Published: 19 July 2023
In this podcast episode, we speak with Professor Jan A. deRoos, HVS Professor emeritus of Hotel Finance and Real Estate, Cornell SC Johnson College of Business as a special guest with extensive knowledge in hotel finance, real estate, and investment in the hospitality industry. We discussed the most interesting and challenging periods for hotel development, including global events and localized factors. Professor Jan A. deRoos shared his insights on the sources of data he looks at in the morning, such as property brokers and research firms and also discussed the impact of the COVID-19 pandemic on hotel valuation. The conversation then shifts to the differences between limited service and upscale hotels in terms of technology and staff, the conversion of office and retail spaces into hospitality assets, and the impact of inflation and interest rates on hotel investments.
Marina Franolic (00:00:30) - Hello everyone. Welcome again to the IDEEA podcast. As you know, we have the IDEEA Hospitality Investment event in Prague in September 18 to 20. And this time I actually have a very special guest. I'm at the moment in Ithaca at the Cornell School, and I've been attending a professional development program. And my professor is Jan A.deRoos was a very famous professor at this university. So Professor Jan A.deRoos is the HBS professor emeritus of hotel finance and real estate at the Cornell School, Johnson College of Business. And he has been teaching here for 35 years. But not only that, he's been into industry. He knows deals, real estate, capital markets, whatever comes to your mind that is linked to investment in hospitality. He knows it and he has many, many examples.
Marina Franolic (00:01:42) - So it is my absolutely amazing pleasure to welcome Professor Jan A.deRoos to this interview. Thank you for joining and thank you for accepting my invitation.
Jan A.deRoos (00:01:56) - You're very welcome, Marina. It's a great pleasure to be here with you today. And I really look forward to answering your questions. And I wish you every success with your next event.
Marina Franolic (00:02:04) - Thank you. So let's go straight to the industry. Professor Jan A.deRoos, you've been teaching Cornell students for the past 35 years with a focus on hotel valuations, financing, development, and control of lodging, timeshare, and restaurant assets. You have also been researching this specific topic. And now when you look back, what would you say were the most interesting and the most challenging periods for hotel development?
Jan A.deRoos (00:02:33) - Let me start with the second part of that question first, which is most challenging times for hotel development, because they tend to be global events where there's a global downturn and the entire industry is affected really, really hard. And it's very difficult for anyone to get financing for a new project or to finish projects that are under construction.
Jan A.deRoos (00:02:57) - In addition, there have been a series of what I will call events that have been fairly localized, that have created great trauma for individual hotel markets like the avian flu, like some of the wars or insurrection in either Latin America or sometimes in the Far East. Those are the most challenging times for hotels because when things get tough, people just stop traveling to that destination because they have other alternatives. Business people stopped the three sources of business, leisure, business and group just all decide they're going to stay somewhere else. Because why would I bother putting either myself or my family at risk? Going to a place that's not very habitable. In terms of interest, that to me has been regional. So the growth of China and all of the hotel development in China is really quite remarkable in terms of how quickly they built their hotel business. Similar things in the Middle East with some very imaginative developments in Dubai, in Saudi Arabia, in the Red Sea, really extraordinary developments. And in addition, places like South America and the Caribbean islands, which are really blossomed in the last 15 to 20 years, are very interesting places.
Jan A.deRoos (00:04:23) - The thing that's most interesting to me is, from my view from the states, I look internationally and I see a hotel stock and a development ethos that creates buildings and hotels that are actually much better quality than the average hotels in the US. It's not to mean we don't have outstanding hotels in the US, but once you start traveling internationally, you realize that the hotel stock in the US really pales in comparison to hotel stock and most of the rest of the world.
Marina Franolic (00:04:53) - I've listened to you now for the past two days, and I see the data that you gather from all different sources. So okay, now you've been retired for a year from Cornell, but when you wake up in the morning, what are the sources of data that you look at? What is what are the websites? What's the most interesting? Where do you gather all this data that you know, except, okay, you've been you've been in the field.
Jan A.deRoos (00:05:20) - So the most interesting data to me is generally collected by people that are market makers, the property brokers, the investment.
Jan A.deRoos (00:05:30) - Banks all produce Reports that help their business and report about the industry or they produce an analysis of additional countries or markets that are of interest. But the sources that I really respect are Smith Travel research and their global reach. PKF CBRE, The PKF shop ended up in a very good place. CBRE is one of two of the largest real estate services firms worldwide. Outstanding job of covering the hotel industry at a micro level, market by market, and we have access to the data through the hotel school in a variety of means. And that to me is a wonderful source of data. In addition, given the amount of time I've been in the industry, I have about 20 different data sources for various items, whether it be financing and calibrating rates or financing terms, whether it's cap rates to look at pricing or whether it's asset management data, to look at how hotels are expected to perform in the future. All of those to me mix into how the industry itself is perceived. And to me, the long-term impact of that is over my career, the last 30 years, hotels have become much, much less risky.
Jan A.deRoos (00:06:57) - There's much more professional management, much more good ideas, and the hotel industries have become much less insular in terms of hiring and promoting from within and bringing in some more outside talent that has a much wider view of either finance or real estate. The hotel industry really woke up in the 1990s when the industry started this separation of the operating company. The people that run the hotels are from the real estate company. That was a huge change in how business was done and in my mind it was a positive force for the industry. Although it was difficult for the traditional hoteliers to get used to given that they felt that they had control over their hotels, in the end, they found out they're simply managers and they really work for someone else.
Marina Franolic (00:07:50) - Covid pandemic caused the hotel industry to reset significantly with travellers habits changing, business travel slowed down, companies realised many businesses business meetings can be done online, leisure travel increased as people realise they want new experiences, they want to enjoy life. How did this situation reflect on hotel valuations? Both those focused on business, leisure, and miss groups, and how do you expect this trend to continue?
Jan A.deRoos (00:08:22) - It appears as if now that we're in the post-pandemic period, that the pandemic was a transitory event, that the industry is recovering.
Jan A.deRoos (00:08:31) - It was leisure first with people doing quote unquote revenge travel business Travel is coming back and given the booking windows for the convention and the mice business, which is generally one year out, that business is slowly coming back. I think that we will return by 2024 to a situation where the mix of business looks very much like it did in 2019, but with slightly different rates based with the typical hierarchy. Business paid the highest rates, leisure, the second highest rates and the MICE the lowest rates. I think that may change over time.
Marina Franolic (00:09:09) - These will be paying higher rates in the business.
Jan A.deRoos (00:09:12) - Yes. And there's now this more blurring of business and leisure where people are combining their trips and the company is paying for part and they pay for part. And companies have figured out how to do the reimbursements on that. And that's a trend that I think will continue. And then what that means is people will be bringing their families with them on a business trip where they'll do both leisure, whereas business and leisure blended together.
Marina Franolic (00:09:36) - I said that recently, actually post-COVID before Covid, when I would ask investors what they're looking for in Europe and Eastern Europe, they would usually always say business, hotels, city centre, 120 plus rooms. It was always the same answer, especially from the big large institutional funds. Now when I ask the the answers are very different. At some point it was everyone was looking at different things, but now everyone is looking much more into leisure. And that, for example, shows Greece is picking up very strongly all these leisure markets, Mediterranean just the interest from investors is way, way higher than it used to be.
Jan A.deRoos (00:10:21) - My sense is that it's very important not to be blinded by leisure demand in 2022 and 2023 is being long term leisure. To demand. I think people got bottled up in their houses. They promised their family the vacation, the big one, they did it. And now they're looking at their checkbook saying, well, maybe we can't do that next year. So I would be very careful to look at leisure demand from 2022 and 2023 is being able to be continued into the future.
Marina Franolic (00:10:50) - Okay. Interesting. And then looking also the contracts with hotel operators, they changed a lot. The owners you know, do not want to sign anymore the 30 year management agreements. And this change actually happened pre-COVID and there are much more franchise agreements with regional third party operators. Brands are keen to keep growing and growing and new brands are coming to the market on almost daily basis. How do you see the development of hotel operating companies and their management services? Do you think they're going to end up being just the marketing companies?
Jan A.deRoos (00:11:27) - Actually, I think the large brands that have 20 to 30 plus brands, they are extraordinarily good at distribution and they know how to touch their customers. Clearly the brands are better to achieve higher rates than the on site staff can achieve. So they have a competitive advantage in distribution and pricing. It's really clear that a third party manager can generally manage anything from a one to a four-star hotel as well, if not better than one of the large brands.
Jan A.deRoos (00:12:07) - And the independent hotel operators. And the third party managers are much more flexible in their terms, which has a lot of resonance or positive feelings from the owner community. So I think the trend will be longer and longer term. The hotel managers or the hotel brands will be in the business of providing franchise services and then some third party will manage them. And if it's a new owner that has limited experience, one of the really interesting innovations, it's 20 years old, but it's an innovation was Hilton, what they call the manches, where they would sign an agreement where they manage the hotel for the first X years, but they'd allow you to convert it to a franchise after a certain period of time when they're convinced that you have the management capability to manage on your own or hire a third party on their behalf. So that's a real innovation. But I really do think that long term, it's not in the hotel brand's interest to stay as management other than in true five star and true five star. There's an enormous amount of moral hazard or monitoring costs in making sure that the manager will maintain those brand standards.
Jan A.deRoos (00:13:18) - And the best five-star operators are still very reluctant to allow anybody else to manage a property that has their name on it.
Marina Franolic (00:13:26) - I've just discussed also with a couple of professionals what's the difference or what the difference between the limited service and the upscale hotels will be long term. And we can agree that that the technology will make a big difference or the number of staff will make a big difference. So for the limited service, you'll actually have lots of this type of technology, self checking, self-checkout, whatever you can actually do yourself, you'll have to do it yourself because the stuff won't be able to pay so much, so many people to work in a hotel. Well, for the luxury one, you'll actually have lots of stuff that will really take care of the guests, but then you will have to reach a really high price of a roommate.
Jan A.deRoos (00:14:13) - To cover the labor. That's exactly, exactly. Additional services. It's really clear in the quality data and the survey data from customers that they love facilitated so-called facilitated self service.
Jan A.deRoos (00:14:28) - So if some help makes it easy for you to serve yourself, the guests love it because they don't have to stand in a queue. They don't have, you know, they just feel like I can get service. Now I'm really okay with checking in a hotel, putting in my credit card. A key is dispensed and I'll have someone there saying, Is there anything you need from the deli that really works for me? Because I really what I'm checking in is business. I don't need to have a conversation Now. On the other hand, if I'm traveling with family and I have some needs, I might want to check in and say, well, tomorrow we want to, you know, what are the amenities at the resort? What's there to do? And I want to really want staff not to actually facilitate transactions. I want staff to welcome me and let me know what's available and that I'm looking for experience, not someone simply they're transactional because a transaction easily is done via technology.
Marina Franolic (00:15:23) - Um, then large segments of the hotel operators work today in Europe is assisting on. In the conversion of office and retail spaces to hospitality assets. You see this string also in the US and what do you see as the opportunity and as a possible obstacle?
Jan A.deRoos (00:15:42) - So this is not simply a European phenomenon. I believe this is a worldwide phenomenon with a lot of resistance from employees to go back to the office. There are even examples of firms saying you all have to show up in the office, but there's not even enough office space for you. And so it's really seen as a way to lay people off or to get people to leave the company to reduce the labor load. But it's very clear that the long-term trend for office space per employee is trending down. And so many large cities have excess office space and the natural conversions are to residential property or hotel property. The difficulty in that is what's known as the core problem, which is how many elevators do I have? How do I move people? And then how do I put plumbing stacks up in the electrical stacks up through that hotel? And I can do that in an economically viable way that produces a return.
Jan A.deRoos (00:16:42) - The secondary issue is in these large urban cause, there may the zoning may be such that the hotels aren't allowed, but many cities are being more flexible in their zoning, and they know that a large residential property population or a large transient residential population, whether it's hotel or residential, really serves the downtown by creating animation, creating demand for the theaters, for the cultural amenities, for the restaurants, for the retail. And if the office employees aren't going to provide that traffic to generate that business, perhaps there's another source of business for that. So cities have a huge incentive to have some residential population or some population in the downtown cores. And at some level, these are seen as replacements for those because if the buildings are going to be 60, 70% occupied, maybe it makes sense to convert that to something else.
Marina Franolic (00:17:36) - Now, I'll go back a little bit on valuation. We see high inflation rates at the moment. High interest rates. How do you think this will affect long term, the valuation of hotels? And I know this is a very broad question and it really depends on the location type of the hotel.
Jan A.deRoos (00:17:54) - It's an if interest rates rise, that means that that becomes more expensive. And it also means that equity becomes more expensive because why would I take a 6% return from, say, a real estate investment trust and for a dividend rate when I could earn 5% on a CD that has zero risk. So everyone's cost of capital is going up. My belief is that the current inflation that we've seen in 2022 and 2023 is fairly transitory. I think inflation will go down not to its long term, almost 0 or 2% that we've seen, or less than three and less than three for the last ten years. But I think it'll normalize back to 3 to 4% and it'll stay a little bit elevated from long-term trends, mostly because the world is shifting away from production in China to other markets. And Chinese goods have historically been something that as the Chinese goods come into the market over the last 50 years, they've really lowered the cost of goods around the world. That will change as well as a phenomenon in the US in which most jurisdictions are now passing laws that supersede the federal minimum wage law, which is about $8 an hour.
Jan A.deRoos (00:19:09) - And most firms are now the entry-level wage is 15 an hour. So that will drive inflation for a while. But think once that you know that inflation is a percentage change in prices from last year versus this year. And once you reset everything, then the percentage changes will be smaller. Okay.
Marina Franolic (00:19:27) - Now, I'm going back to your years here at Cornell and working with students. How would you describe today's students and their knowledge in the field?
Jan A.deRoos (00:19:39) - 30 years ago. When I got here, we could safely assume the students didn't know very much about anything other than so working within a property and providing some of the services. Today, students have access via the internet and they've had a phone since they are 12 or 13, they have an iPad, they have all these devices. They come in extraordinarily sophisticated in terms of their overall view of the world. And what we need to do is work more in sort of helping them learn fundamentals. We need to help them learn the application of those fundamentals and how they use that in a way that is a coherent whole.
Jan A.deRoos (00:20:14) - So today, in general, I'm lucky enough to work at Cornell. Cornell is an elite institution and the quality of our students has gone up over time. If you just look at their raw, either computational or thinking abilities. I love being with my students, but sometimes they kind of scary smart in terms of how they can run circles around you. In my field, I actually it's and I have one of my former students is here is a professor teaching the spreadsheets and the visual basic and how to do these models. And I can't keep up with them. I don't want to. If they do, he can do that. But it's a really interesting to see how quickly the students today have been embraced tech and technology as a way to leverage their efforts. And I'm very interested to see how this plays out with these new AI tools that we have to play with. I mean, one of the things is AI tools may replace if I use AI, I can replace an army of interns, but I think you still need the army of interns to do other things for you.
Jan A.deRoos (00:21:23) - Rather than just churning out spreadsheets, they can create value in other ways.
Marina Franolic (00:21:28) - Does it happen to you now often that you actually get into discussion and that the students know something or have read some information that you actually need to go back to your spreadsheet and include?
Jan A.deRoos (00:21:41) - Yeah, they do it all the time. They either bring in an idea, do you familiar with this brand? And there's some niche brand that's going, Oh my God, I never heard of that. That's really fascinating what they're doing. And then you drill into how that brand really works and it's very innovative. And then part of the learning is the student thinks it's really cool, innovative brand that's doing things that are experiential. I open it up and say, What is the financial model like? And I go, Oh wow, that's really interesting. So yeah, the students today are bringing things to us and requiring us to actually be on top of our game more than we used to. When I was in Cornell as a student, you say, have the professor had the same notes from 20 years ago? If you don't update your notes now, every year, your students will call you on that.
Jan A.deRoos (00:22:27) - And they're paying a lot of money to be here. And they will punish you terribly by not keeping up with the field.
Marina Franolic (00:22:37) - Well, I have to say that your class today was quite tough for me, so. But I'll thank you. Here. I again, it was amazing pleasure just to be here. Thank you so much for the interview. Thank you so much for the conversation, for everything you've shared with us. And I hope that you won't really retire, that you'll keep coming back, because I think that the students can really learn a lot, a lot from you. Well, thank.
Jan A.deRoos (00:23:02) - You very much. I really appreciate the comment. And again, I wish you all the best with everything you do with the bench. Thank you.