in consistent with historic pre-pandemic levels, which is a positive indication that our industry is returning to a more normalized pattern of meeting activity. including the out-of-room spend, our total portfolio generated an additional $120 of revenue per available room in the quarter for a total rev par of approximately $343. For the comparable portfolio, total rev par came in at $317 and exceeded 2019 for the first time since the onset of the pandemic, while remaining 13 occupancy points lower than 2019. On the expense side, we continue to navigate the inflationary environment and look for creative ways to reduce costs. We have worked with our operators to optimize menu offerings and review pricing to mitigate rising food costs and beverage costs. Wage growth has moderated somewhat, but remains in line with our expected range of 4% to 5% and our managers have been able to drive efficiencies in certain areas to help offset higher labor costs. Utility costs have been on the rise, and we expect this likely to persist through the winter. This makes our recent energy efficiency investments that much more worthwhile. In Waialea, the first phase of our solar panel installation has saved nearly $500,000 since it was completed last year and we are now in process on the second phase, which will come online in 2023. As you may have seen in our earnings release, we also published our updated ESG report today, which has additional details on some of the other initiatives we are working on to increase our use of renewable energy and decrease our overall energy, water, and waste intensity to not only benefit the environment, but to also reduce costs. Despite cost pressures, our comparable hotel portfolio generated an EBITDA margin of 30.4% during the quarter, which is only 140 basis points below that achieved for the same quarter in 2019, even with 13 points of lower occupancy. If we exclude the two hotels in our portfolio with significant renovation activity in the quarter, our pro forma hotel EBITDA margin was a very strong 34%, which is the same as our 2019 performance. While we are very pleased with our operator's ability to deliver this level of profitability, our focus is increasingly shifting to maximize portfolio EBITDA as hotels return to normalized occupancy levels. Now turning to segmentation. Our comparable portfolio generated 175,000 total group room nights in the quarter, and the group segment comprised roughly 35% of our total demand. The group room nights volume represents approximately 85% of historical amounts with average rates that are 9% higher than the same quarter in 2019. Group production for all current and future periods for our comparable portfolio in Q3 was 173,000 room nights, which is more than we put on the books in Q3 2021 and at 31% higher rates. In terms of transient business, which accounted for roughly 60% of our total room nights in the quarter, comparable rate came in at $317 and was 23% higher than the pre-pandemic levels that we saw in the same quarter of 2019. We are also starting to see business travel materialize at a more regular cadence. At Renaissance Long Beach, there has been a consistent return of business transient travelers with corporate negotiated revenue up 36% to 2019. The hotel is seeing growth coming from government, aerospace, and consulting segments. Additionally, At Hyatt Regency San Francisco, business transient accounts are contributing higher volumes with significant participation from technology accounts leading to corporate negotiated nights at approximately 90% of 2019 levels and up 17% to Q2. Boston Marriott Long Wharf also continues to see an uptick in business travel sequentially as key accounts have returned to the office or have adopted a hybrid model. Based on our third quarter performance and what we saw in October, we remain encouraged about the outlook for the fourth quarter. Recent trends reflect lead volumes hovering just below 2019 levels and strength in short-term booking activity with a higher contribution from corporate group events. Our group pickup in Q3 for the fourth quarter was higher than the typical pickup amount, underscoring the trend that we have seen of groups booking closer in to their events. Group room nights for the fourth quarter are pacing at approximately 81% of pre-pandemic levels at an average rate that is 7% higher than 2019. This would imply that our overall group revenue pace for this time period is down only 13% from the same time in 2019. If we exclude the Renaissance DC, where the guest room portion of the renovation is in full swing, our fourth quarter group revenue pace is down only 7% to 2019. We have seen strong group booking activity in Boston and San Diego continuing into the fourth quarter. These cities benefit from active citywide calendars and market compression, which is translating into pricing strength. Fourth quarter group pace at our Hilton Bayfront is ahead of the same time in 2019. Boston continues to drive results in both transient and group with increased demand from both leisure and corporate travelers. At Boston Park Plaza, fourth quarter group paces outperforming the same time in 2019 in both rate and volume. As I mentioned earlier in my remarks, the San Francisco market is increasingly showing positive trends. In October, our higher regency at the Embarcadero had several sold-out nights. An additional group and business travel is materializing as we move into the fall our rooms renovation is now complete and the finished product is generating great guest feedback. The city remains a desirable long term lodging market and we fully expect that are well located hotel will contribute to our portfolios earnings growth as the market further recovers in the coming quarters. We were fortunate that our Florida hotels sustained little damage from Hurricane Ian. While Miami was not impacted, Oceans Edge and Key West and Renaissance Orlando both experienced some minor wind and water damage, most of which has already been remediated. We expect to incur approximately $600,000 of expenses in the fourth quarter related to the restoration work. We estimate that the storm's impact resulted in approximately $2 million in displaced revenue across September and October, primarily due to cancellations at Ocean's Edge in Orlando leading up to and shortly after the storm. I'd like to thank our hotel teams in Florida who reacted quickly to minimize the effect of the storm on our physical assets and to protect and to accommodate hotel guests. While the strength of the recovery continues to vary across markets and segments, we are seeing positive trends across our portfolio. When we spoke with you last quarter, we provided some guideposts about how we thought our full year occupancy rate and profitability could play out as we moved into the back half of the year. While those expectations remain consistent with our current thinking, Our better-than-expected performance in the third quarter should position us to achieve the higher end of those indicative ranges. Later, Aaron will provide some additional information to help put this into context. During the quarter, we made further investments to creatively mine value in our portfolio, and we also initiated the value-enhancing repositioning of our recently acquired resort in Miami. Robert will share some additional details of our current and planned capital projects, which we believe will provide a combination of near-term cash flow and long-term growth potential for our portfolio. In addition to capital investments, we also completed an additional $20 million of share repurchases since the end of the second quarter. This brings our year-to-date total repurchase activity to $98 million. at an average price of 1067 per share, a meaningful discount to published estimates of NAV. Together with the dividends for Q3 and Q4, we will return over 120 million to our shareholders this year. To sum things up, as we move into the fourth quarter of 2022, we are encouraged by the recent trends we are seeing across our portfolio. Our well-located urban and group-oriented assets, We'll see continued growth in the coming quarters as demand for business travel and corporate events continues to catch up with the already robust leisure demand at our resort properties. Additionally, Sunstone continues to actively allocate capital, investing in our portfolio, recycling sales proceeds into new growth opportunities, and returning capital to our shareholders through share repurchase and dividends. We believe This is a winning formula that will provide long-term value to our owners. And with that, I'll turn it over to Robert to give some additional thoughts on our recent and upcoming capital investments.

Thanks, Brian. We are pleased to be making a number of strategic investments into our portfolio after closing on several acquisitions and dispositions in the first half of the year. I'll start off with a review of our plans for our recently acquired oceanfront resort in Miami, and then I'll provide an update on some of the other renovations and initiatives we have underway across the portfolio. Our repositioning of the Confidant Miami Beach is in the middle of the design and approval stage and construction will soon be underway. The renovation is scheduled to begin next year following the market's high season and to conclude in the first half of 2024 when the hotel will debut as the Ondas Miami Beach. The investment will transform the asset and better take advantage of its great location and superior beachfront footprint. As we discussed with you on the prior call, we will renovate all aspects of the hotel, including relocating the lobby, reconcepting the food and beverage outlets, reimagining the pool and backyard recreation areas, modernizing the guest rooms, expanding the suite mix, and upgrading the meeting and event spaces. With these enhancements, we anticipate significant ADR growth and believe the property will be able to better compete with nearby luxury hotels. Because of the all-encompassing nature of the repositioning, we will incur significant displacement next year while the work is completed. However, post-repositioning, we expect the hotel to generate a very attractive 8% to 9% yield on our total investment, and we will own a fully renovated oceanfront luxury resort at an all-in basis of approximately $900,000 per key in a market where per key valuations for similar assets are well in excess of $1 million. This is a type of investment we know well and have had great success with in the past. In the initial months of our ownership, we have been impressed with the resort's performance and its ability to grow rate even in its current condition. Year-to-date, rate is up a strong 47% year-over-year compared to the market rate in Miami Beach, which is up a respectable 18%. This supports our investment thesis that there is the ability to push rate, and we have started this process well before the renovation has even begun. As Brian mentioned earlier, we completed the rooms renovation of the Hyatt Regency San Francisco, and the hotel is in great shape as occupancy continues to return to the market. Work is also progressing on the conversion of the Renaissance Washington DC to the Westin brand. The meeting space is completed and initial feedback from group and sales managers is very positive. The rooms are currently underway and the lobby renovations will start before the end of the year, with the entire project expected to be completed by the third quarter of next year. While we incur some renovation displacement, this project will enhance the value of the hotel and contribute to incremental growth upon completion. Given the positive response and list we expect to see from repositioning the Renaissance DC to a Westin, we are also moving forward with a brand conversion at the Renaissance Long Beach where we will renovate the hotel and reposition it as a Marriott. We are in the early stages of this project, but expect the conversion will allow the hotel to better compete for business, grow earnings, and ultimately to enhance its value as an on strategy Marriott Hotel. As part of the project, We will invest approximately $17 million to renovate the guest rooms, add an end club and additional meeting space, and reconfigure the lobby. The conversion is slated to occur in mid 2023. We are constantly looking for ways to creatively grow and enhance the value of our portfolio, both through acquisition and internal investments, and we'll be sharing additional details of our other upcoming projects in future quarters. With that, I'll turn it over to Aaron. Please go ahead.

Thanks, Robert. As at the end of the third quarter, we had approximately $168 million of total cash and cash equivalents, including $50 million of restricted cash. We retained full capacity on our credit facility, which, together with cash on hand, equates to nearly $670 million of total liquidity. We were in the process of exercising our extension option on the mortgage loans secured by the Hilton San Diego Bayfront, which will be completed in the current quarter. Once that is done, we will not have any debt maturities within the next year, and our balance sheet will remain one of the strongest in the sector. Shifting to our financial results, the full details of which are provided in our earnings release and our supplemental. The quarterly results, which surpassed our initial expectations, reflect continued strength in leisure travel and growing corporate and group demand. Adjusted EBITDA RE for the third quarter was $64 million, and adjusted FFO was 24 cents per diluted share. The third quarter results include approximately $1 million of revenue displacement related to the Western Conversion work in Washington, D.C., and we estimate that approximately half of the $2 million in displaced revenue from Hurricane Ian cancellations was in September, with the balance impacting Q4. When we spoke with you last quarter, we provided some broad indications for how we thought full year occupancy, rate, and profitability could transpire as we moved into the third and fourth quarters. While those parameters still generally fit within our current thinking, our better than expected performance in the third quarter would now suggest we are likely to be in the upper half of the ranges we discussed. In 2019, our current 13 hotel comparable portfolio which includes the Confidant Miami Beach but excludes our two wine country resorts, generated rev par of $212, made up of a $252 ADR and an occupancy of 84%. Based on what we have seen so far through October, we anticipate that our comparable portfolio occupancy will likely finish the year down 15 to 16 points as compared to 2019. This full-year occupancy variance is skewed by the Omicron impact in the first quarter, which led to occupancy 27 points lower, while the second and third quarter were down only 12 to 13 points. As we noted in our supplemental, the year-to-date rate growth for the comparable portfolio is at 14% relative to the same period in 2019. This is likely to be a good representation of where we will finish for the full year. Taken together, This would imply that a full-year comparable portfolio REVPAR could be down in the high single-digit range as compared to 2019. Our current expectation is that the year-to-date adjusted corporate EBITDA of $165 million is likely to comprise approximately 75% of our potential full-year earnings. This expectation incorporates our better-than-expected results in the third quarter and is in the upper half of the indications we shared with you last quarter. As we noted earlier, we expect to incur approximately $600,000 of expenses in the fourth quarter related to restoration work as a result of Hurricane Ian. And there is also approximately $1 million in displaced revenue from the storm, which is reflected in the October preliminary numbers we shared in our earnings release this morning. In addition, we will experience some additional displacement in the fourth quarter as we make further progress on the conversion to a Westin at our hotel in Washington, D.C. Now turning to dividends. Our board has authorized a common dividend of $0.05 per share for the fourth quarter and has also declared the routine distributions for our series G, H, and I preferred securities. And with that, we can now open the call to questions. So that we are able to speak with as many participants as possible, we ask that you please limit yourself to one question. Operator, please go ahead.

Thank you. At this time, I would like to remind everyone, in order to ask a question, press star 1 on your telephone keypad. To withdraw your question, press star 1 again. Again, we ask that you please limit yourself to one question. We'll pause for a moment to compile the Q&A roster. Your first question comes from Smitty's Rose from Citi. Please go ahead.

Hi. Good morning. Good morning. Brian, I wanted to ask you just, I guess, a little bit more specifically about the two wine country properties. You know, we have, you know, essentially a year's worth of results now. And I'm just wondering, when do you think that they can start to get to more meaningful returns on the, I think, a combined investment of around $440 million? And I guess specifically for the Four Seasons, is it a matter of taking costs out? Do you think there's upside? Is it got to be more occupancy? I'm just wondering, like a $2,000 daily rate, it seems like maybe there's not a lot of upside there, but maybe there is. I'm just kind of interested in how you think this plays out over the next year.

Yeah, absolutely. Thank you, Smeeds. When we look at both of the wine country resorts, they continue to ramp as they have all year. And this year, What we saw in the summertime is the market started to revert back to the normalized seasonality that you would see in Napa and Sonoma during the summer. If you look back to Q3 of last year, the montage and the market had a very, very strong summer, a very strong occupancy-driven summer, and that was primarily due to fewer luxury options available. you know, to that luxury traveler. This summer is a little bit different story. You had, you know, the U.S. luxury traveler could go international this year. A lot of European, especially European wine destinations like France or Italy were available and they weren't available prior years, which brought that seasonality back to the market. Additionally, the strong U.S. dollar probably exacerbated this a bit, making it more attractive going internationally and making it more challenging for international travelers to come to the U.S. Where we have the resorts now, you know, they have, we've established the resorts for the leisure customer. And both hotels continue to focus on growing their group base. which they have done this year and will continue to do into into 2023 and beyond you know montage has been open a little bit longer so it's a little farther ahead than of the four seasons in this process but when we look to next year both hotels have been able to put significant amounts of group business significantly higher than what was on the books you know at the montage for um for 2022 and so we see we see very good growth on the group side and remember the group business at these hotels while it's a lower rate than the transient rate it is not that much lower than the transient rate and it comes with a lot of ancillary spend upwards of eight hundred dollars plus per group room night and so it's very profitable business And so part of the ramp up and the maturation of these hotels is getting that right group base in there, getting that ancillary spend. That then will significantly impact the profitability and then allow also to to be able to compress transient rates and keep the transient rates as high as they are. And your point on the $2,000 a night, the rate is definitely higher than where we thought it would be at this time, but we expect that to hold as we go into next year.

When we look at our... Brian, can I just interrupt you just for one second? I'm sorry. I just, because I know you probably have a lot of questions and I know we're trying to be limited to one, but I mean, I guess my question really is, it's a $440 million investment. What do you think these things do kind of at peak? I mean, do they ramp to the $45, $50 million range? Is that a reasonable expectation on the returns, sort of cash-on-cash returns?

And what do you think the timeframe to get there is, if that's a reasonable sort of... Yeah, I mean, when we acquired these hotels, our expectation was that they would get to a 6% to 7% NOI yield on our investment. That timeframe, knowing that this type of hotel takes a little bit longer to ramp up, was the kind of 25, 26 timeframe. It's also, when you look at this type of asset, it's also to understand and remember that luxury resorts like this hold their value much better and much more consistently than standard upper upscale hotels. If you look at the transactions that have happened in this market, which are few and far between due to the fluctuations, especially in the debt markets, most of the transactions you're seeing are luxury hotels. That's because the luxury buyer tends to be better capitalized, less dependent on debt, can see through near-term turbulence and are willing to pay a full price for very scarce assets. And so when we look at our long-term cash-on-cash return to these hotels, that hasn't changed a bit. And our view on value is absolutely as strong or probably stronger than where it was when we originally acquired these hotels. Remember, these hotels were not open. They were ramping up. The Four Seasons has a winery associated with it that is very important to the overall luxury guest experience. That's something that we have. The winery was always a question mark of profitability. We have that working towards close to break-even next year, which is a major feat. And so what we have done is we have de-risked these assets. and they are absolutely on their way to achieve the returns that we expected at acquisition.

Your next question comes from Duane Finningworth from Evercar ISI. Please go ahead.

Hey, thanks. Just on the confidant, can you remind us, and I know you touched on it in the call, but just remind us your renovation timeline, when that's expected to be complete, and what you would think about a 2023 EBITDOC contribution relative to this year.

Okay. Good morning, Dwayne. So when we acquired the confidant, the plan was that some renovation in non-guest-facing areas would happen towards the end of this year, beginning of next year, but the majority of the actual of repositioning what happened in kind of the second half of next year after the high season. And for those that have done renovations and repositions in Miami, there's a historic board you have to go through, and some of the regulatory steps take a little bit. And so that is something that we are working through now. major construction will start in the second half of next year our view on when we acquired it on displacement for next year uh was that uh our expectations was was that the hotel would would basically break even um during the you know having some ebitda come in in the high season and then obviously as a hotel the rooms and all the public space and pools are being are being renovated that there would be loss during that time period. The hotel is performing very well this year. We're able to grow rate or continue to grow rate, even though the, you know, some of the demand in the Miami market has softened in the summer for some of the same reasons that we saw in wine country. But the hotel is going to do $13 to $14 million of EBITDA this year in its current conditions. We will have next year, it will make money in the first half and then lose money in the second half. But given what it's been able to achieve so far, we are very excited about this repositioning and we expect it to be able to hit all of our expectations once it debuts as Yon does.

Your next question comes from Michael Belisario from Baird. Please go ahead.

Thanks. Good morning. Brian, on capital allocation, Brian, could you maybe update us on your view of buybacks versus acquisitions and what you're seeing today? And then just also how you think about the pace and cadence of buybacks. Your stock price was lower. You still bought back stock, but you bought a less amount in terms of dollars than you did earlier in the year. Any color around those topics would be helpful. Thank you.

Sure. The way we look at a capital allocation is kind of the same way we look at the portfolio we try to put together is we want to take a balanced approach. And when it comes to being able to successfully allocate capital uh and as we have done all year long we we look to we look at internal capital investment we look at capital recycling uh and using some of the capacity in our balance sheet and then we look at returning capital to to our shareholders um you know and and the trick is really the right the right balance between that and as our uh stock is lower, it obviously puts more emphasis on that return of capital through share repurchase. Capital investment also tends to be some of our higher return alternatives, and so You know, when we look at the West End conversion, when we look at the rooms renovation we did at Hyatt San Francisco and adding the pool in Waialea, those are good return projects. And so when we look at our liquidity and while we have ample debt capacity, you know, we do want to make sure we're mindful of our liquidity in the near term. and and make sure that we have enough um liquidity available to not only repurchase shares but then to also take advantage of opportunities and given the current debt markets um you know with gmbs loans that come maturing over the next couple years uh you know we have seen some deals uh you know either fall out of contract uh we're starting to see things come back to market and so it does appear that in the near to medium term that we may see some interesting acquisition opportunities and having the capital and liquidity available to do that is something that we want to balance also. When it comes to share repurchase and dividend return of capital through dividends, I think we've been very active relative to our market cap size all year. It's something that we think is an important way to return capital, and it's something that we'll continue to look to do, but we'll have to balance it with the other options. But as you've seen and as we've demonstrated, it's something that we look to continue to do if the investment is attractive.

Your next question comes from David Katz from Jefferies. Please go ahead.

Hi, afternoon, everyone, or good morning, depending where you're sitting. Hi. So I just wanted to look at the leverage and think about whether capital returns are a way that you, you know, would sort of raise that leverage. In other words, would you, you know, buy back stock or return capital as an activity or as a means to getting, you know, leverage up into more of the target range?

Yeah, well, I mean, it's a good question, and it's a, you know, let's start with leverage. And leverage, you know, we have some hotels ramping up, and we have a hotel that's going to be repositioned. But if you look at it on a, you know, somewhat normalized basis, I think we're sitting at, call it three and a half times um, you know, death was preferred to EBITDA, which is, you know, given where we are cyclically and given that, you know, we're still, uh, many of our hotels are, are still, you know, behind occupancy in 2019. Um, and a lot of our, you know, we expect to have good growth in, in especially in Q1 of next year as we, uh, as our big group hotels, uh, you know, are compared against the Omicron impact of Q1 of this year, you know, three and a half times is ample leverage to give a lot of capacity and optionality. That's higher than where it was, you know, a year ago where we did use our balance sheet. to acquire assets. We recycled the Chicago assets, but then also used some of our balance sheet capacity and cash on hand to make our acquisitions of Confidant and the 25% of the Hilton San Diego, which sometimes gets lost in the shuffle, but was a you know had debt associated with it and was a leveraging acquisition but also at you know given where that hotel is performing at sub 12 times this year even to multiple was a fantastic acquisition so you know we've already started down the path and we said we were going to do this of using you know, bringing our balance sheet back into an appropriate leverage level. So as we look forward and as we allocate capital going forward where share repurchase has and will continue to be one of the very attractive options out there, that will absolutely come with with additional leverage because that that's the only way it will be done. Even if we're recycling assets, it would it would result in more leverage. So that's that's the plan. It has been the plan. It's been what we're executing on. And so, you know, as we said before, we're not going to be the highest levered of the group, but we also don't think we're going to be the lowest levered anymore either. And so that gives us capacity to to allocate it through share repurchase, through acquisitions, through investment in our own portfolio.

Your next question comes from Anthony Pavel from Barclays. Please go ahead.

Hi, good morning. I guess a question along these lines on dispositions. Looking at the portfolio, I think at least two hotels look like they stick out as potential, you know, disposition candidates. Are those in the plans to maybe sell and could you recycle that into additional buybacks or acquisition activity?

You know, when you look at our portfolio and the question is, you know, do you need to, you know, is there more to sell? I would say that the portfolio, and granted we're at 15 hotels now, is a pretty solid portfolio. And if, you know, you're If you go down the list and the bottom of our portfolio are still pretty attractive hotels. So what I would say at this point is we've done the cleaning up of the portfolio. We exited the markets that we absolutely wanted to be out of. And going forward, everything is opportunistic. When it comes to selling an asset, we'll look at disposing of an asset if we think that the asset's life cycle or our investment life cycle in that asset has come to an end. So any asset in our portfolio, if there is investment or something we think we can continue to do to it where our return on invested capital should grow in the future, then looking at our portfolio now then any asset that meets that criteria probably has a place in the asset at least for you know the the medium the medium term when we look to dispose of an asset we're going to you know it first of all it could be any asset in the portfolio and it would would meet the criteria of one either there could be a higher better use uh someone is willing to pay a very aggressive price for it and we can find better growth by by redeploying that capital elsewhere but as far as you know are there things left on the bottom that need to go absolutely not this is this is a fantastic portfolio it provides us a lot of optionality and everything going forward will be purely opportunistic

Your next question comes from Gregory Miller from Trust Securities. Please go ahead.

Hi. Thanks. Good morning. I'd also like to – good morning. I'd like to focus similarly to Samit's question on the NAPA assets. And I was looking at the margins of the two properties between TQ and 3Q. The montage hotel margins fell about 500 BEPs, and the four seasons fell about 1,400 BEPs. from my read. So I'm just curious if there's anything specific that happened at the Four Seasons and 3Q that might provide greater insights for us from a modeling perspective or any unusual one-time events or maybe more broadly if the margins for the Four Seasons and 3Q were similar to your expectations. Thanks.

When you look at these hotels, I mean, first of all, these hotels have high fixed costs. And the bottom line for the third quarter was that after a year or two plus years of not having the option to travel internationally, a lot of our transient guests traveled. And going to Europe is not something that people do every single year. And so while we saw pent-up demand in Q3 of last year, some of that pent-up demand worked its way out and left the market this quarter. That's fine. And I mean, that's not obviously what we wanted, but it's understandable. As we look going forward and we look at these hotels and their profitability, that's why the group business that they have added and are adding for the back half of this year, but really into next year, is so important because it brings that guest in. It brings the guest in at a very attractive rate with a lot of extra ancillary spend, which is needed in a hotel like this to have the margins that we expect. And when that occupancy falls off, because of the fixed cost, you're going to see margin fluctuations more than you would in a full service or limited service hotel. It's just the nature of this type of asset. And so you'll see some more swings like this up and down. But at the end of the day, our view on the trajectory of this asset is the same. And our view on value, and as we've seen in trades uh recent trades is that this type of asset is highly desirable and the value of it does not fluctuate like your run-of-the-mill you know upper upscale asset does your next question comes from floris van ditchcom from compass point please go ahead thanks guys for taking my questions um morning morning um

I promise you I won't ask the question on your luxury or your ultra luxury hotels. But I had a question on your balance sheet and more specifically on your floating rate exposure. You have some of the highest floating rate exposure, I think, certainly in my hotel coverage universe. Maybe, Aaron, if you could comment a little bit on your 57% floating rate exposure, how that uh, could trend, um, as, as the Fed keeps, you know, um, raising the bar, if you will, and also, um, uh, what your, um, your sort of your, your debt, um, plans could be for the, I mean, you mentioned, you said, you said you're going to, uh, uh, address your, uh, uh, mortgage on the San Diego Hilton. Um, but, uh, how, how you're thinking about, you know, potentially reducing some of that exposure to floater rate going forward, or if there are caps in place.

Sure, Flores, thanks for the question. Yeah, so you're right. So as of the end of the third quarter, we had roughly $800 million of total debt, of which, you know, 42% was fixed or had been swapped to fixed, and the balance, 58% or so, you know, was floating. our floating rate loans have benefited over the last two years from a rather attractive interest rate environment. The mortgage that you're referring to on Bayfront was effectively 1.3% debt for a number of years. So as we move into the backdrop of rising rates, we're going to see, and everyone else who has any degree of floating rate exposure is going to see interest expense move up here for a period. As Brian mentioned, we have overall, you know, a rather, you know, conservative leverage profile. So, you know, overall, while we do have the 58% floating rate exposure, it's on a, you know, a much lower overall debt load than you might see in other spots across the sector. So I think overall, you know, we're pretty, I think, well positioned to deal with the rising rate environment. You know, as of the end of the quarter, you know, we were, you know, call it, as Brian mentioned, all in, you know, three and a half-ish or so times leverage. So it's a rather conservative balance sheet. And, you know, based on where the trajectory, I think, of where interests are at now and where they're expected to be over the next couple quarters, you know, I don't think it's our view that it's the right time to try and, you know, do any kind of broad-scale hedging in terms of locking in anything now. So, you know, we'll keep our eye out over the, you know, the coming months to see how rates transpire and if there might be a window to, you know, to lock in, you know, incremental portions of of our interest rate exposure and maybe hedge some of that that way. But, you know, if you just look at the overall interest, you know, our overall leverage level and our weighted average interest of, you know, call it in the low fours, and you think about, you know, where our preferreds are at, you know, I think, you know, our balance sheet is actually pretty well positioned to withstand the rising rate environment. So, you know, we'll keep our eye out and see if it makes sense to add some incremental swaps here and there, but just time will tell.

Yeah, and like Aaron said, it's something that we can do gradually. We don't have to swap out the entire amount of a term loan. We can do it both in term and dollar amount. We can do it in increments over time. So it's something that we're looking at now, and as Aaron said too, with our leverage where it is, if we were five, six times levered, We would probably be looking at things differently, but that's why you have a balance sheet like we have. It provides optionality and flexibility.

As a reminder, if you'd like to ask a question, press star 1 on your telephone keypad. Your next question comes from Daniel Adam from JP Morgan. Please go ahead.

Hi. Thanks for taking the question. I'm curious if you think non-room-related strength can be sustained next year, given what will likely be a much weaker macro environment.

Thanks. It's a good question. You know, when we look at our group strength and the out-of-room spend this year, you know, We actually feel very good about it next year because when we look at some of our hotels, let's take Waialea, for example. When we look at group business there and you have strong transient demand, that's a hotel where as this year has gone on and as we get into next year, we're becoming more and more selective with the type of group. So we're taking a better quality group there that has a better spend. you know, we're seeing the same thing in Orlando and San Diego. And so while we have, you know, in some of the hotels that have a little bit more capacity, it will be a combination of bringing in additional groups with, you know, with that spend. But in other hotels, it's really being very selective in making sure that you're getting the type of groups that you want that are spending more. And then when you look at the composition of the spend this year, we're still growing that group base, and that group base is still well below where we were in 2019, and there's a lot of room to grow. That's something that will help us continue to bring in more of that group business.

There are no further questions at this time. I will turn the call back over to Brian Giglio, the CEO, for closing remarks.

Great. Well, thank you, everyone, for the interest and support in the company, and we look forward to seeing you at NARICH and the upcoming conferences. Have a good day.

This concludes today's conference call. You may now disconnect. Thank you.