Boutique Hotels In Opportunity Zones, With David Kessler

The hospitality industry has been one of the most watched trends in recent years, with boutique hotels at the forefront of the ever-evolving hospitality business. Smaller, less commercial hotels offer the safety and personalized service travelers seek in a post-pandemic world. Coupled with an Opportunity Zone incentive, investors are taking notice – and the result is as exciting as it is unique.

David Kessler, founder and CEO of Sandstone Partners, shares his experiences in the boutique hotel industry, specific to projects in OZ communities. David has over 19 years of real estate investment and development experience. Sandstone Partners targets underperforming mixed-use, hospitality, and multifamily properties executing business plans ranging from value-add to ground-up development.

Click the play button above to listen to our conversation with David.

Episode Highlights

  • Current state of the hospitality industry and what it means for aspiring investors in this field.
  • How boutique hotel developments can stimulate the local economy and create positive social impact in Opportunity Zone communities.
  • Trends in the hospitality industry and an expert’s outlook on the new frontier of boutique hotels.
  • Strategies hotel investors can leverage to ensure their success in a post-pandemic world.

Featured On This Episode

Industry Spotlight: Sandstone Partners

Sandstone Partners targets underperforming mixed-use, hospitality, and multifamily properties executing business plans ranging from value-add to ground-up development.

Learn More About Sandstone Partners

About The Opportunity Zones Podcast

Hosted by OpportunityDb.com founder Jimmy Atkinson, The Opportunity Zones Podcast features guest interviews from fund managers, advisors, policymakers, tax professionals, and other foremost experts in opportunity zones.

Show Transcript

Jimmy: Welcome to The Opportunity Zones Podcast. I’m your host, Jimmy Atkinson. Joining me on the show today is David Kessler, founder of Sandstone Partners. David joins us today from Hudson, New York. David, welcome to the show.

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David: Hi, thank you so much for having me.

Jimmy: Yeah. Great to be with you, David. You and I met at the Novogradac conference last fall in Cleveland, Ohio. Great to reconnect with you today. You have a historic mansion that you’ve acquired in Hudson, New York in an Opportunity Zone. You’re redeveloping that historic mansion into a boutique hotel.

I wanna get to that project in a second. But first, just to kind of zoom out and give us the lay of the land, two-part question for you, David, to open up today. One, how would you characterize the state of the hospitality industry overall? And then second part of that question is, how does that larger hospitality industry compare to the state of the boutique hotel industry, specifically in drive-to leisure markets such as Hudson?

David: Absolutely. You know, the hospitality market at large in the United States, and globally for that matter, has suffered tremendously during the past two years, during the pandemic. And yes, it’s starting to come back slowly, but it’s taking a lot of time. But if you look at independent boutique hotels under 100 rooms in drive-to leisure markets within 2 hours of major gateway cities, it’s those hotels that have actually performed quite well despite the pandemic.

In fact, all the hotels here in Hudson are charging higher rates now than they did pre-pandemic and they’re more occupied. So if you look at drive-to leisure markets near major cities, so, for example, Palm Springs is about two hours from Los Angeles, if you look at Asheville, North Carolina, which is a couple of hours from Atlanta, and, of course, Hudson, which is my neck of the woods, which is about two hours from Midtown Manhattan via car or train and two and a half hours from Boston, it’s these markets that have performed quite well the past couple of years.

Jimmy: And that makes sense, right? People are leaving more congested cities, want a little bit more space in this time of social distancing, maybe wanna escape some of the stricter measures that are being enacted by the local governments in New York City and Los Angeles and elsewhere, and just relax a little bit more in a place like Palm Springs or Asheville or Hudson. So tell us now about your project…

David: Exactly. In fact, I mean, Hudson has had the most net in-migration, The New York Times just reported this past fall that the town of Hudson has had more net in-migration of anywhere in the country. That is more people have moved to Hudson during the pandemic of anywhere. And if you look at the percentage increase of the number of people that changed their permanent address from Manhattan to Hudson last year, it was over 210% increase from the prior year.

Jimmy: Yeah. The pandemic certainly had quite a lot to do with that, I’m sure. And the government’s response to it to make life a little bit more difficult to living in a big, densely populated city like New York. So tell us a little bit…give us a little bit of the lay of the land in terms of demographic changes that Hudson is undergoing, all very favorable. Tell us now about your project in Hudson, the boutique hotel that you’re building and what makes it unique.

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David: Absolutely. It will be the only professionally managed independent boutique hotel in the city of Hudson. It’ll be four stars. It will have extensive amenities and over 55 keys. And we will have a library, a restaurant, a bar with a speakeasy entrance under the porch of the historic mansion, 2 event spaces where one could hold events as small as 10 people or as large as 200 people for a cocktail-style event.

We’ll have an outdoor spa facilities as well. We’re catering to three distinct customer segments. And we made a lot of design decisions around that to cater to those segments. So we’re catering to the leisure market, the wedding market, and the corporate off-site retreat and partner meeting market. And we made a lot of design decisions around that to cater to those markets effectively.

So let’s take the leisure market, for example. One of the things that we found was Hudson is far less seasonal than other drive-to leisure markets in the Northeast. So if you look at markets like the Hamptons, or Cape Cod, or Newport, Rhode Island, or even the Berkshires, which is 25 minutes away, they’re all far more seasonal than Hudson, and that’s in part due to the Amtrak train.

But one of the things that we did find was, yes, January, February are a bit slower than the rest of the year. So one of the things that we’re doing is we are going to sell packages to Manhattan knights that like to go snow skiing, but don’t own a car. What are their options? Right now, they can rent a car and drive to Hunter or Windham or Vermont, but Hudson’s a much more interesting town than any of those.

And you can get here via Amtrak direct from Penn Station in only two hours on the train. So you don’t need to rent a car. So we’ll sell packages that include round trip transportation to and from the mountain, which is only 25 minutes away, ski lift ticket and rental included. And we’ll have an outdoor sauna, Jacuzzi, and fire pit year-round, with a restaurant and bar and a library and 55 rooms.

So we think that, you know, selling these ski packages, we’ll be busy. It will drive that January, February traffic. One of the things that we also found was that Tuesdays and Wednesdays are slower than the rest of the year. So to solve for that, we are gonna do one to two corporate off-site retreats and partner meetings a year.

I started my career at Ernst & Young over 20 years ago in their real estate advisory services practice, doing due diligence, underwriting, and valuation work. And we had 40 partners nationally that got together quarterly for a partner meeting. There’s no reason why that can’t happen here, given our proximity to New York City and Boston, and how much there is to do in this immediate area when you’re not in your meetings.

So we think with the professional sales and marketing team, and, like I say, over 55 rooms and extensive amenities, we’ll be able to drive that business. And we intend to do one to two corporate off-site retreats a month midweek.

And then the third customer segment that we’re catering to is the wedding customers. In 2019, there was over 200 destination weddings that happened here a year. There’s over 16 wedding venues within a 12-mile radius, yet there’s only 204 rooms in hotels, motels, bed and breakfast, and inns in this area.

So there’s nowhere for these people to stay. There’s nowhere for them to hold their rehearsal dinners and their brunches after the wedding. There’s plenty of places to get married. Over 35,000 people came here in 2019 just to attend a wedding. And so we wanna really cater to that business effectively and we’ll have the spaces to hold the rehearsal dinners, the wedding, the brunches after, and we’ll have the 55 rooms that we can sell wedding blocks.

Jimmy: Yeah, very impressive. A lot of different customer segments you can go after there. Sounds like a pretty substantial market for the hotel, an area that’s currently undersupplied. Let me get a little bit of background on you, David, and on Sandstone Partners. When did you found Sandstone Partners and what are your future plans beyond this first hotel project you’re working on?

David: Absolutely. I have been in real estate for the past 20 years. Most recently, I was the president of Blesso Properties, where I was brought on board to grow the company from doing small walk-up conversions in Manhattan to doing larger ground-up development projects in Brooklyn. And while I was there, I assembled half a million-square-foot development site in Williamsburg, and we got the plans done, and got into a shovel-ready place, and ultimately decided to sell the shovel-ready site for a profit. And that’s when I went out on my own and founded Sandstone.

But also, while I was at Blesso, I oversaw two hospitality projects down in Panama. One was called Tantalo Hotel, which is a 10-room hotel with a rooftop bar and a restaurant. And the other is Teatro Amador, which was a historic theater that we redeveloped into a high-end restaurant and a nightclub. So I oversaw five hospitality operating businesses across two properties down in Panama.

And then prior to Blesso, I was the head of acquisitions and development at Waterbridge Capital for four years, where we closed over $1 billion in acquisitions during my four-year tenure. It was a very small shop, myself and my principal, and we were incredibly active. And one of the projects that I did while I was at Waterbridge is that I assembled the entire city block in Prime North Williamsburg, Brooklyn, that’s between North Third and North Fourth, between Bedford and Driggs.

And I bought that whole block from two sellers off-market and put the entire business plan together and redeveloped the entire block. And now it’s home to the first Apple Store in Brooklyn and a 70,000-square-foot hotel, as well as a 30,000-square-foot condo building across the street that we developed.

Prior to Waterbridge, I was the head of acquisitions for the Safra Family office. And again, I started my career at Ernst & Young in the real estate advisory services practice. I’m originally from Atlanta, Georgia. I went to University of Wisconsin where I studied real estate and marketing.

Jimmy: Quite a bit of experience under your belt overall.

David: Definitely. I mean, I’ve been in real estate since 2001, and I founded Sandstone in 2018. And I was looking for a project of a certain size and scale. I’ve always had an interest in adaptive reuse historic preservation, and I have a background in hospitality, and I was looking for a project that made financial sense. And I came up to Hudson in mid-’19…in the summer of ’19 for a weekend and tried to book a room a month out and couldn’t find one single room and ended up staying in a subpar Airbnb where I paid over $4.50 a night.

And I saw the demand and the lack of supply and started looking around for development opportunities here to build a hotel. And I uncovered the last real hotel development opportunity in the heart of town, literally one block from the main town square. And I purchased this 15,000-square-foot vacant mansion that was built in 1835. It’s been vacant since 2014, and it sits on a half an acre corner lot.

And we are adding a 20,000-square-foot addition, so we’re more than doubling the size of the building and redeveloping it into an independent boutique hotel that’ll be professionally managed with extensive amenities.

Jimmy: Yeah. Pretty impressive opportunity for what it’s worth coming from me. Now, you founded Sandstone Partners a few years ago, 2018. Was it your intention to become an Opportunity Zone developer, or does this Hudson property just happen to fall into an OZ for you? I’m curious, you know, how you…

David: The latter. I don’t believe the OZ nature. It just opens up…it doesn’t make a bad deal good. I wasn’t setting out to do a project in the Opportunity Zone. It just happened to be that it is within the Opportunity Zone. And again, I don’t believe that it makes a bad deal good. It just opens up potential investors for an opportunity that normally they wouldn’t necessarily consider.

Jimmy: Yeah. Agreed there. I think it definitely makes the equity raise a little bit more marketable, helps you find some different investors that might not have otherwise come to the table. You know, talk to me about that. What’s your financing like on this project? Tell me about your capital stack. What’s unique about the structure, and have you run into any challenges raising any equity?

David: Absolutely. The interesting thing is it’s a very conservative underwriting. The total project cost is $22 million, and I’m projecting stabilizing in 4 years’ time at an operating income of $2.7 million. So that means that our yield on cost stabilized, we’re building to a 12.2 yield on cost, which is incredibly unique given that I’m projecting exiting in 10 years time at an 8% exit cap rate.

So there’s 420 basis points of spread between what I’m stabilizing at and what I’m projecting exiting at. And by the way, I believe that exit cap rate to be conservative. But in terms of structure, so out of this $22 million total project cost, we are structuring it with a ground lease with a buyback option in lieu of a construction loan. It’s challenging to obtain a construction loan today for a project of this size for a hotel development, as of the pandemic, and as such, we started to explore creative alternative forms of capital.

And we uncovered one that’s very unique. We essentially would be bifurcating the land from the building, selling off the land, and entering into a 99-year ground lease with a buyback option anytime after 3 years. So essentially, this firm will be buying the land from us for approximately $10 million. We’ll be paying them 6% of that in ground rent per annum. And at any point in time after three years, we can buy back the land based on the ground where we’re paying in a 5.5% cap rate.

So that means that in year 4, I can buy back the land for $10.8 million. But with a net operating income of $2.7 million, we’ll be able to take out a permanent loan, buy back the land, and distribute the rest to equity. And essentially, if you do that and you add that amount to the net cash flow from operations during the first 4 years after ground rent and ground rent reserves, we’re effectively projecting over $15.6 million in partnership distributions during the first 4 years on a $13 million equity investment.

So it’ll be more than cashed out tax-free. And then if we hold it for 10 years and sell it at an 8% exit cap rate, we’re projecting 3.3 multiple and over a 20 IRR on a 10-year hold, which is incredibly unique.

Jimmy: Yeah. Not too shabby, I was gonna say. Did you look into getting historic tax credits? This is a historic building. You mentioned 1835.

David: Absolutely. We did. About a year ago, I hired a historic consultant. We met with Shippo in Albany, and ultimately they said, “Look, we love your project, but we can’t consider doing tax credit equity here. And the reason is that the addition that we’re building is 20,000 square feet and the historic building is only 50 square feet.” So they said, “Look, you need to reduce the addition to roughly a third of what you’re showing here and then come back to us.”

And then it would cause a year delay. We would have to go and get approval from Albany, as well as Washington, D.C. And we still don’t know how much tax credit equity we would be able to get. But ultimately, we would end up with a 20,000-square-foot building instead of a 35,000-square-foot building. And we would end up with under 30 rooms instead of 55.

And we abandoned it as such because, you know, with 20-something rooms, we can’t cater to the wedding customer segment and the corporate off-site retreat and partner meeting customer segments effectively. And also, we believe that the universe of potential buyers 10 years from now for a 55-key hotel is much larger than the universe of buyers for a 25 to 30-key hotel. And it’s much more challenging to find a professional hotel operator that would manage a hotel that’s under 30 rooms.

Jimmy: Yeah, that makes sense. The juice wasn’t worth the squeeze there. It would’ve dramatically reduced the scope of the project. So what about the operation of the hotel? Who’s going to be operating the hotel once you’re up and running?

David: Sure. We went through an extensive search of potential operators and we identified one that specializes in independent boutique hotels in drive-to leisure markets in the Northeast, and they have about a half a dozen hotels operational right now. They just opened 1 hotel about 45 minutes south of us in May of 2021. And they’re averaging over $450 a night in ADR there.

And just as a frame of reference, we’re projecting $390 in ADR 4 years from now. So $60 less than what they’re getting today. And I would argue that Hudson is a much more mature market than Kingston, which is where that hotel is located. And our location within Hudson is stronger than their location within Kingston. The company is called Salt Hotels and the CEO of which used to be the right-hand man to André Balazs, a household name in the independent boutique lodging space.

Jimmy: And we mentioned this is an Opportunity Zone, of course, given the podcast that you’re on here. In theory, that’s been helpful for you in terms of raising equity, opens up some more investors or different class investor to this project. Have you run into any challenges with raising equity for this though?

David: Of course, I mean, raising equity for a hotel during a global pandemic is challenging despite what I spoke to earlier, which is that the market here in Hudson is on fire. But despite that, people are skittish about even evaluating a hotel in this market, you know, given current market conditions, despite where that hotel is located.

And one of challenges that I’m facing, I would say the biggest challenge, is the project size. It’s a bit small for institutional investors yet a bit too large for friends and family investors. However, it’s an incredibly unique opportunity. Hudson is very much undersupplied. So in 2019, we had over 200,000 tourists that came here a year, over 200 destination weddings a year, and the fourth busiest Amtrak station in the state of New York, yet there’s only 204 rooms in hotels, motels, bed and breakfast, and inns in the entire market.

And this is an incredibly unique opportunity. And I moved up here for the project. And as such, I was able to get all the entitlements in place, but I quickly realized that why is this market so under-hoteled, and it’s, in part, due to the challenges in getting the entitlements here in Hudson. And if I was still living in Brooklyn or if I was an out-of-town developer, I would be sitting here two and a half years later within an entitled site. But I moved up here and [inaudible 00:19:34] myself in the community, and I was able to get all the approvals.

And one of the things that makes Hudson unique is it’s an incredibly quaint and charming town and there’s an anti-franchise law. So you won’t see a Hilton, or Hyatt, or a Starbucks in town. And I think that’s one of the things that makes it incredibly unique, but it also limits the development.

You can’t build a massive branded hotel, not that you would want to. I don’t think that the customers that come here are seeking that. They’re seeking the kind of product that we’re creating.

Jimmy: That’s why they go there is for that charm and maybe escape from the more traditional hotel flags and other corporate brands that you might see in a big city. What about…it’s an Opportunity Zone project. I wanna talk with you about, you know, the spirit and letter of the legislation, which was meant to catalyze economic growth in these underserved areas.

You know, you mentioned you’re probably doing this project regardless of whether or not it’s in an Opportunity Zone, but the fact that it is in an Opportunity Zone gives you more access to capital. Maybe you get the project done a little bit sooner, stimulates the economy a little bit sooner. What type of job numbers are you creating? What type of economic growth are you bringing to Hudson?

David: So I pitched this to the Hudson Industrial Development Agency, and as such, I was able to obtain a tax abatement. It’s called a PILOT, P-I-L-O-T, which stands for Payment in Lieu of Taxes. And I was able to get that approved. And this was the first PILOT that the Hudson Industrial Development Agency ever approved. And essentially, it’s added over a million [inaudible 00:21:05] in value to the site.

I essentially went to the city and said, “Look, we’re generating significant sales tax revenue, lodging tax revenue, and parking revenue for the city. And in exchange for…you know, we’re creating 30 to 40 new full-time jobs at a minimum. And we’ll commit to hiring half of those jobs from people who live within the city limits, that is the city of Hudson, which is a 2-square-mile area with only 7,000 people. So we’ll commit to higher half of those 30 new full-time jobs from people who live within Hudson in exchange for this PILOT.

So we negotiated that with the city, and as such, we know what our real estate taxes will be for the next 11 years. And essentially, they stay flat at what we’re paying currently, which is $41,000 a year from now until we start construction. And then it continues to remain flat for the next three years following construction. And then it grows according to a schedule that we negotiated from there.

So it allows us to really know what our taxes will be and know that it is less than what it would be had we not obtained the tax abatement. And we also get to abate any and all mortgage recording taxes, as well as sales taxes on construction materials. And, you know, I’d like to hire all of those 30 full-time jobs from people who live within the city of Hudson, but we’re committing to a minimum of 14.

Jimmy: Very good. Well, it’s an impressive opportunity and doing a lot of good there in the area as well it sounds like. David, it’s been a pleasure to speak with you today, catching up, and learning more about the boutique hotel industry and your project, specifically in Hudson, New York. Before I let you go, can you tell our listeners where they can go to learn more about you and Sandstone Partners and this unique opportunity?

David: Absolutely. Please feel free to email me at [email protected] That’s [email protected], or give me a call at 917-679-6000.

Jimmy: Fantastic. That’s [email protected] And for our listeners out there today, I will, as always, have show notes for today’s episode on the Opportunity Zones Database website. You can find those show notes at opportunitydb.com/podcast, and there you’ll find links to all of the resources that David and I discussed on today’s show. And I’ll be sure to post his email address and his phone number on there as well. David… Yeah, go ahead.

David: If you don’t mind, I have a two-minute sizzle video that shows the building and the plans and outlines of the business plans. Maybe you could post the link to that video as well.

Jimmy: I absolutely will post the link to that video as well. That’s a great idea. I’m glad you mentioned that, David. Of course, yeah, go to opportunitydb.com/podcast to check all that out. David, it’s been a pleasure. Thanks for joining me today.

David: Thank you.