Why Invest in Hotels?
In this article, I would like to offer a brief overview of the investment landscape today, and provide you with an understanding of why we at Bird Dog are currently focusing on our unique approach to investing in the hotel industry.
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When I started my own business in 1989, I considered for a time the possibility of becoming a fee only investment advisor.
In preparation for that, I gained my Certified Financial Planner designation, which involves extensive study on a variety of investment related subjects. While I ended up pretty quickly going down the path of managing private equity portfolios, the information I learned has always been very useful for me and our team.
In a nutshell, it has helped us take a portfolio approach with our investors.
This, among other things, means that we pay careful attention to the historical and expected returns of all the major investment classes. We only recommend investments that fit into a well-rounded portfolio.
For example, we often encourage our investors to put in LESS than their wishes in any one of our funds if we think that they would be too heavily weighted in any one class.
With that as a backdrop, here are some specifics on what we think is going on today.
I will talk about the major alternatives, with an addendum to each on what history teaches us. Of course, for the sake of being brief, I will leave out a lot of detail.
The 5 Places You Can Put Your Money
You have primarily five alternatives for what to do with your money.
1. The Stock Market
You can invest money in public companies by putting money in the stock market.
Public equities have historically returned an average of about 3 to 5 percent annually above the inflation rate. Inflation has been pretty steady in the one to two percent range, and the equity markets have had a MAJOR bull run for the past many years.
Valuations are at historically very high levels, and while money put in today will likely still provide a return in line with historical averages, there is much greater than normal risk today given the valuation levels.
Corrections always happen. Recessions always happen.
A balanced long term portfolio should always have 50 to 70% in public equities, but given the above, I believe it prudent to stay on the low side of that today. Of course, who manages the portfolio matters, but that is a subject for a different day.
I want to reiterate that history teaches us that an investor will achieve positive long term results in public equities REGARDLESS of whether or not the money was put in at market peaks or market dips.
It is VERY hard (virtually impossible) to time the market.
I remember very well early in my banking career in the 1980’s when the Dow Jones Industrial Average hit 1000. Folks everywhere pulled their money out, because the market had never been that high. Today the Dow is over 20,000. Our economy grows, so do equities.
I’m just saying that staying toward the bottom of whatever range is right for a given investor is prudent today.
"I remember very well early in my banking career in the 1980’s when the Dow Jones Industrial Average hit 1000.
Folks everywhere pulled their money out, because the market had never been that high.
Today the Dow is over 20,000."
2. Bonds or Related Interest Bearing Investments
You also have the option of investing in bonds or related interest-bearing investments, such as certificates of deposit.
Unless you take a very risky posture, this class today is paying out one to three percent annually, which is at or even below the rate of inflation.
The low returns are one thing, an increase in interest rates would be another, which would cause the principal value of the investment to go down, meaning that the returns in future years could be negative.
Long term, this class has returned a percent or two above the rate of inflation. The relative stability of this sector means that for conservation of capital, a balanced portfolio should have between 10 and 30 percent in this class. And that safety is really the only reason to hold such investments today.
3. Public or Private Real Estate Investments
Historical returns for this class are generally somewhere between bonds and public equities.
I have never been a big fan of such investments, mostly because the investment structures are so fee loaded. The principals and managers make a lot of money, while investors make less.
Shrewd investors who buy and manage their own real estate investments have done much better, but most investors do not have the time or expertise to do this.
Current yields on things like Real Estate Investment Trusts (REIT’s) are in the 5% range, much better than bonds, but again, there is principal risk if interest rates increase.
The upside (gaining a return above the yield) is very low today, because generally the upside happens only when rates go down, which is hard to imagine with rates so low today.
4. Venture Capital or Private Equity portfolios
Here, of course, who manages the money makes ALL the difference.
As a class, returns here are the highest of any category.
However, in today’s world, there is a phenomenal amount of money chasing deals, which has driven up the cost of private equity investments, which can only lead to lower returns and increased risk.
When I started doing private equity in 1989, there was little competition in our region. Now, there is a lot.
One of the results is that many firms are tending to look at earlier stage companies. This essentially means that they are taking more risk, with of course the potential for greater returns.
Anyone looking to invest in private equity should pay VERY close attention to the historical returns of whoever you give money to in this class.
"As a class, returns here are the highest of any category."
—Paul Schock, on venture capital
Most of the firms with the best track records have become HUGE, and are available only to large institutional investors.
Fees paid to investment managers have also gone up.
The combination of more money under management and higher fees means that the managers make a lot of money—regardless of whether or not they provide returns to investors.
The above two categories, real estate and Venture/Private Equity should represent 10 to 30% of a balanced portfolio.
5. Cash or Very Safe, Short-term Investments
Obviously, there is no expected long-term return for this category.
I have noticed that many investors, being nervous due to the above described environment, have a lot of cash sitting idle. While I understand the anxiety, I would encourage you to remember the long term.
As a general rule, again for safety/emergency reasons, cash should represent no more than 10% of a long-term investment portfolio.
6. Optional Sixth "Investment Strategy"
I suppose there is another option in this category: bury your cash in your backyard or somewhere.
Note that this was often done in the middle ages, and anyone who stumbles on such treasure today has found a fortune.
So if you are willing to wait a few hundred years, this might not be such a bad idea.
Caution: I've heard stories of people burying cash in their backyard, only to dig it up years later and found that the paper had literally deteriorated.
Bird Dog's Hotel Investments
So where do Bird Dog’s current hospitality investments fit into the above discussion?
I have a few comments on where our current investments fit into the above discussion. I also will share about how our investments are structured.
1. Real Estate and Private Equity
First, as a category, our hospitality investments are really a blend between real estate and private equity, with an emphasis on the latter.
I have always felt, in general, folks underestimate how much of a BUSINESS real estate is.
Folks tend to think that all real estate investments rise or fall together, and while that can be somewhat true, it generally isn’t (e.g. farmland would be best example, but even here, how the land has been managed/tended makes a big difference in value).
Just here in Sioux Falls, I’ve seen fortunes made and lost in the same type of real estate. Business skill is just as important in a hotel, as it is a restaurant or manufacturing company.
So, being private equity investments, average returns will be as high as any category. But as mentioned above, who manages the money makes all the difference.
At Bird Dog, going back to 1989 (one of my first two private equity projects was a hotel investment), we have invested tens of millions of equity into hotels, and have consistently generated well-above-average returns both on a current (cash distributions) and long-term basis (when properties are sold or refinanced).
As part of the “who manages the money makes a difference” matter, we believe that we have a unique strategy for acquiring and managing properties that is part of the reason we expect above average returns. That’s a subject for a different blog.
2. Capital Protection
There is also the benefit of capital protection.
Well-managed properties in the right locations do not generally fluctuate greatly in value over time.
We are not leveraging our properties excessively (about 70% on average), so we believe that the returns we are paying are especially attractive given that there is significant downside protection.
3. The Investment Structure
Part of our unique strategy is our investment structure.
As I mentioned above, so many real estate and private equity investments come with very high fees and expenses, where the managers do well regardless of whether or not the investor does.
We find that unacceptable.
We pay a generous preferred return to our investors and then pay a large portion of any additional returns to our investors. Importantly, this means we don’t start making money until our investors have done well.
It's part of our philosophy of winning when the investor wins.
4. Diversification
Finally, in spite of how compelling we think these investments are, we would not suggest that anyone put more than 10 to 30% of their investment portfolio in these investments, for all of the reasons mentioned above.
Diversity has never been a bad idea. You may give up some return, but you have less risk.
It's important to be wise when allocating your portfolio.
I hope you’ve enjoyed the above discussion. For more updates from Bird Dog, you can subscribe to our newsletter by clicking here and enter it on our home page.
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— Paul
*LEGAL DISCLAIMER:
The information on this site is intended to be an informational piece. It is not intended as and does not constitute investment advice or legal or tax advice or an offer to sell any securities or investments to any person or a solicitation of any person of any offer to purchase any securities or investments.