DiamondRock Hospitality Co Q2 FY2023 Earnings Call

Thank you for joining us for the DiamondRock Hospitality Company Second Quarter 2023 Earnings Conference Call. All participants are currently in listen-only mode. After the presentation, we will have a question-and-answer session. I will now hand it over to your host, Ms. Briony Quinn, Senior Vice President and Treasurer of DiamondRock Hospitality. Please proceed.

Thank you, Valerie. Good evening, everyone. Welcome to DiamondRock's Second Quarter 2023 Earnings Call and Webcast. Before we get started, let me remind everyone that many of our comments today are not historical facts and 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 expressed in 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'd like to turn the call over to Mark Brugger, our President and Chief Executive Officer.

Thank you for joining us today for DiamondRock's second quarter earnings call. Global travel demand remained strong. TSA throughput in the quarter reached 99% of 2019 levels and hotel stays in the United States this year are expected to surpass the annual pandemic record of 1.3 billion rooms. DiamondRock has been a leader in the recovery and later, we'll discuss why we are well positioned to hold and expand our leasing sector in years to come. Against the favorable industry backdrop, however, the slowing macroeconomic environment is weighing on the pace of recovery of business travel and the redistribution of leisure travel from the unfettered competition from cruise lines and international destinations is impacting domestic leisure-oriented properties. In our view, some of these adjustments are just momentary events, but they were a headwind in the second quarter and will remain a headwind until later this year. However, we are seeing an emerging new baseline of travel demand that is more weighted towards leisure travel than in the past, and industry growth will build upon this foundation going forward after firming up its new normal in 2023. DiamondRock's competitive advantage remains the high-quality portfolio of hotels and resorts that we have curated to deeply resonate with the desires of today's travelers. Measured by full year revenue, our portfolio is approximately 60% urban and 40% resort. The 20 urban hotels were tailored to be the hotel of choice for the business group and leisure travelers in their respective cities. The 16 irreplaceable experiential resorts are each in special destinations, and in many of these markets, DiamondRock has been the first mover among the hotel REITs. Perhaps our portfolio's most distinguishing feature is that almost 95% of our hotels are unencumbered by long-term management contracts, which gives us greater control over the operations at the properties and a premium valuation upon sale. All of these portfolio advantages enable DiamondRock to deliver modestly positive revenue growth to achieve all-time record revenues in the second quarter. Our hotels outperformed their competitive sets with RevPAR penetration of 112%, which represents a gain of 290 basis points from 2019. Overall, total revenues in the second quarter were $289 million, or nearly 1% ahead of 2022. Hotel adjusted EBITDA in the second quarter was $93.6 million, which was $3.2 million ahead of 2019. Results were held back by the one-time impact of disruption stemming from upgrades at the Salt Lake City Marriott and the former Hilton Boston, combined with a small electrical fire that closed the Hilton Garden Inn Times Square for 1 week during the quarter. Okay. Let's look a little closer at the trends we saw. At urban hotels, year-over-year, RevPAR was strong, up 7.9% and the second quarter marked the first time this cycle that quarterly RevPAR for our urban hotels exceeded 2019. The group segment at the urban hotels performed well, powering solid results at our two largest urban hotels, the Chicago Marriott, which increased year-over-year RevPAR by 22.8%, and Truest the Boston Westin, which increased year-over-year RevPAR by 11.7%. In total, portfolio group room nights increased 4.6% compared to the second quarter of 2022. We are benefiting from having well-maintained hotels and a favorable geographic footprint. But importantly, there is even more opportunity after this year. Second quarter group room nights were still 11.1% behind 2019, and we project that there remains 67,000 group room nights of opportunity after 2023 to just hit prior peak. We want to emphasize that we are very encouraged by the 2024 group bookings for our hotels. 2024 group revenues on the books is up almost 28%, led by strong convincing calendars in many of our most important urban markets. Business transient was more mixed in the second quarter, but demand varies significantly by market. There was good business transient strength in cities like New York, but continued weak demand in places like San Francisco. Midweek business transient occupancy at our urban properties increased 170 basis points in the second quarter versus the comparable period last year. Our trio of select service hotels in Manhattan were stars in the second quarter, as strong business transient demand pushed RevPAR above 2022 and 8.4% over 2019, even with the impact of the 1-week closure at our Hilton Garden Inn. However, we want to point out that business transient comparisons became more difficult for the industry in the second quarter. So the rate of improvement appears to be moderating a bit for business transient. Longer term, we believe an expanding economy will allow business transient demand to eventually recover to the 2019 peak, but it will require a few more years to get there on a nominal basis. For our resort portfolio, second quarter RevPAR was up nearly 32% over 2019, but down 13% compared to last year. While leisure travel for Americans is likely to hit a record this year, unfettered access to international destinations and cruise lines in a post-pandemic world is redistributing some of that demand. As evidence of that trend, the number of Americans traveling outbound from the U.S. to international destinations is projected to be up nearly 20% over last summer, and cruise lines are seeing big year-over-year bookings. We began experiencing the impact of this redistribution late last year, and we expect leisure patterns to approach their new normal comparisons later this year. We are already seeing signs this summer of stabilization at our resorts in Sonoma, Sausalito, and Vail. In fact, the booked RevPAR of Vail Resort for this coming December is up 24% versus the same time last year. And while the impact from this year's redistribution of leisure is leading to some near-term pullback, destination resorts remain a clear winner since the start of the pandemic, and we remain confident that resorts will enjoy the strongest new normal secular travel patterns and lodging due to a number of powerful factors. Let me touch on a few of those. One, hybrid work is a game changer. There have been 2.7 billion days of locational flexibility created post-pandemic. That's more than twice the number of annual hotel stays in the entire U.S., and this locational flexibility will disproportionately benefit leisure properties. Two, people continue to value experiences more than material things, partially powered by the phenomenon of social media sharing. Three, demographic changes are powering leisure with the wave of increasing travel by millennials and baby boomers. By the end of the next decade, there will be nearly 40 million more people either in active retirement or starting a family than there was a decade ago. The wanderlust of baby boomers is often underestimated. And four, one of the most powerful reasons behind our conviction in the bright future for resorts is that there is a fundamental supply imbalance with a limited number of resorts in the U.S. and this imbalance will persist because of the often-insurmountable barriers to build new product in most resort markets. DiamondRock was early to recognize and exploit the long-term outperformance trend in resorts by its early allocation to the segment. In just the second quarter alone, our resorts had RevPAR increase 32% over 2019, and hotel adjusted EBITDA up 47%. That's a lot of NAV growth. Turning to internal growth. We believe that DiamondRock has a competitive advantage from the large number of impactful ROI opportunities within the portfolio. These projects will continue to drive cash flow and increase NAV. In the last 24 months alone, we have completed the conversion and up-branding of the Hythe Vail to a Luxury Collection, the Hotel Clio Denver to a Luxury Collection, the Sheraton Key West to a Margaritaville, and the Lodge at Sonoma to an Autograph Collection. Those four hotels alone generated a collective RevPAR increase of 33.1% over 2019 in the second quarter with hotel adjusted EBITDA up 65.3%, and this is just a start. For example, just a few days ago, we announced the successful conversion of The Dagny in Boston, which marks our 14th independent hotel. The Dagny is projected to grow EBITDA by $3 million next year and ultimately double this year's EBITDA with stabilized EBITDA approaching $17 million. Additionally, we are actively underway with more ROI repositionings such as the Hilton Burlington to a Lifestyle resort to be named the Hotel Champlain, a Curio Collection hotel to be completed early next year, and the Bourbon Orleans repositioning to a premium urban lifestyle resort in the French Quarter of New Orleans to be completed well before the Super Bowl in early 2025. Behind these, DiamondRock has a large pipeline of opportunities. There is a repositioning of The Orchards Inn Sedona, there is the potential expansion opportunity to Lake Austin Spa Resort, and there is the ability to add almost 20% more keys at The Landing Resort in Lake Tahoe. These are just a few examples of the many projects to come so stay tuned. In total, since 2021, we have completed or will soon complete $58 million of ROI repositionings at 16 of our 36 properties. The benefit of these projects often play out for several years, so we expect to continue to reap market share gains and increased profits from these efforts for some time to come. That's a good transition to give you an update on the acquisition market. We have been working diligently to find more of the transactions that have worked so well for us. Owner-operated experiential hotels in unique destinations. We have been focusing on these destination markets for the better part of a decade and have a first-mover advantage. We also have a deep well of understanding about unlocking value at these types of properties, which puts us in a great position to create value when we can pry these types of properties loose. As we said last call, any deal we would do this year would have to be something we really love. While without one small deal that fits the bill, the Chico Hot Springs Resort in Paradise Valley, Montana. This independent resort has been owner-operated for a century. This is a resort with a deep history, a fiercely loyal following, and is a treasured part of the local Montana community, which we are very respectful of preserving. We are buying the resort at an 8.1% NOI cap rate, and we projected to stabilize at north of a 10% NOI yield as it benefits from our best practices and a modern revenue management system. The prior owner-operator typically set rates just once per season, did not adjust rates based on demand, and regularly accepted reservations 2 to 3 years in advance at current rates. Most of the reservations were still made over the phone because there was no GDS system or modern booking tools in place. Encouragingly, year-to-date through the end of the second quarter, RevPAR has increased 8.7%. In addition to the benefits related to booking practices, there are also a number of opportunities to add value with various enhancement projects on the 153-acre hotel site. Chico is a special place and a special opportunity and is representative of the type of investments we seek out.

Thanks, Mark. I apologize for our operators' technical difficulties earlier. I understand there might be some call quality issues that we're working to resolve. As I mentioned in our last earnings call, Q2 was set to be a challenging quarter, given difficult comparisons on both revenue and expense. I want to start by breaking down the year-over-year changes to revenue and EBITDA to give you a little more insight into the portfolio and help with comparability to peers. All of the statistics I will discuss are on a comparable basis. Portfolio RevPAR increased 0.5% and total revenue increased 0.9% in the quarter. This breaks down to a 7.1% increase in total revenue for our urban hotels and an 8.3% decrease for our resort portfolio. Our urban hotels were nearly flat to 2019, down just 0.7%, but our resorts were robust 33% higher. Broadly speaking, Florida continues to exhibit the same year-over-year trend we've discussed since late last year. If we excluded all 7 of our Florida hotels, a few of which were up year-over-year in the quarter, RevPAR for our non-Florida hotels increased 3.7% and total revenue increased 3.3%. We had a few sources of disruption and displacement during the quarter. The Hilton Garden Inn in Times Square was closed for a week in June due to a minor electrical fire originating from an MEP repair. We also experienced some disruption from the completion of the rooms upgrade at the Dagny in Boston and the Salt Lake City Marriott. Collectively, these events shaved about 50 basis points off our revenue metrics for the quarter, implying revenue growth would have been about 1.5% for the entire portfolio and closer to 4% for the non-Florida portfolio. Switching to EBITDA. Hotel adjusted EBITDA was $93.6 million at a 32.4% margin. It was 381 basis points below Q2 last year, but only 178 basis points below 2019. Adjusted EBITDA was $85.8 million. Comparisons were particularly difficult this quarter, and they remain even more challenging due to two events: the disruption mentioned earlier and property tax refunds achieved last year from several appeals. Let me break down the bulk of the $10 million variance in hotel adjusted EBITDA versus last year. Disruption shaved about $1 million from EBITDA in the quarter and the property tax refunds we received in Q2 of last year for prior periods, created a $2.5 million headwind in Q2 of this year. Importantly, were it not for these two factors, we estimate our hotel adjusted EBITDA margin would be 100 basis points higher, and our adjusted EBITDA would have been a little better than $89 million or ahead of consensus. Continuing with the bridge, our insurance policies renewed on April 1 so our Q2 results reflect a full impact of significantly higher premiums, with this expense being more than $2 million over 2022 in the quarter. Finally, wages and benefits were up 6.4% year-over-year or $5.1 million. These costs were partially offset by aggressive asset management initiatives that generated incremental profit from other income items such as parking. I must commend our asset managers here at DiamondRock and our third-party managers at the properties for their exemplary performance during what was expected to be a difficult quarter. Okay, let's transition to talk about capital allocation. We prioritize capital towards the highest IRR opportunities on a leverage-neutral basis. We constantly evaluate internal ROI projects, which generally have yields above 20%, common and preferred share repurchases, and finally, external growth opportunities. Mark already spoke to several of our ROI projects as well as the very special deal in Montana we announced. In the quarter, we repurchased 262,000 shares at an average price of $7.67 per share for a total of $2 million. In the past 12 months, we have repurchased over 1.9 million shares or nearly 1% of our float for approximately $14.7 million at $7.77 per share. Our purchase price equates to approximately a 10% capitalization rate. We are exploring dispositions, the proceeds of which can be used to fund additional repurchases, future repositionings, or external growth. Regardless of the ultimate capital allocation, we will remain opportunistic on all fronts. We remain committed to having a strong, flexible balance sheet. We have low leverage as demonstrated by our trailing net debt-to-EBITDA ratio of 3.6x. We have about $75 million of mortgage debt maturing in the next 18 months, a small mortgage on our Courtyard Midtown East in Manhattan. Our liquidity is very strong at $600 million or 30% of our market cap, consisting of over $200 million of corporate and hotel-level cash plus a fully undrawn $400 million revolver. It remains difficult to provide guidance in a range that we feel is useful, so let me walk you through some thoughts on the balance of the year. First, on revenue, group demand is solid in Boston, San Diego, and Washington, D.C.; but Chicago, our biggest group market, was materially stronger in the first half than we expect it will be in the second half of the year. Business transient gains are leveling off. Visibility is short, but we are hopeful we can see some pickup after Labor Day as more people return to the office. Leisure demand continues to reset to a new normal, well ahead of 2019 but a little behind 2022, and this normalization may play out the remainder of the year. Taken together, the outlook is in line with the demand we saw in the second quarter that resulted in nearly 1% revenue growth, but the back half of 2023 has a slightly more difficult revenue comparison. Between the two remaining quarters, the fourth quarter is currently poised to finish stronger than the third quarter. One final note, renovations and repositionings are projected to negatively impact second half total revenue growth by roughly $4 million, or an additional headwind of 115 basis points per quarter on RevPAR. For the full year, that impact is expected to be $8 million or a little over 100 basis points. Switching to expenses. Cost controls remain a priority. On labor costs, our largest single expense, we are fully staffed, and we expect the wage and benefit cost increases should level off at the increases seen in Q2. Property insurance and property taxes are ultimately tied to factors like inflation, the recovery of income, market values, and replacement cost. DiamondRock has been a leader in returning to and exceeding prior peak performance, so naturally, we're among the first to see revenue and value-dependent costs moving up. I suspect our peers will eventually see the same. The cost of our property insurance is increasing by $9 million on a full 12-month period beginning with our renewal on April 1. Second quarter fully reflected this new cost, which I mentioned in my bridge earlier, was a greater than $2 million increase in the quarter. Property tax comparisons will also be a headwind in the second half of 2023. We successfully negotiated $9 million of abatements for prior periods in Chicago that we received in the second half of 2022, but these will not repeat this year. All else equal, we expect the year-over-year property tax and property insurance increases will impact second half hotel adjusted EBITDA margins by approximately 270 basis points compared to the second half of 2022. We do not expect tax headwinds in 2024. Finally, for full year 2023, we expect our corporate overhead to be $32.5 million. Preferred dividends are just under $10 million, and debt service costs will be about $63 million. And with that, let me turn the call back to Mark.

Thanks, Jeff. I'll conclude with a few thoughts on why we remain constructive on travel generally, and DiamondRock specifically headed into 2024. For the industry, overall U.S. travel is projected to hit a new record next year with occupancy of more than 1.3 billion hotel nights. The leisure segment in the U.S. next year will have its adjustments to the new normal behind it and can resume its long-term trend line of outperformance. And U.S. industry fundamentals should benefit over the next 3 to 5 years from constrained hotel supply as high construction costs and high borrowing costs limit the viability of many new projects. For DiamondRock, we have room to run. If our urban and resort properties just get back to prior peak occupancy that is worth $54 million in incremental revenue. Group room nights and associated spend just get back to 2019 levels, that alone is worth $30 million in incremental revenue. ROI projects will also continue to pay off. For example, the Dagny Boston repositioning this year is projected to grow profits by 35% in 2024 with revenues up about $3.5 million. And importantly, for DiamondRock, we are excited about our group prospects for next year. Group revenue pace is up a terrific 28%. Our hotels in Boston, Chicago, San Diego, Washington D.C., and Phoenix generate nearly 45% of our Urban Hotel EBITDA. Currently, these markets have 3.2 million citywide room nights on the books for 2024. This is 10% or 300,000 room nights more than in 2019, so we are obviously encouraged by the group trajectory in 2024. As you can tell, we remain positive on the future of travel. Travel is one of the most highly valued assets in our society and around the world, and we believe that DiamondRock is well positioned for this cycle with a high-quality portfolio, a focused strategy, and ample liquidity to move opportunistically. At this time, we would like to open it up for your questions. Just if I could summarize, I know there's been some technical difficulties. So we will 8-K the transcript of this call.

Our first question comes from Duane Pfennigwerth. Your line is open.

Duane, are you there?

Sorry, I didn't hear the name they called, but nice to speak with you.

Sorry for the issue.

Can you help us maybe size the year-over-year impact you'd expect from the ROI projects that are underway this year and the acquisitions that you've completed this year? What could that look like on a year-over-year contribution basis into 2024?

I'm just thinking about it. And the answer for that is I'm trying to build it up in our head. My suspicion is it's going to be a few million dollars from the acquisitions when you think about all the acquisitions that were effectively closed in this year because we have Chico, obviously, which just happened, and then late last year, we had Lake Austin. If you're going back that far. And then this year, we also have some of the ROI projects that are kind of come in, and I think would be another few million dollars on top of that. There will be some offsets this year. Duane, as I mentioned, the Dagny Boston was probably about $8 million of disruption but then next year, I think you should see a good chunk of that begin to reverse.

Yes. If I could just jump in, a couple of pieces here. So the Dagny and Chico are probably the easiest one to bridge here. So we said on Dagny is that we expect the revenues next year to be up at least $3.5 million and probably $3 million in EBITDA year-over-year. On Chico, which is our acquisition this year, we expect it to do north of $3 million in EBITDA in 2024. And then for the disruption, obviously, the disruption from the 1-week closure at Hilton Garden and we expect to get 100% of that back next year. And that Salt Lake City was a rooms renovation, and we would expect that to all return in 2024 as well. The Dagny, which we gave specific numbers on, will take probably 3 years since its conversion from a brand to an independent to fully ramp up to its stabilized number.

Okay, thanks. And then for my follow-up, maybe you could just give us a sense, I thought the ex-Florida portfolio performance was interesting. But as you look at the balance of the year, markets like Key West, in particular, are you thinking it's just more of the same normalization? Or do you see any potential path to pick up later this year, maybe fourth quarter? Thanks for taking the questions.

Duane. So Florida is interesting. I'll let Justin jump in here, too. So every asset is a little different. And Tranquility Bay, which is in Marathon Key, we actually saw it stabilize in July, and we're encouraged by what's going on there. The pace of decline in the Keys is getting better so we're seeing it get better as a summer. It's still negative year-over-year. And as you may recall from our results and comments at the end of last year, we were seeing some deterioration there in the Florida Keys earliest that they've gotten just kind of crazy high. So it was kind of first to start the readjustment, if you will, to the new normal, so we would expect it to be one of the markets that we start getting more normalized as we get to November, December of this year. Justin, do you want to add anything to that?

Yes, I think it's really more the sort of normalization of the comparable year as we get to the back half of the year. As Mark mentioned, we saw the Florida Keys being one of the first assets that we had start to drop off from a year-over-year basis in the summer of last year, and some of our other leisure assets fell off sort of the back half of the summer. So as we work through the third quarter and get to the fourth quarter, the comp just gets easier for us on a year-over-year comparable.

Okay, thank you.

Thank you. One moment, please. Our next question comes from the line of Anthony Powell of Barclays. Your line is open.

Hi, good evening, everyone. Thanks for the question. Business transient, you mentioned a plateauing or kind of slowing a bit, a bit different commentary that we're hearing from others. I guess outside of San Francisco, are there any other markets where you're seeing kind of that slowdown or that, I guess, moderation? Or is it more of a broader comment that you're observing?

The data we are analyzing indicates that RevPAR for business transient travel is approximately 20% lower than 2019 levels, particularly focusing on special corporate travel. The variation is significant; for instance, New York City has surpassed its 2019 performance, while San Francisco is lagging considerably. Recovery rates for business transient travel were quite promising in the latter half of last year and in the first quarter of this year. While we are currently experiencing a moderation in this recovery, we remain optimistic for improvements following Labor Day as employees return to the office and business travel increases in the fall compared to summer. We want to keep you updated on the real-time developments we are observing.

Yes, thanks. And maybe on the conversion in Boston to the independent hotel and the acquisition of the independent hotel in Montana, you've gone much more heavily independent in your kind of branding and your acquisitions in recent years. Maybe comment on why you're doing that? And are you seeing the value of some of these brands kind of decline? Or are these more special situations in your view?

Yes, I believe the brands still hold value, and most of our hotels continue to feature them. However, we assess each hotel individually, and branding can be costly. In some instances, the brand offers a significant return on investment, particularly in large group hotels where they clearly enhance value. However, certain hotels, like Chico for instance, operate effectively as their own brand, and we're unlikely to see a substantial increase in demand relative to the brand's costs. So, it's not that we don't appreciate the value of brands—we truly do. It's more about adapting our approach to each specific property to determine if branding is suitable. Generally, the majority of our branded hotels are performing much better than unbranded ones in terms of both revenue and profit.

I guess maybe in Boston, what's drove that particular decision?

Yes. Boston is kind of a unique location. It's a historic building, and it's in a 7-day-a-week location. And we looked at what it does not have a material group component, which is often a reason to have the brand to attract the groups. And it performs very well 7 days a week, but it's a great business location. It's also close to Faneuil Hall. It's a great leisure location as well, and we thought that it can perform relatively equally well as a branded hotel with less cost associated with it. The other thing is even if it was just equal profitability, the unencumbered nature of having that hotel probably adds 10%, 50, 100 basis points on the back end. So it probably increases the NAV of the hotel by $15 million to $20 million. So those were the factors that led us to embrace this conversion.

All right. Thank you.

Thank you. One moment, please. Our next question comes from the line of Floris Van Dijkum of Compass Point. Your line is open.

Thank you for the question. Could you elaborate on the new acquisition? What led to this transaction? You've mentioned that you've been monitoring it for a couple of years. What prompted the owner to sell at this time, and who were the other bidders? Additionally, can you discuss whether the 8.1% yield is appropriate for this deal? Also, please share your thoughts on the current acquisitions environment.

Sure, there are several questions in your inquiry. Let me start with the general acquisition environment. Acquisition volume has decreased by over 70%, and there are not many transactions happening in the market. This situation presents a favorable opportunity for public companies like us due to our lower cost of debt. We are borrowing at a rate of around 135 basis points, while private equity is borrowing at about 450 basis points, which gives us a clear advantage. We also need to consider other options for capital allocation. We have a strong interest in Montana, particularly in areas like Big Sky, Bozeman, Paradise Valley, Jackson Hole, and Yellowstone, which are priorities in our search for unique properties. The property we are looking at is a well-known small resort in Montana that has been under the same owner-operator for over twenty years, who is now looking to retire. This timing is advantageous for us, as the owner will continue to be involved with the property, and we plan to build on that relationship with both the property and the community. Interestingly, this property was initially under contract with private equity buyers for $40 million about six months ago. We evaluated it but found the price too high for our willingness to pay, which was disappointing. That deal later fell through for reasons we don’t know, and we were chosen because we could pay in cash, eliminating financing risks. Although we may not have been the top bidder in terms of price, we were the most reliable buyer in terms of closing certainty, which ultimately gave us a significant advantage. We believe we obtained great value with this deal. Our plan is to implement our professional best practices and modern reservation systems to enhance the property. The previous owner was somewhat limited in managing the property, which gives us an opportunity to improve it. We hope these improvements will lead to higher customer satisfaction, increased demand, and ultimately, greater revenue for the property.

And I think you mentioned it was on 153 acres. I mean is there expansion opportunities here down the road?

We have only owned the property for 48 hours, and our immediate focus is to gain a thorough understanding of it. There is significant land available, which presents opportunities, but our primary objective is to enhance the property itself and ensure it's operating effectively. Properties like this often have several avenues for value creation, and while we see potential for luck in those areas, we are committed to simply improving the current property first. I believe that this approach alone will make it a very successful investment for DiamondRock.

For a final follow-up, does this increase your interest in acquiring additional properties in the area to create a cluster? Are there nearby properties you would like to acquire in Montana? Does having an initial investment there open up more opportunities, or does it indicate that you’re finished with Montana and prefer to explore other regions?

This entire investment is $33 million for a company with $4 billion in assets. We are not finished in Montana. We appreciate Montana, the community, and the potential there. We like Yellowstone, Bozeman, and Big Sky. There are many other opportunities we want to explore and build relationships within. Our goal is to establish our reputation in the community, which we hope will enable us to access off-market transactions. Since it's a relatively small community, by being responsible with our assets and nurturing these relationships, we believe we can secure more deals in the state. We would certainly expand our presence there if favorable opportunities arise.

Thanks, Mark.

Thank you.

Thank you. One moment, please. Our next question comes from the line of Gregory Miller of Truist.

Thanks. Mark, in the prepared remarks, you spoke briefly about NAV, so I thought to ask a question about it. How do you view your internal NAV today relative to a quarter ago? And in particular, if you're able to comment on the drive-to leisure assets you've acquired in the last number of years, I'd be curious to hear about that as well.

Yes, that's a great question. We recently had a Board Meeting where we discussed this issue. The reality is that there are very few data points in the market due to low volumes, so anyone claiming a change in value is likely just making an educated guess. There appears to be a significant amount of capital on the sidelines, with several hundred billion dollars in private equity interested in real estate, which indicates a number of potential buyers are waiting. From the seller's viewpoint, many are hesitant to enter the market, believing that conditions will improve and become more favorable in six to twelve months, so they’re waiting to sell their assets. Consequently, transaction volumes are low, making it difficult to determine what affects value. While there has been some decline in the performance of resorts, which could lead to valuation changes, they continue to be a topic of interest among private equity funds. Generally, there's still a belief that this sector will be appealing over the next five to seven years. Additionally, these assets, unlike purchasing a hotel in cities like San Francisco, generate attractive trailing cash flows of around 6% or 7%, compared to 0% in markets like San Francisco or San Jose at the moment. Therefore, they are still viable for financing and remain intriguing investments. I know there was a recent transaction in Nashville, which we regard as a lease-oriented asset. Can you remind me of the cap rate we discussed?

Yes, it was about a 6% cap rate.

Yes. On trailing cash flow, it's a fairly stabilized asset at a 6% cap rate and is a relatively independent leisure-oriented asset in Nashville. There aren't many data points available, so if we suggested it was 3% less, it would just be a guess. However, we still believe there is strong demand for these types of assets.

You provided some data points, I appreciate that and thanks for the commentary. For the follow-up question, I thought you asked specifically about the Dagny, a little more depth on the outlook that you provided through 2027. Could you walk us through the bridge and how you get to $17 million of EBITDA in 2027 versus $9 million this year? And how much of the underwriting is driven by operating expense reductions relative to top line gains?

Yes, Greg, this is Jeff Donnelly. I can walk you through it. A significant portion of the transition from this year to next year will involve reducing some of the disruption caused by the conversion. As Mark mentioned, about $3.5 million of EBITDA is expected to come from this. Additionally, we anticipate cost savings from removing the overhead associated with being a branded asset, which will enhance profitability by allowing us to retain more revenue as an independent operator. Lastly, how we position the asset will be crucial in increasing our share in both the leisure and business transient markets. We project $35 million in gross revenue for this year; in 2019, revenues were $43 million. Returning to the 2019 peak, coupled with a renovated and rebranded asset, represents a significant potential upside. The brand costs for an asset like this are over 10%, considering it is mostly driven by room revenue from franchise fees and a precoat program. For a $40 million room revenue asset, being independent saves us about $4 million in brand costs. In summary, combining a return to previous peak revenues with a more efficient cost structure should allow us to significantly increase profitability.

That's all very helpful. Thank you very much.

Thank you. One moment, please. Our next question comes from the line of Smedes Rose of Citi. Your line is open.

Hi, thanks. I just wanted to ask you, you mentioned that group business in Chicago is slowing or slower in the second half. I was wondering, is that in line with what you were expecting already? Or has that changed from your last update? And then I'm just wondering, on group in general, if you could just talk a little bit about what you're seeing in terms of kind of composition. Is it more corporate? Is it just associations coming back that's helping the citywide calendars or kind of just a little more color around the tenor of group, I guess.

In Chicago, the citywide layout has significantly influenced the situation. The calendar for 2023 had most events concentrated in the first half of the year, which aligns with our expectations. Looking ahead, 2024 appears very promising for Chicago, and our bookings for that year are robust. We are optimistic about the future. This is simply a matter of seasonality and aligns with our predictions regarding citywide events. And a number of our markets, as I mentioned in the prepared remarks, Q4, back half of the year, and particularly Q4 looked to be stronger.

Just wondering what you do practically to keep short-term disruption to a minimum.

Yes, we have been diligently preparing for the August first date for quite some time. We have held weekly revenue calls, developed strategies, and worked on web designs. One of the most significant measures we implemented was taking 80 rooms and placing Delta in there at a reasonable rate to help mitigate the transition period this fall. There will be some disruption as we navigate this process, as mentioned in Jeff's numbers during his prepared remarks. The hotel looks beautiful, and we are eager to see how well it performs on its own. Justin, would you like to add anything?

Yes. As Mark mentioned, we did a lot of prep work just to ensure that we really didn't have any significant revenue loss during the dark period. In fact, we intentionally sold the hotel out for the first week of August to sort of insure against that. But we were live, both on GDS and most e-channels within 24 hours so we do have all active reservations up and actively looking. We've also done a significant amount of base building, both through the Delta contract and on the group side. So we're forecasting a drop in revenue as we continue to build brand awareness for the Dagny, but we have over $1 million of incremental group rooms on the books for the back half of the year versus last year in addition to the Delta contract. So August and September are both 70% sold, and we're in a significantly better place than we were at the same time last year for the balance of the back half of the year. So we've got a great base to really preserve rate integrity as we grow brand identity.

Great. Thanks for the detail.

Thank you. One moment, please. Our next question comes from the line of Chris Darling of Green Street. Your line is open.

Thank you. Mark, in the prepared remarks, you mentioned exploring a few dispositions perhaps in the near term. Wondering if you could elaborate on what markets, maybe what assets? And then how are you thinking about seller financing in terms of effectuating the transaction today?

Yes. So great question. So we are committed to our resort and leisure-oriented properties. We think that that is the best long-term place to be, so those will not be on the disposition list. We'll continue to pare down some of the urban exposure. I think we want to identify publicly which assets are, but they'll be smaller assets in this market that are financeable. The large loans are the ones that are very difficult. So it will be a couple of smaller assets that are not core to the portfolio. As far as your question about seller financing, one of the reasons we're selecting smaller assets as they are financeable and don't need seller financing. We prefer not to do any and so we'd rather preserve that capacity. If it involved a small piece to fill the capital gap, that might be something we'd entertain, but we're not going out to the market to offer seller financing.

Got it. That's helpful. And then one for Jeff maybe. You gave a lot of good detail in terms of the different moving pieces on the expense side this year. But, just curious, maybe taking a longer-term view, 2024 and beyond, what do you view as sort of a reasonable run rate for overall expense growth, kind of assuming maybe a more normalized demand backdrop? Is 3% to 5% annually, a decent betting line for us to think about?

It's probably a decent range. But when you think about it, I mean, of course, it's going to relate to ultimately what sort of inflation is at the macro. I think for us, when you look at how our properties have recovered and we've largely recovered our revenues and earnings, a lot of the factors that municipalities use to drive things like taxes. I don't expect our taxes are going to see sort of outsized increases over a long period of time. And property insurance is more difficult to forecast. I'd like to believe that this past year was a year, maybe a little bit like a post-Katrina-type event where you saw a big spike and then you had decreases in costs or slowing significantly thereafter. But it's hard to forecast because those rates are renegotiated every year. There might be some catch up in the industry. I can't necessarily speak to us off the top of my head, but on labor cost, but I think same thing that tends to follow inflation over time. So I think your range is reasonable. If I was a betting man, I'd probably be towards the lower to middle end of that, but that's just a guess.

Right. That's all very helpful. Thank you.

Thank you. One moment please. Our next question comes from the line of Michael Bellisario of RW Baird. Your lines is open.

Thanks. Good evening, guys. Just a quick first follow-up on the transaction front. Was Chico set up as a reverse 1031? Any pressing need to sell something on the back end of this one?

It was not set up as a reverse 1031.

Got it. Okay. And then just on the transaction, maybe can you give us a little bit of background on who the customer is? Maybe what states people are coming from? And then any percentage if you have it just on a number of repeat guests that come to the property?

Yes, this is an institution. The clientele obviously changes depending on the time of the year. It is remarkable because of the hot springs how year-round this asset really is. Obviously, in the peak season when people are going to Yellowstone, this is close to an entrance to Yellowstone. You get, in the summer, you get more than 50% out of greater than 50%, but you got a fair amount of repeat folks. And then in the rest of the year, it is kind of the local draw. It's probably the best restaurant within 20 miles of the location. So it's got kind of a great local following from Livingston and other areas. But probably on average, it's about 50% from out in other states from all over the country.

Michael, I'd add, it's a very popular hangout with locals, even just to go to the saloon and take a soak in the hot spring.

I won't ask if you guys did that too on your tour. And in your one page that you put out the other day, you referenced a 40 plus or minus percentage point RevPAR delta. What is your underwriting assumed in that Chico does versus the comp set and maybe how long does it take to get there?

Yes, to sum it up, the gap will come from both implementing the revenue system and achieving revenue gains, but there are likely productivity improvements and best practices we can implement on the expense side that haven't been addressed yet. So it will involve both aspects. However, starting from an 8.1% NOI cap rate, reaching 10% doesn't require much bridging over time. The comparison set is quite broad in that area since it includes locations like Gardiner and Livingston. We can expect to see more potential for rate increases in the summer compared to other seasons.

Helpful. Thank you.

Thank you. I'm showing no further questions at this time. I'd like to turn the call back over to Mark Brugger for any closing remarks.

Well, thank you, everyone, for tuning in to our call, and we look forward to updating you on our earnings next quarter. Take care, and have a great evening.

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.