DiamondRock Hospitality Co Q1 FY2021 Earnings Call

Good day, and thank you for standing by. Welcome to DiamondRock Hospitality First Quarter 2021 Earnings Release. Please be advised that today's conference is being recorded.

Good morning, everyone. Welcome to DiamondRock'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 DiamondRock, 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 breakeven in February and clearly profitable in March. In April, RevPAR for our open hotels increased an amazing 1,113%. Two, reduced burn rate was impressive. Our low monthly AFFO burn rate was 44% 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 The 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, DiamondRock had total revenues of $72.9 million. Total portfolio occupancy for the quarter, including closed hotels, jumped 5 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 RevPAR 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 basis points higher than 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 opened 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 2 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 DiamondRock'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 was just 8% of our total room revenues in the quarter, we did see group revenue increase an impressive 65% 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 DiamondRock 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 DiamondRock 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% 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 companies are either resuming travel or expected to revise travel policies in May. Now I'd like to focus on the success DiamondRock 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 and 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 per occupied room, or CPOR, improved to $59 from $69 in the prior year, a 14% decrease, 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 cost 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 and 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 continue 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 with low 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. L'Auberge de Sedona saw a 25% increase in RevPAR, driven exclusively by significant rate growth. Total RevPAR surpassed $800 per night, and EBITDA margins increased a whopping 1,250 basis points in the quarter. And our Key West Resorts remained consistent, great performers. Combined total RevPAR 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 Resorts. 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 DiamondRock 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 years. I also want to take this opportunity to welcome to the Board our newest Director, Tabassum Zalotrawala. She comes with a wealth of construction and design experience that I know will be additive to DiamondRock. In late 2020, we also added Mike Hartmeier 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 our 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 rate of 3.5%. Additionally, our debt is well-laddered, with just 4% of our total debt maturing 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 is 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 DiamondRock 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 million to $8.5 million we provided in February. The total burn rate for the company was $13.9 million, which 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 million to $18 million per month. Looking to Q2, we expect the total company burn rate will range between $11 million 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 DiamondRock's plans to transition to an offensive strategy. 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 breakeven hotel EBITDA in February on a 65% decline in RevPAR. Early in the pandemic, we estimated we would 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.

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 into 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%. The hotel is under contract for $185 million, which represents a 6.3% cap rate on 2019 NOI and a 5.8% cap rate on 2018 NOI. We received a nonrefundable $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 30, 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: One, 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 DiamondRock an even better risk-adjusted investment option. These two transactions really helped 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 DiamondRock. 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 breakeven. 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 DiamondRock's group business is very encouraging. Recall that prior to the onset of the pandemic, DiamondRock 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 high ROI projects. We now have seven repositionings either underway or under evaluation for this year, including the upgrades 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 DiamondRock. 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.

Our first question is from Smedes Rose with Citi.

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

Sure, Smedes, it's Mark. Those are both excellent questions. Regarding labor, we are seeing a significant uptick in hospitality and leisure jobs, according to the latest jobs report. There is a rush to rehire, and while many people were unfortunately laid off during the pandemic, some have found other employment, and others are staying home to care for children or deal with other pandemic-related issues. The experiences are varied across different markets. We consider ourselves to be strong employers, but labor availability can vary based on the market conditions. In some areas, we are offering incentives to attract employees back. Nevertheless, we have a strong grasp on our situation. For instance, in New York City, the total compensation for housekeepers, including benefits, can reach around $80,000, making these jobs attractive compared to other options. However, we are encountering challenges in places like Florida, but we are actively working on solutions. As for corporate rates, particularly for frequent travelers such as consultants and banks, we expect rates to remain relatively stable moving into next year. It's still early, but there seems to be a trend of maintaining pre-pandemic rates. Travel budgets have not yet been adjusted, but as we transition into the fall after Labor Day, we anticipate Corporate America will feel the need to resume travel for business. It's too soon to predict how customers will respond, but many are actively evaluating their travel needs. From my own experience, I've had several business lunches recently as vaccinated individuals begin to travel again to meet with clients. I believe corporate rates will remain relatively flat compared to pre-pandemic levels, although adjustments may be necessary for some clients. However, I think this fall will mark a significant return to travel, prompting companies to reevaluate their travel budgets based on the needs of their operations.

Our next question comes from Rich Hightower with Evercore.

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. After those two transactions, we’re approximately 40% focused on true drive-to resorts and lifestyle markets. Our strategic goal, as we've mentioned over the past few years, is to exceed 50% and aim for closer to 60%. By freeing up the capital from Frenchman's, despite its merits in location and market, we believe that allocating the $200 million along with another $105 million in work will significantly enhance our ability to differentiate ourselves and implement that strategy.

Okay. Yes. And then just to kind of pick up on that idea. It seems like in certain leisure-heavy markets even today, and I'm thinking maybe if Key West is a good example, 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, what are DiamondRock's underwriting expectations generally in terms of the progression back to peak, above prior peak, over what time? And then how would you estimate that the market is similarly underwriting?

So I guess it's a nuanced answer because every market and every resort is a little bit different. So to kind of give you two different ways we're looking at the world. So overall, we believe that we are on the cusp of continued leisure outperformance. 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 record levels of leisure travel for the next several years. So we subscribe to that overarching trend, and we believe the data backs it up. In different hotels, it's going to perform differently. If you look at our Fort Lauderdale Westin, for instance, a terrific hotel, it's on the beach and has a great group platform as well. So that one, we would expect to be below prior peak numbers. We expect as group layers in there to boost the transient that we'll see that really accelerate. We would underwrite that asset, assuming the group comes back in there. Therefore, we could pressure the transient rate because we could fill those rooms. In, say, a 150-room hotel in Key West, we think it's pretty durable there. 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 believe those markets are very durable. And the leisure trend, the overall kind of wave, 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 optimistic. And I think the overall market, we all have a lot of similar data. We probably have a little bit more conviction than some. But it's shown that those are more valuable assets and the market is pricing them accordingly.

Our next question comes from Dori Kesten with Wells Fargo.

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?

We engaged a global brokerage firm to conduct outreach for a marketing campaign and received more interest than anticipated, ultimately resulting in ten offers. We expressed our flexibility, emphasizing our desire to rebuild the resort, which we consider a valuable asset. We wanted to retain some potential upside while removing funding obligations. We received ten written offers from various entities, including developers and established private equity firms. The level of interest was significant, and after several bidding rounds, the winning bidder stood out due to their credibility and enthusiasm. They aligned with our vision for the asset and demonstrated a commitment to a quick restart, along with the ability to execute effectively through their local government relationships. Hence, we decided to accept this particular offer based on certainty, execution, and alignment. We believe this deal benefits both them and us. When considering the financials, with $240 million in insurance proceeds and $35 million received on April 30, we are close to returning to our 2017 value. Furthermore, any profit participation reflects additional upside potential, which could be quite valuable if everything aligns. Overall, we see this as a favorable outcome that allows us to free up capital for reinvestment, which we believe will benefit our shareholders.

Our next question comes from Chris Woronka with Deutsche Bank.

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 the question is, obviously, there's a lot of capital out there, right, looking for similar stuff and not all that 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?

Yes. I mean I think we have three advantages in the marketplace: relationships, expertise, and synergies. First, on relationships, as you know, quarter-after-quarter, we've been talking about this thesis for several years. And so our internal investment team and really our whole management team has relationships with many owners of these kind of assets we've been talking to for years. So we've built relationships, contacts, and trust. We think we probably have broader, deeper relationships in these kinds of assets than any other public lodging REIT. So relationships are important, especially since we're starting to do off-market transactions. Then we have expertise. 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 kinds of assets. And I think that gives us a real edge in our ability to underwrite them and execute on that once we buy them. I'd say the third advantage we have is synergies because we are in many of these micro markets, whether that's Vail or Sedona, Sonoma, or Lake Tahoe, the ability to not just have relationships but also when we can find an asset to buy, hopefully off-market, we have synergies. We can have one GM over both properties. We can cut out one Director of Revenue on sales, but there are just a lot of synergies, especially when you're talking about smaller assets; those synergies can be very powerful on the return profile. We think those relationships, expertise, and synergies give DiamondRock an edge as we execute over the next couple of years.

Our next question comes from Michael Bellisario with Baird.

Good morning, everyone. Mark, just back to The Lex, what are the risks to closing this deal or getting 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 million nonrefundable deposit. They actually posted a second deposit in the coming weeks to increase that amount. The timing is due to the way their endowment funds are coming in. So they're all set. It's just we had to align 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 raised money around a New York thesis. They're big believers in the rebound in New York City. That's kind of what they're investing for. So we feel good about it; it's a 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?

Yes. I mean, New York City is still the #1 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 Midtown, it used to be encouraged and excited. So we think that just this opportunity allowed us to reduce our New York exposure. We remain with three select service hotels, which we think is a smart place to play in that market. It's also allowing us to accelerate our overall strategic goals of getting into more drive-to resorts. So it just seemed like the right time to pivot in the marketplace. Given that 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 Frenchman's. Maybe could you provide any details on what needs to occur there for you to realize the earn-out in terms of hurdles? And then what's your base case for the timing of this potential payout?

There are many factors involved, including construction costs and asset valuation, as well as the ramp-up timeline. I believe we have similar underwriting to our partner in this transaction. If I had to estimate, I would say it will take about four to five years for them to fully realize the equity value from the asset. We revalue the asset every quarter, and the more certain we feel about it, the more we can recognize the gain over time. There are specific hurdle rates and an IRR hurdle rate applicable. There's also a complex structure for gains, where we receive 100% at one level, then 20% after reaching another threshold. However, we have confidentiality agreements regarding the specifics of those arrangements.

Our next question comes from Anthony Powell with Barclays.

So the resort performance was great, but the urban hotels continue to burn cash. I guess, as you look forward to the summer and the fall, what's the prospect for those hotels to get back to breakeven? Can they get back to breakeven with this leisure demand as cities reopen? Or do you really need that business transient and group to come back just to get to breakeven?

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 the first quarter, and it looks like that's continuing in the second quarter. I do think, ultimately, to drive meaningful profitability in the back half of the year, you are going to need to see some level of business transient and group come back in the third and fourth quarter, which is really what our expectation is.

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

Yes, this is Mark. So on the acquisition front, 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 on synergies, and we have deeper relationships in those markets. We've targeted 50 micro markets throughout the U.S. It's also other markets like Jackson Hole and similar places that you would think have those characteristics. We're not wedded only to the markets we're in. We are actively working on other opportunities. We are concentrated. If you look at 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 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 directed toward off-market transactions. Jeff, do you have anything you want to add to that?

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

And our next question comes from Floris Van Dijkum with Compass Point.

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?

Yes. Good question. We're currently at 40% of resort and lifestyle drive-to markets, and we'd like to get that certainly to 50%, which I think we could do relatively easily with the capacity we have now. Ultimately, we probably end up between 50% and 60%. We think that will distinguish us among all the other investment choices. We do like having a diverse portfolio, including business transient and some group activity across different segments. Over an extended cycle, things do move at different times. So we would never want to be vulnerable to fluctuations in those movements. So we'll maintain 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 another factor we're really focused on is having an unencumbered by management portfolio. Today, with the exception of two hotels, we have terminal agreements at all of our properties for management. That gives us the ability to execute better on asset management. We believe it gives us higher exit value or lower cap rates. Some of our asset managers are very talented, but they have more control over their properties when they can under terminal management agreements, allowing them to do what they think is in the best interest of the property.

Thanks, Mark. I have a follow-up question. Regarding your stabilized EBITDA, I understand that no one is providing guidance for this year or next year. However, considering the cost reductions mentioned, are you anticipating that 1% to 2% of your cost base will be eliminated once everything stabilizes?

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 franchise is unique to us of about a 50 basis point improvement in our EBITDA margins on a 2019 pro forma basis. Beyond that, I think, as Mark mentioned, when we look at our open hotels or, I believe our resort hotels in this quarter compared to 2019 on lower revenue, we had about 80 basis points better margin. So we look at those as indications about where cost reductions and margin improvement can go in the future. And as I said, it's sort of 50 basis points on top of whatever the industry can generate at the hotel level. One point I'll make is that I recognize, based on our call and other calls, people have asked about labor. I actually think there's an opportunity due to labor shortages in some markets. It does give rise to the possibility of redefining the labor model, whether it's increased usage of digital check-in or, again, changing customer behavior in areas like room cleaning.

Our next question comes from Chris Darling with Green Street.

I just 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 special permits 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?

Yes, it's a great question. So let's look at the facts. The M1 zones were rezoned with a similar special permit requirement. Since that passed two years ago, there's been virtually no new building permits pulled within those zones. If they adopt something similar for the entire city, which is the proposal and legislation that's moving through right now, we would expect it would have a significant impact on supply after all existing permits are put through. 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. So I think it means that the long-term prospects for New York look brighter due to the anticipated supply constraint through new legislation. However, this won't impact the supply over the next 36 months. They'll still need to work through that existing supply currently under construction. I think it's easy to build a more bullish case for New York over the 5 to 10-year horizon, certainly the 10-year horizon, but they will have to work through the existing supply currently under construction.

Our next question comes from Austin Wurschmidt with Keybanc.

I'm curious how deep the pool of qualified bidders for The Lexington was maybe versus other periods that you've shopped the 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?

Sure. Yes, Austin, to answer your question, we do have capacity. Obviously, it's a function of the asset size that you'd be considering, but we do have the capacity to move ahead with an acquisition before The Lexington closes.

Yes. Like with Frenchman's, we engaged an international broker and did a full marketing process on Lexington back in the fall and early winter this year, and we had some good interest. I'd say there were about half a dozen qualified bids that we worked our way through to get to this one. There was not an oversubscription to New York acquisitions in the middle of the pandemic, but we were pleased with the amount of interest in this particular property. So I think it was a good execution.

Got it. Appreciate that. And just on ADR. 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 in 2019 for the overall portfolio.

Tom, you want to talk about rate trends that you're seeing at properties?

Sure. When we consider overall rates, the main factor in the coming quarters will be the recovery of group and corporate business transient. Our group performance for 2022 is showing an increase in average daily rate compared to the previous year, using 2019 as our reference point. In Boston, we are nearly back to our 2019 levels heading into 2020. Chicago remains stable compared to 2019. These trends are promising indicators. If the conventions take place, it will boost demand and enhance transient business in those areas. Ultimately, the return of corporate business will be key for maintaining rates, though we should not ignore the impact of low-rate competition.

Thanks, Tom. A couple of other comments. 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 higher occupancy levels where we can really control the mix shift within the properties. You'll see as the mix gets better, as we move through the next 12 months, that will help the rates. In the short term, I would note we're focused primarily on profit here. So we'll be reopening some of our closed hotels, which we've done over the last couple of weeks. So that will lower ADR due to the mix in reopened hotels. But this still means more profit, and that's our focus, ensuring we get higher levels of dollars coming to the bottom line.

Our next question comes from Patrick Scholes with Truist Securities.

Earlier, you had mentioned an action plan to hire employees. Does that action plan include raising wages? And then I have another question.

Yes, Patrick, this is Mark. And yes, in some markets, it's going to include wage adjustments. There's only so much we can afford in our model. We think the labor pool in many markets is still good. In some markets, it's very tight. For those areas, we've had to provide incentives to get people to come back. I would imagine this fall as the unemployment enhancements burn off after September, that's when our demand should really surge. So there'll be some overlap in improving incentives for people to get back to work just while we're going to really keep them in the fall. But we're being creative and pulling out all the stops. There is some wage pressure in certain markets.

Okay. And then, I guess, since COVID began last March, what would you say is your accumulated deferred CapEx to date?

Yes, Patrick. The good news for DiamondRock is we entered the pandemic with a mostly renovated portfolio. If you look at our percentage of revenue over the prior three and five-year periods versus the peer set, it was running between 12% to 14%. So we invested heavily in our portfolio. We had very little deferred maintenance going into this. Some room renovations got pushed a year or two, but for better or worse, there wasn't a lot of wear and tear in some of our urban hotels over the last 12 months. So that makes sense and didn't lead to any accumulation of deferred maintenance. Looking at our five-year CapEx plan going forward, it's at pretty normal levels; there's no backlog as these properties were in good shape going into this event.

And our last question comes from Bill Crow with Raymond James.

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 at the hotels. How do you think about balancing the staffing model with what guests are used to?

Yes. Bill, we're super focused on guest satisfaction. If you look at our TripAdvisor scores for our 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 business that you have in terms of your ability to satisfy customers even with more restrained labor models. But we're confident our operators worked with our asset management teams to raise those scores despite very tight labor models. Tom, do you have additional thoughts?

Bill, I would say that our primary focus is on adjusting and adapting to create incentives. The objective is to implement incentives that reward performance rather than just increase everyone's wages. We want to encourage strong performance during good business times and decrease those incentives when business softens. We're evaluating incentives across all markets, and a major observation has been with fixed full-time equivalents. We've set baselines for our portfolio based on occupancy levels. We've assessed every type of fixed position, such as greeters, supervisors, and managers, as fixed full-time equivalents. We're establishing benchmarks for our hotels and monitoring them monthly. We're confirming that the positions that enhance customer experience and directly engage with customers are prioritized for hiring. Positions that are less essential, which have gradually increased over the last few years, will be reduced. The individuals who perform the work are vital to our success and the experience of our guests.

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

Thank you, everyone. We appreciate your continued interest in DiamondRock, 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. Good day.