Deric Eubanks is the CFO of three separate publicly held companies. In fact, there is a single management team that runs all three.
That’s an unusual setup, but less so in the real estate investment trust (REIT) space. Indeed, REITs and what you normally think of as “companies” have about as much commonality as house cats and leopards: you know they share a broad category, but you wouldn’t confuse them with each other.
In November 2013, Ashford Trust, a REIT that owned a diversified portfolio of hotels, decided to spin off its higher-end properties into a new REIT called Ashford Prime. Ordinarily with a spinoff, some executives stay with the parent and others go with the spun-off entity. Ashford, though, wanted to keep its management team intact.
Happily, rules for forming and operating REITs allow them to be operated by “external advisers” that provide investment management services and everything needed to run a business, including an executive team. For the first year of Ashford Prime’s existence, Ashford Trust served as its external adviser. But that meant the older company was getting management fees from the newer, and under REIT rules, the vast majority of a REIT’s income must come from real estate investments.
So, in November 2014, Ashford Trust spun off a second company, Ashford Inc., which acts as external adviser to both REITs. Most of its revenue to date is from management fees paid to it by Ashford Trust and Ashford Prime, and it’s open to advising other investment platforms as well. (It also operates Ashford Investment Management, an equity long/short alternative asset manager specializing in the real estate, hospitality, and leisure sectors.)
Most recently, in September of this year, Ashford Inc. announced an agreement to acquire 80% of Remington Holdings, a hotel management company controlled by Ashford’s chairman and CEO, Monty Bennett, and his father. The deal, expected to close in early 2016, will more than double the size of Ashford Inc. and position it for future growth.
Eubanks, who joined Ashford Trust when it launched in 2003 and became its CFO in June 2014, recently spoke with CFO about the “All in the Family” structure and his role in running the businesses. An edited transcript of the conversation follows.
Why did you spin off your higher-end hotels into a new REIT?
The rationale was to simplify the investment strategy. One of the things we heard from investors over the years was that they preferred investment platforms that had more well-defined strategies, as opposed to an opportunistic strategy of investing capital where we felt we could get the best returns.
What are the management fees for the REITs based on?
It’s based on what we call the total capitalization of the [REIT]. We add up its market capitalization, debt, and any preferred equity and multiply it by 0.7%. That’s the base fee.
Some external advisory agreements have fees based on gross asset value. We didn’t want to do it that way. We wanted to show investors in the REITs that the management team is highly aligned with them to really increase the value of those platforms. And if it’s not increasing value — if the stock’s going down — it’s not good for Ashford Inc.’s fees.
Since all of the Ashford entities have a common management, it seems like these fees are just being passed around internally, rather than actual revenue that’s being generated. How do you view it?
Well, they are separate companies, with separate sets of shareholders and independent boards of directors. The REITs own hotels, they get all of the revenue that the hotels generate, they pay the hotels’ expenses, but they do not have any employees — those are provided by Ashford Inc. So the fee is comparable to the G&A expenses of an internally managed REIT. It’s just accounted for as an advisory fee, which Ashford Inc. uses to pay the management team and its other expenses.
How significant to your overall strategy is the Remington transaction?
Very significant, for Ashford Inc. It doesn’t really affect the REITs. As a REIT, you have to have third parties manage your properties. Trust and Prime both own a lot of hotels, but we don’t have employees at the hotels. Their employees work for the management firms, like Hilton or Marriott or Westin, that we hire to run the hotels. And there are also independent third-party hotel managers, which could be franchisees [of those chains, or companies like Remington].
A combination with Remington was really the next step for Ashford Inc. We can get into the business of managing hotels. And the deal is structured in a way that allows us to acquire a much larger company than Ashford Inc. We’re paying only $10 million in cash, plus we will issue $230 million of convertible preferred shares and 916,000 shares of nonvoting common stock. Typically when a company acquires a much larger company, it has to give up some voting control or pay more in cash.
What’s the biggest item on your plate since you became CFO last year?
We had just completed the Ashford Prime spinoff and were in the process of completing the Ashford Inc. spinoff, so there were a lot of SEC filings and financial reporting around those.
But the biggest part of my job recently has been investor relations. It’s a bit of a complex structure, and there is a lot of moving pieces. If you were an investor in Ashford Trust, you now own stock in these other two companies as well. So there’s a lot of communicating the story and the strategy, why we’ve done what we’ve done and why we feel that it will ultimately create more value for shareholders than if we hadn’t done anything and stayed as Ashford Trust.
Where does that incremental value come from?
This management team has a long record of delivering very attractive returns to our shareholders that have significantly exceeded our peer average. But Ashford Inc.’s structure now will enable it to grow, which we weren’t able to achieve as well when we were just Ashford Trust.
I think one of the reasons we’ve [delivered those attractive returns] is that insiders own a lot of the stock. Trust and Prime have the highest insider ownership of any of the hotel REITs. We think and act like investors, because we are significant investors.
What are your upcoming challenges?
We’ve got some debt maturities that we’re working through. The debt markets have been a little bit volatile from a spread standpoint [that is, the spread of debt interest rates over an index rate like LIBOR, the prime rate, or a U.S. Treasury rate]. Typically as we go through a business cycle, debt spreads continue to compress as more lenders become more aggressive. In this cycle, it’s been a little bit different. Spreads start to compress, then they widen back out.
I think that’s the sign of a healthy market. It shows discipline on the part of lenders and bond investors. We’re not anywhere close to what we were seeing in 2006 and 2007, which I’d call the peak of the credit cycle, where lenders were providing very aggressive loans and the underwriting standards had fallen quite a bit.
At the same time, a challenge we’re having right now is that it’s hard to buy hotel assets in a way that accretive to shareholders, because our cost of equity has gone up quite a bit with what’s going on in the stock market. Cost of capital is very important to a REIT, because you have to pay out almost all your earnings as dividends, so you’re relying on the capital markets to grow.
When stock prices drop, if we feel like the future prospects of our business haven’t changed, it increases the potential return an investor could achieve from owning our stock. That means we have a higher cost of equity — if we want to buy a hotel that’s accretive to our shareholders, we would need to earn a higher return on that hotel than the return an investor could get from just owning our stock. Otherwise, our shareholders would have been better off if we didn’t buy that particular hotel.
Are hotel REIT stocks performing worse than the overall market?
Yes. The stocks have performed pretty poorly. That could be a function of investors’ concerns about interest rates possibly going up and how that might impact hotel values and earnings.
The reality is, as a hotel owner we would love for interest rates to go up. That means either the economy is doing better or inflation is heating up, and both of those things are great for the hotel business. If the economy is doing better more people are traveling, and if inflation is going up we can reprice our rooms every day.
Or it could be the fact the hotel industry has had a pretty long recovery up to this point, and people are people are thinking we’re toward the end of the cycle and so they’re cycling out of REIT stocks.
But there is a disconnect between [the poor stock performance] and the fundamentals at our hotels. If you look at hotel earnings growth, it’s been strong. Industrywide, revenue per available room is up 6.7% through August.
This in turn has led a disconnect between what we call public market values and private market values. Public value refers to how the stock market is valuing portfolios of hotels owned by publicly held companies, while private values refers to [the purchase prices] of hotels being traded by either public or private companies. The private market values are way higher than the public market values.
That disconnect doesn’t tend to last long, because people can take advantage of that arbitrage — they can buy a hotel REIT, take it private, and sell the assets. Or if it’s the other way around, you might see a bunch of private companies trying to go public. Either public market values are going to go up, or private market values are going to go down. But with the strong fundamentals at our hotels, it’s tough to see how that could result in private hotel values coming down.