Building relationships

As RLJ Development's debut lodging fund nears completion, firm co-founders Robert L. Johnson and Thomas Baltimore Jr. spoke with PERE about the value of personal relationships, mitigating risk in hotel investment and how real estate is like cable television. By Aaron Lovell

Relationships are something Robert L. Johnson takes seriously. The entrepreneur and founder of Black Entertainment Television (BET), the first television channel aimed at African-Americans, approaches any business venture in much the same way, be it a cable television operation, a professional basketball team or a Residence Inn in Poughkeepsie, New York.

“It's based on building relationships,” Johnson says from the offices of The RLJ Companies, overlooking downtown Bethesda, Maryland.“And from relationships come opportunities. And if I feel the opportunities suit my interests and I can add value to the opportunity, nine times out of 10 I'll go for it.”

Several years back, Johnson's relationships almost put him at the helm of his own airline. As a board member of US Airways, which was contemplating a merger with United, he was in a unique position to pick up a number of routes being jettisoned for anti-competitive reasons.

“Fortunately—in one way of looking at it—the government didn't approve the merger so I didn't get into the airline business,” he says.

But the story illustrates Johnson's approach. Even before the US government scuttled the plans for the US Airways merger, a similar opportunity emerged in the hotel business thanks to Johnson's position on the board of Hilton.

Around 2000, the hotel chain was looking to divest a number of hotel properties; Stephen Bollenbach, chief executive officer at Hilton Hotels, asked if Johnson might be interested. Though he had never owned real estate on such a large scale, Johnson knew the lodging business from his time on the board.

Beyond that, he applied the same logic he uses when approaching any transaction: “I look at a deal and say, ‘Can I add value? Do I have strategic relationships that can help me in the value-add?’”

In this case, the answer to both questions was “yes.” Since acquiring the seven-hotel portfolio in 2000, Johnson has built the properties into RLJ Development, a real estate company with approximately 130 hotels and $3 billion in assets.

Of course, it was not the first time that Johnson has turned a relatively small asset into a much larger business. In 1979, he borrowed $15,000 to launch BET, an upstart, niche channel on the fledging medium known as cable television; in 2000, Johnson sold his network to media company Viacom for $3 billion.

Following the BET sale, Johnson was able to purchase the Charlotte Bobcats, a professional basketball team based in North Carolina. Johnson remained the chief executive of BET after the sale to Viacom; he left in 2005 to start The RLJ Companies, an umbrella group that includes a private equity fund, a bank, a hedge fund of funds, a financial services company called Rollover and a video gaming company, as well as the Bobcats. He's also looking at expanding into the movie business.

And much like BET—where Johnson teamed up with Liberty Media head John Malone—Johnson's new ventures incorporate blue-chip strategic partners: in the case of the lodging company, it's Hilton; for his hedge fund of funds, he has teamed up with Deutsche Bank Asset Management; and for his LBO activities, he is working with The Carlyle Group.

Because of his unique stature, Johnson is used to being “first.” He owned the first African-American cable channel, which was also the first African-American-owned company to be listed on the New York Stock Exchange. And he was the first African-American owner of a large US sports franchise.

Yet while his suite of companies represents another round of firsts in the financial arena, Johnson says strategy and returns are more important than his status as one of the country's preeminent African-American businessmen.

“It [isn't] because you were African-American,” Johnson says, referring to the process of attracting investors. “It's because you were good.”

Like all of his business lines, hotel investing was a logical step. He knew the business from his time on the board of Hilton; he knew people in the industry like J.W. “Bill” Marriott, Jr., the chairman and CEO of Marriott International, from living in Washington DC. He also points out there were no large-scale African-American owners in the hotel business, allowing Johnson “the added visibility of being first.”

“This is something I can gravitate to, because it has all the elements I like,” he thought. “It's a business I understand, I can add value, I can leverage strategic relationships and I can be first.”

“I knew this was where I wanted to be, because, to some extent, the stars had aligned,” Johnson concludes.

RLJ launched in late 2000 with the purchase of the seven Hilton hotels and $100 million of Johnson's own capital. To oversee and manage the new hotel assets, Johnson needed lodging talent. Thanks once again to his contacts at Hilton, he met Thomas Baltimore, Jr., a fast-rising executive with the company.

A native of nearby Silver Springs, Maryland, Baltimore studied at the University of Virginia as both an undergraduate and graduate student in business. After working as an auditor with Price Waterhouse, he left for a position with Marriott. There he held a number of senior posts, as well as positions at Host Marriott and Hilton.

“[Hilton] let me keep the day job and work nights and weekends with Bob to put this thing together,” Baltimore says. He eventually joined RLJ full-time as president when the firm began stalking deals outside the initial Hilton hotel portfolio—and analyzing whether to raise a stand-alone fund.

“It turns out it was a good time for him and a good time for me,” Johnson reminisces. “I said, ‘Let's do this and see where it leads. We could be pretty big in the space.’”

The firm's strategy was established with the first Hilton deal: To this day, RLJ continues to look for upscale, branded hotels in dense urban areas with limited service. It's a strategy Baltimore likes to call “heads and beds.”

“You end up having a pretty efficient box,” he says.

Baltimore says the niche offers revenue per available room that is comparable to full-service hotels in the same markets—but with a much leaner operating structure, generating a higher return on investment. Ross Bierkan, RLJ Development's executive vice president, adds that these types of hotels perform well in rising markets and are more resilient in falling ones.

Branding is another important part of the RLJ strategy. The firm has invested in hotels under brands by Marriott, including Courtyard and Residence lines, as well as Hilton, most notably the Garden Inn and Homewood Suites banners.

Bierkan adds that recognized brands are helpful in a downmarket. Or, as Baltimore often puts it, “No one is going to object to seeing a Courtyard by Marriott on an expense sheet.”

Geographically, RLJ looks at the 30 to 40 largest markets in the US, as high barriers to entry are an important part of its overall business plan. Baltimore mentions both coasts and Chicago as areas of interest, but the firm is not against doing deals in smaller regional markets.

“We try not to redline an entire market just because the macro doesn't look good,” Bierkan says.

As an example, RLJ purchased a hotel near the University of Alabama in Birmingham out of its first fund. Adjacent to the school's growing medical center, the hotel was in the middle of an urban area with a number of demand generators.

“It's really become the hotel of the hospital,” Baltimore says. “We've found there is value in small markets with the right brand and the right location.”

RLJ doesn't manage its hotels—something Bierkan says leads to relationships with a number of independent managers and increased deal flow. Rather the firm focuses on owning, underwriting and capitalizing the property, along with aggressive asset management. Baltimore says this means poring over mid-month forecasts and quarterly site visits—even monthly if a hotel is underperforming.

If the lodging business is closely linked to the business climate, as Baltimore maintains, the RLJ strategy could continue to pay off, particularly coming off the down years following the terrorist attacks of September 11, 2001.

“We think we're relatively early in the business cycle,” Baltimore says. “Some people have said, ‘[It's the] third inning.’ We think that's pretty reasonable.”

With a track record, strategy and dedicated team in place, RLJ began raising a private equity real estate fund in 2004. But when placement agents predicted a 14- to 18-month fundraising period, Johnson was taken aback. After all, he says, with access to his own capital, he saw little reason to tap institutional investors for more.

“If you expect me to spend the next 14 months going around and begging for money, I'm not going to do it,” he laughs. “We're going to raise the money in eight or nine months or else forget it.”

The firm was able to reach its capital goals in eight months, closing on $315 million in April 2005. While RLJ's track record of successful deal-by-deal transactions helped sell the fund to limited partners, Johnson reached out to a number of business contacts as well. Again, much of it came back to relationships.

Johnson recalls being at a Hilton board meeting when the hotel company approved a $20 million commitment to the RLJ fund. At the end of the meeting, John Myers, the chief executive of GE Investment and a fellow board member, came over and expressed interest in the vehicle. GE later became a limited partner.

Johnson's high profile in North Carolina as the owner of the Bobcats also led to a number of contacts at the state level. Perhaps it's no surprise that the North Carolina State Treasury also committed to the debut fund.

In addition to knowing Johnson and Baltimore through other ventures, investors can also take heart in the firm's ability to source, execute and exit deals. With an un-leveraged IRR “north of 11 percent” for its first year, the fund is already returning capital to investors and is currently around 78 percent deployed with another 6 percent of the capital committed. The fund could be fully invested by early fall.

Last year, RLJ purchased 19 hotels worth around $630 million— comprising a large chunk of the debut fund. Though it underwrote the properties for three- to five-year holds, the firm has already flipped one hotel and is currently marketing five others.

RLJ is looking to continue this strategy with a follow-up vehicle that is currently being raised. Much of that fund, however, will be tied up in a 100-hotel portfolio the firm is acquiring from White Lodging Services, a management company, for $1.7 billion.

Announced earlier this year, the firm will close on the transaction this summer. Baltimore describes the White portfolio as an “opportunistic” deal and one that was cinched thanks to a close relationship with the company— White has been managing RLJ's Hilton Garden Inn in downtown Chicago since 2002.

In terms of the hotels themselves, Baltimore says around 70 percent of the assets are in recovering markets and one-third are less than 3 years old. More than 90 percent of the properties, which are located throughout the US, are under the Hilton banner.

Such a large portfolio presented some challenges, not the least of which was the number of players involved: 99 of the hotels were tied up in 89 separate partnerships involving around eight different families from around the US.

“The art of keeping the coalition together was a unique challenge,” says Baltimore. “I'm glad we were able to navigate around that. It wasn't easy to wrestle this tiger to the ground.”

The White portfolio will represent around 90 percent of the next RLJ hotel fund—which has a target of $600 million—leaving some capital for opportunistic investments.

The firm should have little trouble finding new deals. Working with so many independent management companies, RLJ is able to source a number of transactions from different partners—more than half the deals from the first fund were sourced off-market.

It also helps to have Johnson's relationships. Bierkan says that Johnson's high profile attracts all manner of transactions. “He's a deal-flow magnet,” Bierkan says.

Ever looking toward the future, RLJ is thinking about expanding beyond hotels into other property types. As Johnson points out, the company is set up to take advantage of different relationships within the RLJ organization. And as Johnson has increased his profile in Charlotte after successfully acquiring the Bobcats, other opportunities have emerged.

Baltimore points out that the firm sees a number of urban infill deals and could eventually look into sectors like retail, office and residential. RLJ has already done some stand-alone deals with various municipalities, including an apartment project in Baltimore; the hotel in the convention center in Washington, DC; and a mixeduse facility in Norfolk, Virginia.

“We would certainly want to expand into other product types,” Baltimore says. “I think residential, office and retail are certainly in our future at some point.”

With Johnson's personal contacts and Baltimore's solid team of real estate professionals, moving into new property types should not be hard for RLJ Development. So far, the business acumen that allowed Johnson to turn an upstart cable channel into a household name, build a basketball franchise from the ground up and become a leader in African-American-owned financial services also seems to be a good fit in the world of private equity real estate.