Sunstone Hotel Investors Inc

NYSE:SHO

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Sunstone Hotel Investors Third Quarter 2022 Earnings Call. At this time all participants are in a listen-only more. [Operator Instructions]

I would like to remind everyone that this conference is being recorded today, November 8, 2022, at 12:00 p.m. Eastern Time.

I will now turn the presentation over to Mr. Aaron Reyes, Chief Financial Officer. Please go ahead, sir.

[Aaron Reyes, Chief Financial Officer]

Thank you, operator, and good morning, everyone. Before we begin, I would like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties, including those described in our prospectuses, 10-Qs, 10-Ks and other filings with the SEC, which could cause actual results to differ materially from those projected. We caution you to consider these factors in evaluating our forward-looking statements. We also note that this call may contain non-GAAP financial information, including adjusted EBITDAre, adjusted FFO and property level adjusted EBITDAre. We are providing that information as a supplement to information prepared in accordance with generally accepted accounting principles.

On today's call, references to our comparable portfolio will mean our 13 hotels portfolio, which includes the Confidante Miami Beach, but excludes Montage Healdsburg and Four Seasons Resort Napa Valley.

Additional details on our second quarter performance have been provided in our earnings release and supplemental, which are available on our website.

With us on the call today are Bryan Giglia, Chief Executive Officer; Robert Springer, President and Chief Investment Officer; and Chris Ostapovicz, Chief Operating Officer.

Bryan will start us off with some commentary on our second quarter operations and recent trends. Afterward, Robert will discuss our recent capital investments. And last, I will provide a summary of our current liquidity position, recap our third quarter earnings results and provide some additional context as to how we are thinking about earning to the remainder of the year. After our remarks, the team will be available to answer your questions.

With that, I would like to turn the call over to Bryan. Please go ahead.

[Bryan Giglia, Chief Executive Officer]

Thank you Aaron. And good morning everyone. We are pleased with our portfolio's performance in the third quarter as robust leisure demand in the final months of the summer transition to encouraging signs of increased corporate and group travel as we head into the fall. The quarter represents the strongest relative performance that we have seen since the onset of the pandemic with comparable rooms RevPAR in September and total RevPAR for the quarter, both coming in above pandemic levels.

Once again, our operators were able to aggressively push pricing which contributed to comparable average daily rate of $288 and 11% increase from last year and a 16% increase as compared to 2019. While we saw meaningful year-over-year rate growth across our portfolio, the greatest increase was at our urban and group-oriented hotels, which grew rates 20% in the quarter as compared to the prior year.

San Francisco led the portfolio on rate growth and we are encouraged by the recent trends we are seeing there, especially with our recently completed rooms’ renovation. San Francisco also saw a meaningful increase in occupancy as corporate and group customers returned to the market.

While the market has a way to go to return to 2019 levels, 69% RevPAR growth compared to 2021 is a positive step in the right direction and we expect that to continue into the fourth quarter.

Our resort portfolio once again performed well and managed to further grow rate above what was a very impressive 2021 performance. Our two premier wine country assets continued to season and they generated a combined third quarter ADR of over $1,500, the highest combined quarterly rates we have seen since our acquisition. Including these two hotels our total portfolio generated a third quarter RevPAR of $223 made up of occupancy of 71% at a $312 average daily rate.

Non-room revenues came in strong during the quarter benefiting from increased group business and related banquet spend. In our comparable portfolio we once again saw significant contribution from food and beverage revenue, which exceeded 2019 levels.

Banquet and AV sales per group room was $207 for the comparable portfolio in Q3 compared to $176 in 2019, up 17%. Our outlet spend continues to build growing sequentially, quarter-over-quarter, maintaining the positive trend we've seen all year.

The strength in group activity has been encouraging with several of our larger hotels exceeding pre-pandemic levels. Following a strong Q2, Renaissance Orlando has an even better group performance in the third quarter with group room nights, 12% higher, rates, 13% higher and catering contribution 11% higher than the same quarter in 2019.

Similarly, at Wailea Beach Resort group business in the third quarter generated a significant premium to 2019 with banquet spend per group room night, 31% higher. Hyatt Regency San Francisco, which has been slower to recover than many of our hotels, had more than nine times the group volume in house compared to last year, accompanied by catering contributions up 76% year-over-year and 14% higher than in 2019.

We also saw meaningful increases in destination and facility fee revenue, a product of increasing occupancy levels and rolling out these programs to more of our hotels.

Cancellation fees in Q3 came in consistent with historic pre-pandemic levels, which is a positive indication that our industry is returning to a more normalized pattern of meeting activity.

Including the out-of-room spend our total portfolio generated an additional $120 of revenue per available room in the quarter for a total RevPAR of approximately $343. For the comparable portfolio, total RevPAR came in at $317 and exceeded 2019 for the first time since the onset of the pandemic, while remaining 13 occupancy points lower than 2019.

On the expense side, we continue to navigate the inflationary environment and look for creative ways to reduce costs. We have worked with our operators to optimize menu offerings and review pricing to mitigate rising food costs and beverage costs. Wage growth has moderated somewhat but remains in line with our expected range of 4% to 5% and our managers have been able to drive efficiencies in certain areas to help offset higher labor costs.

Utility costs have been on the rise and we expect this likely to persist through the winter. This makes our recent energy efficiency investments that much more worthwhile. In Wailea, the first phase of our solar panel installation has saved nearly $500,000 since it was completed last year and we are now in process on the second phase, which will come online in 2023.

As you may have seen in our earnings release, we also published our updated ESG report today, which has additional details on some of the other initiatives we are working on to increase our use of renewable energy and decrease our overall energy, water, and waste intensity to not only benefit the environment but to also reduce costs.

Despite cost pressures, our comparable hotel portfolio generated an EBITDA margin of 30.4% during the quarter, which is only 140 basis points below that achieved for the same quarter in 2019 even with 13 points of lower occupancy. If we exclude the two hotels in our portfolio with significant renovation activity in the quarter, our pro forma hotel EBITDA margin was a very strong 34%, which is the same as our 2019 performance. While we are very pleased with our operator's ability to deliver this level of profitability, our focus is increasingly shifting to maximized portfolio EBITDA as hotels return to normalized occupancy levels.

Now turning to segmentation. Our Comparable Portfolio generated 175,000 total group room nights in the quarter and the group segment comprised roughly 35% of our total demand. The group room night’s volume represents approximately 85% of historical amounts with average rates that are 9% higher than the same quarter in 2019.

Group production for all current and future periods for our comparable portfolio in Q3 was 173,000 room nights, which is more than we put on the books in Q3 2021 and at 31% higher rates. In terms of transient business, which accounted for roughly 60% of our total room nights in the quarter, comparable rate came in at $317 and was 23% higher than the pre-pandemic levels that we saw in the same quarter of 2019.

We are also starting to see business travel materialize at a more regular cadence. At Renaissance Long Beach, there has been a consistent return of business transient travelers with corporate negotiated revenue up 36% to 2019. The hotel is seeing growth coming from government, aerospace and consulting segments. Additionally, at Hyatt Regency San Francisco, business transient accounts are contributing higher volumes with significant participation from technology accounts leading to corporate negotiated nights at approximately 90% of 2019 levels and up 17% to Q2.

Boston Marriott Long Wharf also continues to see an uptick in business travel sequentially as key accounts have returned to the office or have adopted a hybrid model. Based on our third quarter performance and what we saw in October, we remain encouraged about the outlook for the fourth quarter. Recent trends reflect lead volumes hovering just below 2019 levels and strength in short-term booking activity with a higher contribution from corporate group events.

Our group pickup in Q3 for the fourth quarter was higher than the typical pickup amount, underscoring the trend that we have seen of groups booking closer in to their events. Group room nights for the fourth quarter are pacing at approximately 81% of pre-pandemic levels at an average rate that is 7% higher than 2019. This would imply that our overall group revenue pace for this time period is down only 13% from the same time in 2019. If we exclude the Renaissance DC where the guest room portion of the renovation is in full swing, our fourth quarter group revenue pace is down only 7% to 2019.

We have seen strong group booking activity in Boston and San Diego continuing into the fourth quarter. These cities benefit from active citywide calendars and market compression, which is translating into pricing strength. Fourth quarter group pace at our Hilton Bayfront is ahead of the same time in 2019. Boston continues to drive results in both transient and group with increased demand from both leisure and corporate travelers.

At Boston Park Plaza, fourth quarter group paces outperforming the same time in 2019 in both rate and volume. As I mentioned earlier in my remarks, the San Francisco market is increasingly showing positive trends. In October, our Hyatt Regency at the Embarcadero has several sold out nights and additional group and business travel is materializing as we move into the fall. Our rooms’ renovation is now complete and the finished product is generating great guest feedback. The city remains a desirable long-term lodging market and we fully expect that our well located hotel will contribute to our portfolio's earnings growth as the market further recovers in the coming quarters.

We were fortunate that our Florida hotels sustained little damage from Hurricane Ian, while Miami was not impacted. Oceans Edge in Key West and Renaissance Orlando both experienced some minor wind and water damage, most of which has already been remediated. We expect to incur approximately $600,000 of expenses in the fourth quarter related to the restoration work.

We estimate that the storms impact resulted in approximately $2 million in displaced revenue across September and October, primarily due to cancellations at Oceans Edge in Orlando leading up to and shortly after the storm. I'd like to thank our hotel teams in Florida who reacted quickly to minimize the effect of the storm on our physical assets and to protect and to accommodate hotel guests.

While the strength of the recovery continues to vary across markets and segments, we are seeing positive trends across our portfolio. When we spoke with you last quarter, we provided some guideposts about how we thought our full year occupancy rate and profitability could play out as we moved into the back half of the year. While those expectations remain consistent with our current thinking, our better than expected performance in the third quarter should position us to achieve the higher end of those indicative ranges. Later, Aaron will provide some additional information to help put this into context.

During the quarter, we made further investments to creatively mine value in our portfolio and we also initiated the value enhancing repositioning of our recently acquired resort in Miami. Robert will share some additional details of our current and planned capital projects, which we believe will provide a combination of near-term cash flow and long-term growth potential for our portfolio.

In addition to capital investments, we also completed an additional $20 million of share repurchases since the end of the second quarter. This brings our year-to-date total repurchase activity to $98 million at an average price of $10.67 per share, a meaningful discount to published estimates of NAV. Together, with a dividends for Q3 and Q4, we will return over $120 million to our shareholders this year.

To sum things up, as we move into the fourth quarter of 2022, we are encouraged by the recent trends we are seeing across our portfolio. Our well located urban and group oriented assets will see continued growth in the coming quarters as demand for business travel and corporate events continues to catch up with the already robust leisure demand at our resort properties. Additionally, Sunstone continues to actively allocate capital, investing in our portfolio, recycling sales proceeds into new growth opportunities and returning capital to our shareholders through share repurchase and dividends. We believe this is a winning formula that will provide long-term value to our owners.

And with that, I'll turn it over to Robert to give some additional thoughts on our recent and upcoming capital investments.

[Robert Springer, President and Chief Investment Officer]

Thanks, Bryan. We are pleased to be making a number of strategic investments into our portfolio after closing on several acquisitions and dispositions in the first half of the year. I'll start off with a review of our plans for our recently acquired Oceanfront Resort in Miami, and then I'll provide an update on some of the other renovations and initiatives we have underway across the portfolio. Our repositioning of the Confidante Miami Beach is in the middle of the design and approval stage, and construction will soon be underway.

The renovation is scheduled to begin next year following the market's high season and to conclude in the first half of 2024 when the hotel will debut as the Andaz Miami Beach. The investment will transform the asset and better take advantage of its great location and superior beachfront footprint.

As we discuss with you on the prior call, we will renovate all aspects of the hotel including relocating the lobby retting, the food and beverage outlets, reimagining the pool and backyard recreation areas, modernizing the guest rooms, expanding the suite mix, and upgrading the meeting and event spaces. With these enhancements, we anticipate significant ADR growth and believe the property will be able to better compete with nearby luxury hotels. Because of the all-encompassing nature of the repositioning, we will incur significant displacement next year while the work is completed.

However, post repositioning, we expect the hotel to generate a very attractive 8% to 9% yield on our total investment and we will own a fully renovated oceanfront luxury resort at an all-in basis of approximately 900,000 per key in a market where per key valuations for similar assets are well in excess of $1 million. This is the type of investment we know well and have had great success with in the past.

In the initial months of our ownership, we have been impressed with the resort’s performance and its ability to grow rate even in its current condition. Year-to-date, rate is up a strong 47% year-over-year compared to the market rate in Miami Beach, which is up a respectable 18%. This supports our investment thesis that there is the ability to push rate and we have started this process well before the renovation has even begun.

As Bryan mentioned earlier, we completed the room’s renovation of the Hyatt Regency San Francisco and the hotel is in great shape, its occupancy continues to return to the market. Work is also progressing on the conversion of the Renaissance Washington DC to the Westin brand. The meeting space is completed, and initial feedbacks from group and sales managers is very positive.

The rooms are currently underway and the lobby renovations will start before the end of the year with the entire project expected to be completed by the third quarter of next year. While we incur some renovation displacement, this project will enhance the value of the hotel and contribute to incremental growth upon completion.

Given the positive response and lists we expect to see from repositioning the Renaissance DC to a Westin, we are also moving forward with a brand conversion at the Renaissance Long Beach where we will renovate the hotel and reposition it as a Marriott. We are in the early stages of this project, but expect the conversion will allow the hotel to better compete for business, grow earnings and ultimately to enhance its value as an on strategy Marriott Hotel.

As part of the project, we will invest approximately $17 million to renovate the guest rooms, add an M Club, an additional meeting space and reconfigure the lobby. The conversion is slated to occur in mid-2023. We are constantly looking for ways to creatively grow and enhance the value of our portfolio both through acquisition and internal investments and we’ll be sharing additional details of our other upcoming projects in future quarters.

With that, I’ll turn it over to Aaron. Please go ahead.

[Aaron Reyes, Chief Financial Officer]

Thanks, Robert. As at the end of the third quarter, we had approximately $168 million of total cash and cash equivalents including $50 million of restricted cash. We retain full capacity on our credit facility, which together with cash on hand equates to nearly $670 million of total liquidity. We’re in the process of exercising our extension option on the mortgage loan secured by the Hilton San Diego Bayfront, which will be completed in the current quarter. Once that is done, we will not have any debt maturities within the next year and our balance sheet will remain one of the strongest in the sector.

Shifting to our financial results, the full details of which are provided in our earnings release and our supplemental, the quarterly results which surpassed our initial expectations reflect continued strength and leisure travel and growing corporate and group demand.

Adjusted EBITDAre for the third quarter was $64 million, and adjusted FFO was $0.24 per diluted share. The third quarter results include approximately $1 million of revenue displacement related to the Westin conversion work in Washington DC and we estimate that approximately half of the $2 million in displace revenue from Hurricane Ian cancellations was in September with the balance impact in Q4.

When we spoke with you last quarter, we provided some broad indications for how we thought full year occupancy rate and profitability could transpire as we moved into the third and fourth quarters. While those parameters shall generally fit within our current thinking are better than expected performance in the third quarter would now suggest we are likely to be in the upper half of the ranges we discussed.

In 2019, our current 13 hotel comparable portfolio, which includes the Confidante Miami Beach, but excludes our two wine country resorts generated RevPAR of $212 made up of a $252 ADR at an occupancy of 84%. Based on what we have seen so far through October, we anticipate that our comparable portfolio occupancy will likely finish the year down 15 points to 16 points as compared to 2019.

This full year occupancy variance is skewed by the Omicron impact in the first quarter, which led to occupancy 27 points lower. While the second and third quarter were down only 12 points to 13 points. As we noted in our supplemental, the year-to-date rate growth for the comparable portfolio is at 14% relative to the same period in 2019.

This is likely to be a good representation of where we will finish for the full year. Taken together, this would imply that a full year comparable portfolio of RevPAR could be down in the high-single digit range as compared to 2019. Our current expectation is that the year-to-date adjusted corporate EBITDA of $165 million is likely to comprise approximately 75% of our potential full year earnings.

This expectation incorporates our better than expected results in a third quarter and as in the upper half of the indications we shared with you last quarter. As we noted earlier, we expect to incur approximately $600,000 of expenses in the fourth quarter related to restoration work as a result of Hurricane Ian, and there is also approximately $1 million in displaced revenue from the storm, which is reflected in the October preliminary numbers we shared in our earnings release this morning.

In addition, we will experience some additional displacement in the fourth quarter as we make further progress on the conversion to a Westin at our hotel in Washington DC.

Now turning to dividends. Our Board has authorized a common dividend a $0.05 per share for the fourth quarter, and this also declared the routine distributions for a series G, H and I preferred securities.

And with that, we can now open the call to questions. So that we are able to speak with as many participants as possible, we ask that you please limit yourself to one question. Operator, please go ahead.

[Operator]

Thank you. [Operator Instructions] Your first question comes from Smedes Rose from Citi. Please go ahead.

[Smedes Rose, Citi]

Hi, good morning.

[Bryan Giglia, Chief Executive Officer]

Good morning.

[Smedes Rose, Citi]

Bryan, I wanted to ask you just I guess a little bit more specifically about the two wine country properties. We have essentially a year’s worth of results now and I’m just wondering when do you think that they can start to get you more meaningful returns on the – I think the combined investment of around $440 million?

And I guess specifically for the Four Seasons, does it – is it a matter of taking costs out? Do you think there’s upside? Is it got to be bit more occupancy? I’m just wondering like a $2,000 daily rate. It seems like maybe there’s not a lot of upside there, but maybe there is. I’m just kind of interested in how you think this plays out over the next year.

[Bryan Giglia, Chief Executive Officer]

Yes, absolutely. Thank you, Smedes. When we look at both of the wine country resorts, they continue to ramp as they have all year and this year what we saw in the summertime is the market started to revert back to the normalized seasonality that you would see in Napa and Sonoma during the summer.

If you look back to Q3 of last year, Montage and the market had a very, very strong summer, a very strong occupancy driven summer and that was primarily due to fewer luxury options available to that luxury traveller. This summer is a little bit different story. You had – the U.S. luxury traveller could go international this year. A lot of European, especially European wine destinations like France or Italy were available and they weren’t available prior years, which brought that seasonality back to the market.

Additionally, the strong U.S. dollar probably exacerbated this a bit, making it more attractive going internationally and making it more challenging for international travellers to come to the U.S. Where we have the resorts now, they have – we’ve established the resorts of the leisure customer and both hotels continue to focus on growing their group base, which they have done this year and will continue to do into 2023 and beyond. Montage has been open a little bit longer, so it’s a little farther ahead than of the Four Seasons in this process. But when we look to next year, both hotels have been able to put significant amounts of group business significantly higher than what was on the books at the Montage for 2022. And so we see very good growth on the group side. And remember the group business at these hotels, while it’s a lower rate than the transient rate, it is not that much lower than the transient rate and it comes with a lot of ancillary spend upwards of $800 plus per group room night. And so it’s very profitable business.

And so part of the ramp up and the maturation of these hotels is getting that right group base in there, getting that ancillary spend that then will significantly impact the profitability and then allow also to be able to compress transient rates and keep the transient rates as high as they are. And your point on the $2,000 a night, the rate is definitely higher than where we thought it would be at this time, but we expect that to hold as we go into next year, when we look at our…

[Smedes Rose, Citi]

Bryan, can I just interrupt you just for one second? I’m sorry. I just – because I know you probably have a lot of questions and I know we’re trying to be limited to one. But I mean, I guess my question really is, it’s a $440 million investment. What do you think these things do kind of at peak? I mean, do they ramp to the $45 million, $50 million range? Is that a reasonable expectation on the returns sort of cash on cash returns? And what do you think the timeframe to get there is if that’s a reasonable fit sort of all longer [indiscernible]?

[Bryan Giglia, Chief Executive Officer]

Yes. I mean, when we acquired – we acquired these hotels, our expectation was that they would get to a 6% to 7% NOI yield on our investment. That timeframe, knowing that this type of hotel takes a little bit longer to ramp up was the kind of 2025, 2026 timeframe. It’s also when you look at this type of asset, it’s also to understand and remember that luxury resorts like this hold their value much better and much more consistently than standard upper upscale hotels.

If you look at the transactions that have happened in this market, which are few and far between due to the fluctuations and especially in the debt markets, most of the transactions you’re seeing are luxury hotels. That’s because the luxury buyer tends to be better capitalized, less dependent on debt can see through near-term turbulence and are willing to pay a full price for very scarce assets.

And so when we look at our long-term cash on cash return to these hotels that hasn’t changed a bit. And our view on value is absolutely as strong or probably stronger than where it was when we originally acquired these hotels. Remember, these hotels were not open, they were ramping up. The Four Seasons has a winery associated with it. That is very important to the overall luxury guest experience. That’s something that we have the winery was always a question mark of profitability. We have that working towards breakeven – close to breakeven next year, which was – which is a major feat. And so what we have done is we have de-risked these assets and they are absolutely on their way to achieve the returns that we expected at acquisition.

[Operator]

Your next question comes from Duane Pfennigwerth from Evercore ISI. Please go ahead.

[Duane Pfennigwerth, Evercore ISI]

Hey, thanks. Just on the Confidante, can you remind us and I know you touched on it in the call, but just remind us your renovation timeline, when that’s expected to be complete. And what you would think about a 2023 EBITDA contribution relative to this year?

[Bryan Giglia, Chief Executive Officer]

Okay. Good morning, Duane. So when we acquired the Confidante, the plan was that there some renovation in non-guest facing areas would happen towards the end of this year, beginning of next year, but the majority of the actual repositioning would happen in the – in kind of the second half of next year after the high season. And for those that have done renovations and repositions in Miami, there’s the historic board you have to go through and some of the regulatory steps take a little bit.

And so that is something that we are working through now and major construction will start in the second half of next year. Our view on when we acquired it on displacement for next year was that – our expectations was that the hotel would basically breakeven during the – having some EBITDA come in the high season and then obviously as a hotel, the rooms and all the public space and pools are being renovated that there would be lost during that time period.

The hotel is performing very well this year. We’re able to grow rate or continue to grow rate even though the – some of the demand in the Miami market has softened the summer for some of the same reasons that we saw in wine country. But the hotel’s going to do $13 million to $14 million of EBITDA this year in its current condition. We will have next year – it will make money in the first half and then lose money in the second half. But given what it’s been able to achieve so far, we are very excited about this repositioning and we expect it to be able to hit all of our expectations once the debuts is beyond us.

[Operator]

Your next question comes from Michael Bellisario from Baird. Please go ahead.

[Michael Bellisario, Baird]

Thanks. Good morning.

[Bryan Giglia, Chief Executive Officer]

Good morning, Michael.

[Michael Bellisario, Baird]

On capital allocation, Bryan, could you maybe update us on your view of buybacks versus acquisitions and what you’re seeing today and then just also how you think about the pace and cadence of buybacks, your stock price was lower, you still bought back stock, but you bought a less amount in terms of dollars than you did earlier in the year. Any color around those topics would be helpful. Thank you.

[Bryan Giglia, Chief Executive Officer]

Sure. The way we look at capital allocation is kind of the same way we look at the portfolio we try to put together is we want to take a balanced approach. And when it comes to being able to successfully allocate capital and as we have done all year long, we look to – we look at internal capital investment, we’ll look at capital recycling and using some of the capacity on our balance sheet, and then we look at returning capital to our shareholders. And the trick is really the right balance between that and as our stock is lower, it obviously puts more emphasis on that return of capital through share repurchase. Capital investment is also tends to be some of our higher return alternatives.

And so when we look at the Westin conversion, when we look at the rooms renovation we did at Hyatt, San Francisco and adding the pool in Wailea those are good return projects. And so when we look at our liquidity and while we have ample debt capacity, we do want to – we want to make sure we’re mindful of our liquidity in the near-term and make sure that we have enough liquidity available to not only repurchase shares, but then to also take advantage of opportunities. And given the current debt markets, with CMBS loans that come maturing over the next couple years, we have seen some deals either fall out of contract we’re starting to see things come back to market.

And so it does appear that in the near to medium-term that we may see some interesting acquisition opportunities and having the capital and liquidity available to do that is something that we want to balance also. When it comes to share repurchase and dividend – return of capital through dividends, I think we’ve been very active relative to our market cap size all year. It’s something that we think is an important way to return capital and it’s something that we will continue to look to do. But there will be a – we’ll have to balance it with the other options. But as you’ve seen and as we’ve demonstrated it’s something that we look to continue to do if the investment is attractive.

[Operator]

Your next question comes from David Katz from Jefferies. Please go ahead.

[David Katz, Jefferies]

Hi. Afternoon everyone or good morning, depending where you’re sitting. So I just wanted to look at the leverage and think about whether capital returns are a way that you would sort of raise that leverage. In other words, would you buy back stock or return capital as an activity or as a means to getting leverage up into more of the target range?

[Bryan Giglia, Chief Executive Officer]

Yes. Well, I mean, it’s a good question and it’s a – let’s start with leverage. And leverage, we have some hotels ramping up and we have a hotel that’s going to be repositioned. But if you look at it on a somewhat normalized basis, I think we’re sitting at, call it 3.5x debt plus preferred to EBITDA, which is given where we are cyclically and given that we are still – many of our hotels are still behind occupancy in 2019. And a lot of our – we expect to have good growth in especially in Q1 of next year as we – as our big group hotels are compared against the Omicron impact of Q1 of this year.

3.5x is ample leverage to give a lot of capacity and optionality that’s higher than where it was a year ago where we did use our balance sheet to acquire assets. We recycled the Chicago assets, but then also used some of our balance sheet capacity and cash on hand to make our acquisitions of Confidante and the 25% of the Hilton San Diego, which sometimes gets lost in the shuffle. But was a – had debt associated with it and was a leveraging acquisition.

But also at given where that hotel is performing at sub 12x this year EBITDA multiples was a fantastic acquisition. So we’ve already started down the path and we said we were going to do this of using – bringing our balance sheet back into an appropriate leverage level. So as we look forward and as we allocate capital going forward where share repurchase has and will continue to be one of the very attractive options out there that will absolutely come with additional leverage, because that’s the only way it will be done even if we’re recycling assets, it would result in more leverage.

So that’s the plan. It has been the plan, it’s been what we’re executing on. And so, as we said before, we’re not going to be the highest lever to the group, but we also don’t think we’re going to be the lowest levered anymore either. And so that gives us capacity to allocate it through share repurchase, through acquisitions, through investment in our own portfolio.

[Operator]

Your next question comes from Anthony Powell from Barclays. Please go ahead.

[Anthony Powell, Barclays]

Hi. Good Morning. I got a question along these lines on – good morning, on dispositions looking at the portfolio, I think at least two hotels look like they stick out as potential disposition candidates. Are those in the plans to maybe sell and could you recycle that into additional buybacks or acquisition activity?

[Bryan Giglia, Chief Executive Officer]

When you look at our portfolio and the question is, do you need to – is there more to sell? I would say that the portfolio and granted we’re at 15 hotels now is a pretty solid portfolio. And if you go down the list in than the bottom of our portfolio are still pretty, pretty attractive hotels. So what I would say at this point is we’ve done the cleaning up of the portfolio, we exited the markets that we absolutely wanted to be out of. And going forward, everything is opportunistic. When it comes to selling an asset, we’ll look at disposing of an asset if we think that the assets life cycle or our investment life cycle in that asset has come to an end.

So, any asset in our portfolio, if there is investment or something we think we can continue to do to it, where our return on invested capital should grow in the future than looking at our portfolio now than any asset that meets that criteria probably has a place in the asset at least for the medium-term. When we look to dispose of an asset, we’re going to – first of all, it could be any asset in the portfolio and it would meet the criteria of one, either there could be a higher, better use. Someone is willing to pay a very aggressive price for it and we can find better growth by redeploying that capital elsewhere.

But as far as – are there things left on the bottom that need to go? Absolutely not. This is a fantastic portfolio. It provides us a lot of optionality and everything going forward will be purely opportunistic.

[Operator]

Your next question comes from Gregory Miller from Truist Securities. Please go ahead.

[Gregory Miller, Truist Securities]

Hi. Thanks. Good morning. I’d also like to – I like to focus similarly to Smedes’ question on the Napa assets. And I was looking at the margins of the two properties between 2Q and 3Q. The Montage Hotel margins fell about 500 bps and the Four Seasons fell about 1,400 bps from my read. So I’m just curious if there’s anything specific that happened at the Four Seasons in 3Q that that might provide greater insights for us from a modeling perspective or any unusual one-time events? Or maybe more broadly if the margins for the Four Seasons in 3Q were similar to your expectations? Thanks.

[Bryan Giglia, Chief Executive Officer]

When you look at these hotels, I mean, first of all, these hotels have high fixed costs. And the bottom line for the third quarter was that after a year or two, two-plus years of not having the option to travel internationally, a lot of our transient guests traveled and going to Europe is not something that people do every single year. And so there, while we saw pent-up demand in Q3 of last year, some of that pent-up demand worked its way out and left the market this quarter. That's fine, and I mean, that's not obviously what we would – we wanted, but it's understandable.

As we look going forward and we look at these hotels and their profitability, that's why the group business that they have added and are adding for the back half of this year, but really into next year is so important because it brings – it brings that guest in. It brings the guest in at a very attractive rate with a lot of extra ancillary spend, which is needed in a hotel like this to have the margins that that we expect. And when that occupancy falls off because of the fixed cost you're going to see margin fluctuations more than you would in a full service or limited service hotel.

It's just the nature of this type of asset, and so you'll see some more swings like this up and down, but at the end of the day, our view on the trajectory of this asset is the same. And our view on value and as we've seen in trades – recent trades is that this type of asset is highly desirable and the value of it does not fluctuate like you're running the mill upper upscale asset does.

[Operator]

Your next question comes from Floris van Dijkum from Compass Point. Please go ahead.

[Floris van Dijkum, Compass Point]

Thanks guys for taking my question.

[Bryan Giglia, Chief Executive Officer]

Good morning, Floris.

[Floris van Dijkum, Compass Point]

Good morning. I promise you I won't – I won't ask the question on the – on your luxury or your ultra luxury hotels. But I had a question on your balance sheet and more specifically on your floating rate exposure. You have some of the highest floating rate exposure, I think in certainly in my hotel coverage universe. Maybe Aaron, if you could comment a little bit on your 57% floating rate exposure, how that could trend as the fed keeps raising the bar, if you will, and also what your – sort of your debt plans could be for the, I mean, you mentioned you said you're going to address your mortgage on the San Diego Hilton. But how you're thinking about potentially reducing some of that exposure to floating rate going forward or if there are caps in place?

[Bryan Giglia, Chief Executive Officer]

Sure. Floris, thanks for the question. Yes, so you're right. So as of the end of third quarter we had roughly $800 million of total debt of which 42% was fixed or had been swapped to fixing the balance 58% or so was floating. Our floating rate loans have benefited over the last two years from a rather attractive interest rate environment. And the mortgage that you're referring to on Bayfront was effectively 1.3% debt for a number of years. So as we move into the backdrop of rising rates we're going to see and everyone else who has any degree of floating rate exposure is going to say in just expense move up here for a period.

[Aaron Reyes, Chief Financial Officer]

Yes. As Bryan mentioned, we have overall a rather conservative leverage profile. So overall while we do have the 58% floating rate exposure, it's on a much lower overall debt load than – than you might see in other spots across the sector. So I think overall we're pretty, I think, well positioned to deal with the rising rate environment. As of the end of the quarter we were call out as Bryan mentioned, all in 3.5-ish or so times lever. So it's a rather conservative balance sheet. And based on where the trajectory, I think of where interests are at now and where they're expected to be over the next couple quarters. I don't think it's already viewed at the right time to try and do any kind of broad scale hedging in terms of locking in anything now.

So we'll keep our eye out over the coming months to see how rates transpire and there might be a window to lock in some incremental portions of our interest rate exposure and maybe hedge some of that that way. But just if you just look at the overall interest – our overall leverage level and our weighted average interest of call it in the low-4s and you think about where our preferred are at, I think our balance sheet actually is actually – is actually pretty well positioned to withstand some – the rising rate environment. So we'll keep our real see if it makes sense to add some incremental swaps here and there but it'll just time will tell.

[Floris van Dijkum, Compass Point]

Yes. And like Aaron said, it's something that we can do gradually. We can – we don't have to swap out the entire amount of a term loan. We can do it in both in term and dollar amount. We can do it in increments over time. So it's something that we're looking at now and as Aaron said too it, with our leverage where it is, if we were 5, 6 times levered we would probably be looking at things differently. But that's why you have a balance sheet like we have. It provides optionality and flexibility.

[Operator]

[Operator Instructions] Your next question comes from Daniel Adam from J.P. Morgan. Please go ahead.

[Daniel Adam, J.P. Morgan]

Hi, thanks for taking the question. I'm curious if you think non-room related strength can be sustained next year given what will likely be a much weaker macro environment? Thanks.

[Bryan Giglia, Chief Executive Officer]

It's a good question. When we look at our group strength and the out room spend this year, we actually feel very good about it next year because when we look at some of our hotels, let's take Wailea, for example. When we look at group business there and you have strong transient demand, that's a hotel where as this year has gone on and as we get into next year, we're becoming more and more selective with the type of group. So we're taking a better quality group there that has a better spend. We're seeing the same thing in Orlando, in San Diego and so while we have in some of the hotels that have a little bit more capacity, it'll be a combination of bringing in additional groups with that spend.

But in other hotels it's really being very selective in making sure that you are getting the type of groups that you want that that are spending more. And then when you look at the composition of the spend this year, it's still – we're still growing that group base. And that group base is still well below where we were in 2019, and there's a lot of room to grow. That is – that's something that will help us continue to bring in more of those – that group business.

[Operator]

There are no further questions at this time. I will turn the call back over to Bryan Giglia, the CEO for closing remarks.

[Bryan Giglia, Chief Executive Officer]

Great. Well thank you everyone for the interest and support in the company, and we look forward to seeing you at Nareit and the upcoming conferences. Have a good day.

[Operator]

This concludes today's conference call. You may now disconnect. Thank you.