Raising capital for hotel investments has never been easy, but today it’s become an exercise in patience, persuasion and proof of performance. With distribution activity dropping and valuations under question, limited partners (LPs) are tightening their standards, slowing their commitments and demanding more say in how deals are structured. The result? General partners (GPs) have to adapt.
“There’s just less capital to deploy because the investors are not receiving that capital back,” says Angela Johnson, managing partner at Noble Investment Group. “Distribution activity is down 74 per cent, yet capital call activity is up 20 per cent to 30 per cent – in some cases, 40 per cent.”
That math isn’t sustainable, and LPs know it. Many are pausing new allocations or pushing for governance-heavy structures that give them more control over timing, terms and exit decisions. Meanwhile, GPs are being forced to justify their strategy and, in some cases, their role.
“I think LPs are starting to realize in this market where they had a good sponsor and where they need to look for a new sponsor, and we're seeing a lot of that,” says Zahara Kassam, managing director of FTI Consulting.
The pressure is real, and hospitality investors are caught in the middle. Those who understand the shifting expectations between capital providers and capital users may still find room to get deals done, albeit likely without the easy commitments and assumed alignment of yesteryear.
Today’s reality is pragmatic. It requires transparency, customization and often a willingness to let the LP take the driver’s seat. That’s something GPs aren’t always eager – or prepared – to do.
Why distributions matter more than IRR right now
Limited partners commit capital based on projected returns…in theory. In practice, they’re motivated by something far more tangible: how fast that money is returned to their pockets. Unfortunately, that capital replenishment is happening far slower than they’d like.
The result, Johnson notes, is a “structural issue.” One where LPs are being asked to fund new investments without realizing returns on their existing commitments.
This has created hesitation, particularly among institutional investors who face pressure to report gains, rebalance portfolios or simply meet liquidity targets.
It’s also redefined what LPs look for in a partner. For many, the theoretical appeal of a 20 per cent internal rate of return (IRR) isn’t enough anymore – not if distributions are delayed or nonexistent, anyway. The focus now is on what’s real: what a GP has returned, what they can return and how well they’ve handled the market as it is, not as they hoped it would be.
Some are turning to credit or preferred equity as a strategy to generate faster returns without taking on the full weight of owning the property.
“The risk-reward is just very attractive,” Johnson adds.
She points to preferred equity or first-loss positions on CMBS SASB loans, especially among groups re-entering the U.S. from Asia, as appealing options.
“That’s pretty attractive at a double-digit, levered return,” she continues.
It’s a telling shift, one that moves away from long-term equity plays and toward structures that return investors’ money sooner.
LPs push for more control
The more-selective nature of LPs isn’t simply changing where they invest. It’s changing the terms under which they invest. That often means demanding greater governance rights, more asset performance transparency and decision-making power that previously belonged to the general partner.
It sounds like a lot of control because it is. But when that control isn’t baked in, tensions tend to rise.
“You have very contentious ELPAC meetings that are underway right now, and that's when you figure out who has alignment with the GP versus not,” Johnson says. “So, it's figuring out how to create that alignment on the front end.”
For some LPs, that alignment comes in the form of customized structures that can give them direct authority over exit timing and strategy. Others are opting out of traditional funds in favor of direct investments, which give them more control and fewer partners to navigate.
But who controls the sale is only one piece of the puzzle. There’s also the what, why, how and when, all of which can lead to – you guessed it – more tension. Kasam notes that LP priorities can also vary dramatically, especially across regions or political environments.
“What might make the most sense for all the parties economically is not always the final solution,” she says.
That disconnect is forcing GPs to reconsider how they position themselves to investors.
“There are a whole lot of funds that want to invest in hotels,” says Tim Hodes, principal at Wheelock Street Capital. “But what makes your platform different and unique?”
Hodes believes that a 20 per cent IRR is “sort of a fallacy” nowadays, at least given the cost of capital, lack of growth and embedded cost structures in hotels. Instead of making pie-in-the-sky promises, he advises aiming for value-add or opportunistic returns into the teens.
“That’s the strategy that makes sense in today's environment,” he adds. “It’s what folks are looking for.”
Getting LPs to say yes
It’s clear that GPs can’t rely on reputation or hypothetical upside to bring LPs to the table. Not when limited partners are taking a harder look at who they trust, what they’re promised and when they’ll see their money returned.
This puts the onus on GPs to demonstrate an understanding (and internalizing) of investors’ priorities, from liquidity and transparency, through operational credibility and even market dislocation. It should be no surprise, then, that today’s limited partners also want to hear downside protection.
“I think there's a lot to be learned from COVID,” Kassam says. “How do you structure around struggles [like COVID] when the management team is out of the money? How do you structure alignment so that LPs still have some hope of getting their money back?”
She notes that disputes are increasingly common when LPs don’t receive distributions, while management teams still collect significant fees. Issues like these are often rooted in existing agreements that both sides had accepted...until now.
“It’s something both parties need to be more aware of going forward,” she adds.
Today’s power struggles point to one truth – that this capital environment doesn’t reward passive relationships. Instead, proactivity, transparency and future-proofing (to whatever degree possible) reign supreme.
Yet, despite these struggles, the goal remains the same. Everyone wants to make money, and garner a reputation for doing so. The good news is the capital is still out there, when and if GPs can meet LPs where they are.
And in this environment, that place is somewhere between cautious optimism and rigorous accountability.