Hospitality | Why Now is the Best Time to Consider a Change

Market Overview

California’s hospitality sector has remained afloat despite economic volatility. However, there has been a slowdown in hotel travel due to diminished pent-up demand from the pandemic, and much of the savings accumulated during COVID-19 have been spent. This, as well as rising interest rates and economic volatility, have all caused consumers to travel and spend less. Nevertheless, the state has continued its construction endeavors to cater to the escalating demand. Witnessing an upswing in investor attention and a substantial turnover of hotels, California’s hospitality realm underscores a thriving and optimistic market outlook.

Why 1031 Exchange?

Engaging in a well-strategized 1031 exchange offers several advantages. One of these is diversification, as it allows for the distribution of risks by tapping into various markets or acquiring multiple properties. This strategy enables investors to safeguard their investments against the volatility of a single market. Furthermore, the 1031 exchange facilitates an enhanced return on investment by enabling investors to focus on areas that hold the potential for greater returns. By reallocating funds from one property to another, investors can optimize their financial gains and capitalize on more lucrative opportunities.

The California hospitality sector is constantly evolving, and California hotel owners need to keep up with the times. The following provides some vital trends and data that could significantly reshape California hotel owners’ financial futures.

3 Reasons to Consider a Change

1. California’s Evolving Business Landscape

Current CRE and hospitality dynamics in California suggest a looming uncertainty as fast food minimum wage will increase to $20 an hour on April 1, 2024. The combined weight of AB 257 implications, soaring insurance costs (an 8.3% hike in just Q2 2023 for properties), rising labor and payroll taxes, the migration out of state like Tesla or Oracle, and potential moves by giants like Google signal a changing economic climate. AB 257’s influence on the fast-food sector will have a cascading effect on other industries. There’s a rising concern that this might drive employees from sectors, especially hospitality, towards fast-food jobs seeking higher wages due to the California Fast Act’s minimum wage of $20 for fast-food chains. As a result, hoteliers might grapple with increased wages and recruitment challenges. At the same time, commercial landlords could face tenants renegotiating rents or even looking at alternative business models, such as ghost kitchens.

2.Rising Property Insurance Costs 

In addition to the Fast Act’s passing, California property insurance premiums rose 8% in Q1 2023 alone. This escalation in insurance costs compounds the financial burden on NNN tenants, who are already responsible for covering their business operating expenses, including the rising property taxes. One might question, “Well, my tenant currently fulfills their rent obligations, so what is the concern?” However, this short-term stability may mask a potential long-term issue. As leases expire, large corporations like McDonald’s may shift their focus away from expanding within California due to reduced profitability in the face of these exorbitant insurance premiums.

3.Decline in Hotel Travel 

Industry analytics indicate a slight decline in hotel travel, the section of the service industry that encompasses guest accommodation or lodgings. With the changing dynamics of the travel and hospitality industry, especially in metropolitan areas like Los Angeles, hoteliers could face reduced occupancy and revenue. The longer owners wait to sell, the greater the risk of the property’s value being adversely affected, potentially resulting in a loss of millions of dollars in sale proceeds. 80% of Consumer’s pre-COVID-19 savings have been wiped out, meaning non-essential Leisure travel will be the next to feel the repercussions of the upcoming recession predicted in Q1 and Q2 2024.

1031 Exchange Solutions

In light of the aforementioned challenges, the following strategies are centered around improving California hotel owners’ cash flow or security.

Professional Management or Increase Cash Flow (Hospitality)

Out-of-State Hotel with Professional Management 

• Maximize Investment Returns with Strategic Relocation: Leverage a 1031 Exchange Out-of-State to transition to regions with a more business-friendly legislative framework. This move allows you to sidestep some of the unique challenges California’s labor laws pose while enjoying increased cash flow in these business-friendly states. By selecting states that promote business growth and offer lowered operational expenses, you can secure higher profitability and maintain a steadier cash flow for your investment.
• Unlocking Profit Potential: Seek out regions with economic vibrancy, like Nashville, Austin, Tampa, Fort Lauderdale, and more, where robust economic growth is driven by various factors, catering to both leisure and corporate travel. In addition, consider the higher appreciation potential that certain out-of-state markets may offer, potentially surpassing California’s growth prospects.
• Asset Upgradation: Considering the potential acquisition of a new hotel that has undergone a recent Property Improvement Plan (PIP) necessitating less maintenance, aims to maintain peace of mind by utilizing professional management, with access to a brand with millions of loyal customers, thereby drawing consistent revenue to the underlying asset.
• Diversification: Spreading risks by accessing different markets or multiple properties.

Zero Management & Security (NNN)

NNN Properties with Zero Landlord Responsibilities

• Stabilized Cash Flow: In states with positive business trajectories, opportunities promise consistent rents subject to long-term 10, 15, or 20-year triple-net (NNN) leases with minimal or zero landlord responsibilities.
• Peace of Mind: Investing in NNN ensures long-term security.
• NNN Risk Mitigation: Protecting against regional economic challenges as the tenant, such as McDonald’s, Starbucks, Target, etc., bears all economic and political changes while being responsible for rent checks to you as the Landlord.
• Retirement and Family Time: Given hotel owners’ commendable years of hard work and dedication, they deserve to reap the rewards of their labor. By selling now, owners can exchange 1031 for passive NNN properties. This exchange guarantees a stable return and alleviates the responsibility of burdensome operating expenses, including building maintenance, insurance, property taxes, and more. With tenants handling these responsibilities, owners can comfortably retire and cherish priceless moments with grandkids and family.

In a rapidly shifting landscape, timely decisions are of the essence. The goal is to protect and grow your investment. Matthews™ specialized agents are here to discuss and collaborate on potential paths forward, ensuring hotel owners make informed and beneficial choices.

Benefits of Working with a Matthews™ Agent

A. 1031 Exchange with Capital Gains Deferment: Navigate the tax landscape effectively by using a 1031 exchange via Matthews™ 1031 Private Client Exchange Program. This strategy allows owners to sell their assets and reinvest the proceeds while deferring capital gains tax, maximizing your investment power.

B. Leverage Matthews™ Broker Relationships: With our strong ties to national hotelier owners, we can provide you with prime investment opportunities that others might not have access to.

C. Exclusive Access to National Auction Platforms: Being a client of Matthews™ grants owners direct access to the most exclusive and valuable upcoming hotel auctions or NNN properties, ensuring they are always at the forefront of promising investment opportunities.