PEB - NYSE

Greetings, and welcome to Pebblebrook Hotel Trust Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Raymond Martz, Co-President and Chief Financial Officer. Thank you. You may begin.

Thank you, Donna, and good morning, everyone. Welcome to our second quarter 2025 earnings call. Joining me today is Jon Bortz, our Chairman and Chief Executive Officer; and Tom Fisher, our Co-President and Chief Investment Officer. But before we start, I'd like to remind everyone that our remarks today are effective only as of today, July 30, 2025. Our comments may include forward- looking statements that are subject to various risks and uncertainties. Please refer to our SEC filings for a detailed discussion of these risk factors and visit the high end of our ranges for both adjusted EBITDA and adjusted FFO. Same-property hotel EBITDA totaled $115.8 million for the quarter, $1.8 million ahead of our midpoint. As anticipated, Los Angeles remained a modest drag on performance with a $2.2 million EBITDA headwind, which was about $700,000 more than we anticipated. Encouragingly, the rest of the portfolio more than offset the softness, reinforcing the strength and diversification of our portfolio. To better understand the underlying performance of the portfolio, if we adjust for the onetime real estate tax credits in last year's results and exclude Los Angeles, same-property hotel EBITDA increased by $2.5 million over the prior year quarter. And on a year-to-date basis, same-property hotel EBITDA is up $2.3 million. These adjusted figures more clearly reflect the continued recovery in our other markets and a meaningful ramp-up across our recently redeveloped hotels and resorts. One key trend that we're watching closely is the continued shortening of the booking window, especially for leisure travel. It's putting near-term pressure on leisure rates and reducing forward visibility in today's uncertain macroeconomic environment. That said, our teams have adapted quickly, capturing demand within shorter lead times. Despite these headwinds, our teams executed exceptionally well. Hotel level results were strong across most markets, more than offsetting the softness in L.A. and Washington, D.C. Adjusted EBITDA was $117 million, $6.5 million above our midpoint. Adjusted FFO came in $0.65 per share, $0.06 ahead of our midpoint. This outperformance reflects a combination of solid hotel EBITDA results, a strong $1.8 million beat from Newport Harbor Island Resort and $1.5 million more than expected in business interruption proceeds from the LaPlaya's insurance claims. Newport, which is excluded from our same-property results due to its closure for part of Q2 last year, outperformed expectations, fueled by strong business group and leisure demand and excellent flow-through across rooms and non-rooms revenues. We also received $3.2 million of BI income related to LaPlaya, $1.5 million above our outlook. Turning to hotel level performance. Total property -- same-property RevPAR grew by 1.3% year-over-year, led by a 1.7% increase in our urban portfolio and a 0.6% gain at our resorts. However, the strength of the broader portfolio is more apparent when we exclude Los Angeles, which continues to face a unique set of market-specific headwinds. Excluding L.A., same-property total RevPAR rose 2.7%, with our urban portfolio increasing a healthy 4.1%. These are encouraging results, particularly in light of reduced government travel, weaker international inbound demand and macroeconomic certainty stemming from ongoing policy and geopolitical disruptions. San Francisco led the portfolio once again this quarter with RevPAR climbing a robust 15.2%, fueled by an impressive 9-point increase in occupancy. The city's performance was supported by a stronger convention calendar, robust growth in business group and transient demand, particularly from the expanding tech and AI sectors and a continued push for return to office among the city's major employers. Momentum continues to build in San Francisco, and Jon will share more color on that shortly. Portland continued to recover with RevPAR climbing 10.4% as the market continues to rebound from its more prolonged COVID-related challenges. Gains were driven by increased business travel and a steady rise in demand from regional leisure travelers, again, evidenced by healthy gains in weekend occupancies. In San Diego, our urban hotels posted a RevPAR growth of 8.6%, fueled by a healthy convention calendar and strong weekday demand. Our recently redeveloped downtown properties continue to outperform, gain market share and deliver meaningful growth in both rate and occupancy. At our resorts, demand remained resilient. Total RevPAR increased 0.6% year-over-year as a 1-point occupancy gain and continued strength in out-of-room spending offset a nearly 3% decline in ADR. This gain underscores the resilience of leisure demand. Out-of-room revenues at our resorts rose 3.3%, led by a 2.5% growth in food and beverage revenues as guests continued to spend across our resort dining outlets, bars and event offerings. Same-property total revenues grew 1.3%, driven by a 1.7% increase at our urban properties. Excluding L.A., revenue growth rose 2.7%, supported by stronger event space utilization, elevated food and beverage performance and the benefit of upgraded amenities across our redeveloped properties. Total out of rooms revenues increased 2.6% overall and climbed 3.5%, excluding L.A., with food and beverage revenue up 3.3% year-over-year. Looking at our monthly trends, April was our strongest month with RevPAR increasing by 3.6%, benefiting from a favorable Easter shift and extended spring break season and a major San Francisco convention that moved into April this year from May last year. That timing benefit created a tougher comp for May, which was down 0.8% and June declined 0.6%. Excluding L.A., RevPAR was positive in all 3 months, up 5.5% in April, 0.7% in May and 0.6% in June. Group demand also remained strong with group room nights rising 1.9% and accounting for 27% of room revenue, up 100 basis points from last year. This reflects the continued resilience of the group segment and the early success of our multiyear strategic reinvestment program, particularly at our resort properties, where we've been focused on growing group-related business. On the expense side, our teams remain laser-focused and delivered another strong quarter of disciplined cost control, along with further productivity and efficiency improvements. Same-property hotel expenses, excluding fixed costs, rose just 1.7% year-over-year. And on a per occupied room basis, expenses declined by 0.8%, a very favorable result. Energy was a standout this quarter with costs down 2.1%. This was driven by reductions in energy and water usage following some focused efforts to optimize the efficiency of some of our hotel systems and equipment. These results reflect the relentless focus and innovative efforts of our hotel teams and asset managers. Our strategic productivity and efficiency program is driving meaningful operating improvements, enhancing guest satisfaction, profitability and long-term value. We're incredibly proud of the execution across the portfolio. Looking ahead, we're also embracing new technology as a lever for future efficiency gains. We've begun piloting a number of AI-enabled operating tools in collaboration with our hotel partners, which we believe will lead to increased productivity, reduced hotel operating expenses, improved hiring and retention and enhanced real- time decision-making. We believe these tools would have the potential to significantly reshape our operating model over time. Shifting now to LaPlaya in Naples, Florida. We're pleased to report that the resort is fully restored and operational following last year's hurricanes. We've increased our full year BI income forecast to $11.5 million, up from $8.5 million previously. We now expect LaPlaya to generate approximately $35.5 million in adjusted EBITDA this year, including both hotel EBITDA and BI income. This compares to $42.8 million in 2024, which included elevated BI collections following Hurricane Ian. As a reminder, BI income is excluded from our same-property hotel EBITDA but is included in adjusted EBITDA and FFO. Turning to insurance. We completed our property insurance renewal on June 1 with significantly better results than expected. We reduced our overall premium by roughly 10%, thanks to a 13% rate drop while increasing insurable values by 4% to reflect higher replacement costs, all without material changes to coverage or business terms. This favorable outcome lowers our near-term expense run rate and demonstrates the success of our proactive risk management strategies. On the capital front, we invested $21 million into the portfolio during the quarter, net of the key money received from Hyatt related to the Delfina Santa Monica rebranding and renovation. We remain on track to invest $65 million to $75 million this year, primarily focused on capital maintenance and targeted ROI projects. And finally, our balance sheet remains in great shape. We ended the second quarter with $267 million of cash on hand, an increase of $49 million from last quarter, and we have more than $640 million of availability on our unsecured revolver. Nearly all of our debt is unsecured, and we have no significant maturities until December 2026. Our weighted average interest cost is a very attractive 4.2%, among the lowest in the sector with 90% -- 96% of our debt now fixed. We continue to generate strong free cash flow in addition to our existing cash, and we intend to deploy the vast majority of it towards future debt paydowns, including the convertible notes. And with that, I'd like to turn the call over to Jon for a deeper dive into hotel operations, industry trends and expectations for the rest of the year. Jon?

Thanks, Ray. When we look at industry performance in the second quarter, we note that demand softened slightly from Q1. Both demand and RevPAR for the industry were negative in Q2 on a year-over-year basis. The decline was led by group, which was down in all 3 months versus last year, largely due to reduced government travel, weaker international participation in conventions and conferences and some increasing attrition. Transient demand held up better and while it was weaker for the same reasons, it remained positive versus 2024. I recognize that the group softness may surprise some of you, but the STR data clearly shows this trend over the last 3 months, and it has unfortunately continued into July. In terms of industry performance by price point or scale, there remains a sharp divide between the upper and lower ends of the market. Premium hotels and resorts continue to perform better, while the bottom half is seeing more weakness as lower-income consumers shift some of their spending toward necessities. In contrast, Pebblebrook outperformed the industry during the quarter. We successfully grew occupancy, including from group and delivered modest RevPAR growth even with the specific market challenges in Los Angeles. We attribute our outperformance to the strong recovery in several previously lagging markets like San Francisco, Portland and Chicago and the continued share gains at our redeveloped properties. While our San Francisco hotels led the way in our portfolio, our redeveloped hotels and resorts once again were leaders, including Newport Harbor Island Resort, Estancia and Southernmost Resort in Key West and several urban standouts like the 1 Hotel San Francisco, Hilton Gaslamp Quarter and Margaritaville San Diego Gaslamp Quarter. For our portfolio, we continue to see a recovery in business travel in both transient and group. Group room nights, group ADR and business transient rates all improved. Leisure demand also grew, though we saw increasing price competition due to much shorter booking windows. Still, weekend occupancies were up all across our portfolio, demonstrating the continued appeal of our high-quality properties, especially for leisure and social group customers. As mentioned, our results were even stronger, excluding Los Angeles, which faced another difficult quarter. The combination of a post-fire slowdown in business and transient demand and the often-exaggerated media coverage around the ice rates, which created the impression that the protests and damage were all over the city when, in fact, they were isolated to a few blocks in Downtown L.A., caused cancellations and a slowdown in bookings. The administration's military response only amplified the negative media coverage, creating an even broader misperception about safety in the market. Despite these short-term challenges, we remain confident in L.A.'s long-term outlook. It's a global gateway destination. It's the entertainment capital of the world, and it has big, beautiful beaches and great weather among many unique amenities. And we don't expect to see any meaningful new hotel supply for the next 5 to 10 years. We're encouraged by the new state legislation doubling film and television tax credits to $200 million to $750 million, which will help spur production activity, much of which should directly benefit Los Angeles. The city also passed legislation that makes it easier and cheaper to film in Los Angeles, and the President has talked about making Hollywood great again by bringing production back to the U.S., especially to L.A. Additional demand for L.A. will come from a loaded future calendar of events, starting with the NBA All-Star game in February and 8 World Cup matches next summer, then the Super Bowl in 2027 and finally, the Summer Olympics in 2028, including all the preparation generating demand in 2026 and 2027. Plus the rebuilding of thousands of homes in the 2 neighborhoods destroyed by the January fires should also generate incremental demand for the market well before the games begin. San Francisco, one of our previously slower to recover cities, demonstrated very strong performance in Q2 for the second quarter in a row and led all of our markets. RevPAR for our 7 hotels there rose a robust 15.2% with occupancy gains in the market from all segments. Business travel rose significantly from a better convention calendar and increases in transient and in-house group. Leisure demand also grew as leisure travelers return to the city. SF Travel is doing a great job bringing more concerts, sporting events and future conventions to the city, which is drawing increased business and leisure travel. We're also extremely encouraged by the new city leadership who are focused on improving safety, cleanliness and quality of life issues. San Francisco looks and feels great. It's rapidly getting busier and very positive momentum is clearly building each day. San Francisco has definitely turned and we're very excited. Portland and Chicago also made progress. Both cities are benefiting from cleaner, safer downtowns and are hosting more concerts and sporting events in their many venues, helping to successfully attract leisure back to the cities. Turning to performance at our redeveloped properties. Newport Harbor Island Resort led the way as it continued its strong ramp following the $50 million transformation completed last spring. The resort generated $5.1 million of EBITDA in Q2, which was $1.8 million above forecast. Revenues rose over 60% from Q2 last year and out-of-room revenues jumped 70%, making up 50% of the resorts revenue mix. This revenue shift demonstrates the benefits of the significant improvements and additions we made to the restaurants and bars as well as the dramatic enhancements we made to the number and quality of indoor and outdoor event venues. We now expect Newport to generate over $15 million of EBITDA in 2025, well ahead of the $13.6 million acquisition in mid-2022, which was a peak year for most resorts. We're very excited about Newport's future, and 2025 is just our first full year of post redevelopment operations. We believe the resort is positioned to generate even stronger performance over the next few years as it continues its ramp and benefits from increased group and leisure demand. And Newport is just one example. Across the board, our redeveloped hotels and resorts are gaining share and growing cash flow with most still having multiple years left until they stabilize. This includes Estancia, Chaminade, Southernmost, 1 Hotel San Francisco, Hilton Gaslamp, Margaritaville Gaslamp and Jekyll Island Club among others. There's more upside to come. Now shifting to operations. As Ray noted, we held same-property total expenses to just 1.7% growth after adjusting for last year's tax credits. Per occupied room expenses declined. That's a direct result of our team's relentless focus on improving every aspect of our cost structure and the benefits of our strategic productivity and efficiency program. We're working collaboratively with our operators to attack every expense category with targeted productivity and efficiency initiatives. This includes smarter labor scheduling through new technology and training, tighter procurement, appealing our tax assessments with almost 100 tax appeals underway and operational upgrades to reduce accidents and claims. We're also investing in physical improvements to mitigate weather-related damage, particularly at properties like LaPlaya. On the technology front, we're piloting AI and automation tools aimed at improving hiring, retention, service delivery and overall productivity across the portfolio. The pace of AI and robotics innovation is accelerating rapidly, and we're working closely with Curator to identify and implement the most impactful solutions. We believe the operating model for hotels will look quite different in a few years, and we intend to be ahead of that curve. We're still in the early innings of new technology that reduces energy and water usage. We're applying the findings from our engineering audits and rolling out new systems, including solar and HVA upgrades where the ROI justifies the investment. On top of that, we're actively pressing the major brands to pass through savings through their economies of scale and from the rollout of their own AI tools and centralized services. We believe these will evolve meaningfully over the next few years, ultimately resulting in additional cost reductions for owners. We're also clustering more operating teams where it makes sense to reduce costs and improve our property leadership teams. We're leaving no stone unturned. We're in the early stages of what we see as a transformational shift in hotel operations, and we intend to lead that evolution. Our teams deserve tremendous credit. Their creativity, discipline and relentless execution are driving positive results and positioning us for even greater success going forward. Now let's shift to the third quarter and the macro outlook. We remain cautious about the macroeconomic outlook given the continuing uncertainty related to tariff policy and governmental efforts to reduce government spending and the ultimate impact of those policies on the economy in the next few quarters. While it's becoming increasingly clear where most tariffs are likely to settle, we believe both businesses and consumers remain hesitant until there's more clarity. Economists continue to forecast slower growth in the back half of this year. As a result, we expect the demand growth outlook to remain muted in the second half of this year with Q3 likely the weakest quarter due to its heavier leisure mix. Leisure demand is expected to remain relatively price sensitive. For July, RevPAR is trending down 2% to 3% for our portfolio, though we expect higher occupancy year-over-year. That increase is being offset by modest ADR declines. In addition to the continuing overall weakness in Los Angeles from the multitude of negative events in the market, we're facing some less favorable citywide comps in Q3 in markets like Chicago, which hosted the DNC last year, Boston and San Diego to a lesser extent. Our total revenue pace for Q3 is down 3%, with group pace down 4%, mostly on group room nights. In addition, group attrition has recently ticked up modestly. On the brighter side, Q4 group pace is currently flat, and we're no longer seeing the same group hesitancy to sign contracts that we experienced last quarter. And importantly, we've not yet seen any increase in group cancellations. This gives us greater confidence that Q3 will likely mark the low point in performance for the year. As a result, our Q3 outlook assumes same-property RevPAR will decline 1% to 4%, with total RevPAR down 0.5% to 3.2%. On the cost side, due to the benefits of our strategic efficiency and productivity program, we expect total hotel expenses to grow just 0.2%, which means expenses per occupied room should decline again. As for the year, the midpoint of our guidance still reflects our most likely outcome. While there's still macro uncertainty, the good news is we see no systemic issues at this time. Employment and corporate profits remain solid. If policy uncertainty improves, that alone could give the economy a boost, which should benefit the hotel industry. We're increasingly optimistic about 2026. If economic uncertainty fades, hotel demand should normalize with GDP growth. Supply is extremely restricted, and our industry fundamentals are set up for a very good year. For Pebblebrook, we're in a very good place, and we expect to outperform the industry. Our redeveloped properties will contribute to this outperformance. Several of our urban markets, including San Francisco, Portland and Chicago, are expected to continue their recoveries. L.A. comps, of course, will be much easier. On top of that, we'll see incremental demand from a multitude of major events across our portfolio, 7 World Cup matches each in Boston and Miami, NCAA men's basketball tournament rounds in 5 of our markets. the 250th U.S. anniversary celebrations in D.C. and Boston, the Super Bowl in San Francisco and the NBA All-Star Game and World Cup matches in Los Angeles. While most of the events of these events have yet to put many rooms on the books for next year, except for the Super Bowl in San Francisco, our group and total pace for next year are currently very favorable. For 2026, group room nights are up nearly 9%, ADR is ahead by almost 4% and group revenues are up by 13.1%, over $10 million ahead of 2025. Total revenue pace, including both group and transient, is up by a strong 19%, over $17 million ahead of same time last year. So while none of this guarantees a great year, the setup for 2026 is very strong. And we're confident in our trajectory by executing on our strategic plan, driving revenue, maximizing productivity and growing free cash flow, we're creating the foundation for durable long-term value creation. With a solid balance sheet, proven execution and a redeveloped portfolio, we're positioned not just to navigate uncertainty, but to capitalize on it. We just need the macro to fall into place. To wrap up, we believe our relentless focus on generating operating efficiencies, our disciplined and nimble revenue strategies, our team's deep experience navigating cycles and the transformational investments we've made across the portfolio, all position us to outperform and deliver meaningful long-term returns. So that completes today's remarks. Donna, we'd now be happy to proceed with the Q&A.

[Operator Instructions] Today's first question is coming from Smedes Rose of Citi.

Jon, I wanted to ask you a little more just about Los Angeles. Just looking at just STR data for the quarter, L.A. was up 3.8%, I think, for RevPAR. So that stands in contrast to what you saw. I'm just kind of wondering what's your confidence that the declines in RevPAR were largely related to the ICE activity that you mentioned or if there's maybe something going on in addition at your portfolio that's dragging on those assets?

Sure. So the fires benefited a lot of the lower end of the market and a lot of the suburban end of the market because that's where a lot of your EPA, where your per diem, many of your middle-income homeowners who lost their homes have relocated. Where the market has suffered has been in the West L.A. market, which is the higher end of the market. And the higher up the properties, generally the bigger the suffering. So that's really what's impacted our portfolio, which is really spread from Santa Monica on the West side through Westwood and Beverly Hills in the middle of the West side and then to the East into West Hollywood, which sounds weird because it's West Hollywood, but if you go further east, you get to Hollywood, obviously. So that's really what's happening in the market. The overall market doesn't really indicate how each of the individual submarkets are performing. And it's those other markets that are really benefiting from the fires, whereas the central part of the market, including much of downtown, is really suffering as a result of the fires.

And I just wanted to follow up on, as these ICE activity and the raids seem to be stepped up, we're just hearing anecdotally that even some workers that are even here probably legally, et cetera, are maybe not showing up for work or afraid of what's going on. Are you seeing that at all across your hotels? Or do you feel pretty good about where your labor and staffing are right now?

No, no, we're not seeing that at all across our hotels. So we've not had an impact from that. And just I want to make it clear, it's not the ICE raids themselves that created the problem for -- and the falloff in demand. It was the media attention around them and the military response that really created this misperception of a lack of safety throughout the marketplace. And as you know and most people know, L.A. is extremely spread out. We had cancellations in Santa Monica when the events that were going on were concentrated in a 3-block area in downtown L.A., which is a 45-minute to an hour drive when traffic is not bad. So it's not because of the ICE raids. It all has to do with the media attention and the creation of this misperception of the lack of safety.

The next question is coming from Duane Pfennigwerth of Evercore ISI.

Just to follow up on Smedes's question. And I want to ask you about really 2 markets, the recovery trajectory for L.A. and the continued growth trajectory for San Francisco. I don't know if you implicitly have sized like an L.A. headwind in the back half, what do you think that looks like into the third quarter and into the fourth quarter. And the other half of that coin is just the convention calendar, do you see sustained strength in San Francisco as you look at maybe like the fourth quarter?

Sure. So I think as it relates to L.A., I mean, we were on a pretty good recovery trajectory from the fires throughout much of Q2 until those activities happened in downtown L.A. So I think our -- I mean, we feel pretty good that things are recovering. It's what we hear from our customer base there. We're seeing more production demand in the market that may or may not be related to -- I mean, I suspect it's related to 1 or 2 of the following. It's related to the ongoing recovery from the strikes with production coming back; and two, with additional credits available beginning July 1 of this year that the state is offering for production in California. So look, it's been hard to forecast L.A. It jumps around from month to month, and we've had some unexpected activities. But I think the back half should continue to improve. And we have a much easier comp, particularly in Q4 when we had the renovation that started at what was Le M ridien that became the Hyatt Centric in Santa Monica, where we had a large amount of disruption in Q4. So we think L.A. should get better as the year goes on. As it relates to San Francisco, I mean, we do see sustained progress in sales related to the convention calendar, and Q4 is a blowout on a year-over-year basis compared to last year. So San Francisco is going to benefit from Dreamforce moving from September to October. But then September, Dreamforce being backfilled with a number of small- to medium-sized conventions that are driving pretty healthy demand for September. And then with Dreamforce in October and then the success of bringing in Microsoft Ignite in November, which was in Chicago last year, and to use a pun, ignited that market when it was there. We expect the same result in San Francisco. So it's AI-focused, that conference. And so, Q4 sets up -- I mean, if the numbers are huge in terms of the increase. At the same time, we have business transient, business group and leisure returning to the city. So San Francisco looks really good in the back half of this year, especially in Q4.

And Duane, just to provide a little reference of where San Francisco was in '24 and where it's trending in '25. In '24, in our properties, our occupancies were about 64%. This year, based upon our implied outlook, occupancy is going to finish upper 60, 68% to 70%. So that's a pretty big improvement, but it's still a long way off from where it was in 2019. Not that 2019 should be the year that we should reference because it was a very busy year in San Francisco, but occupancies in our portfolios were in the upper 80s in 2019. So there's a long way to go, but it's certainly a very encouraging trend that we've seen here over the last 2 years in San Francisco.

The next question is coming from Aryeh Klein of BMO Capital Markets.

I guess as it relates to the guidance, it looks like it implies some improvement in the fourth quarter relative to the third. Can you talk about what underpins that? Is that largely the San Francisco set that you talked about? Or are there other things driving that as well?

Sure. So Aryeh, it's a few things. One is it's some negative things in Q3 that are making Q3 worse, like the fact that Chicago had the DNC last year and doesn't have it this year. We have some weaker convention calendars, including in Boston, which is an important market for us, in Q3, which then gets better in Q4. I mentioned the easier comp in Santa Monica in Q4 related to the Hyatt in that market, that will help us. We also had about 100 basis point impact from storms down in Florida outside of the impact on LaPlaya. We may have storms again. We don't have them in our forecast. Maybe we should, who knows. But if we don't have those storms, we have that benefit, which we're taking into account. And then there's -- for D.C., there's no election this year, and we hope less DOGE disruption by the fourth quarter. So those should all help Q4 be better than Q3. And then the one thing I'd add, so those are all specific really to our portfolio and our markets. The one macro thing I'd say is it just -- as the public markets have clearly looked through this economic uncertainty, that's beginning to happen on the private side. I mentioned the fact that the hesitancy we had seen for groups to book later in this year that we saw a few months back had gone away and those contracts came back signed, and we're not seeing that hesitancy again. Doesn't mean it won't come around again, but we're not seeing it right now. We just think as there's more clarity on these issues and clearly the tax bill has passed, so there's no uncertainty about that at this point. We think that will ultimately lead to an improving economic outlook and companies and the leisure customer being a little less hesitant to travel at the margins than they are this summer.

And then maybe on the expense side, growth was sub-2% in 2Q and flattish, I guess, in the third quarter. Do you think 2% or even sub-2% growth is something that can prove sustainable? And how significant can these efficiency and productivity enhancements that you're looking at ultimately be?

Yes. I mean I'll let Ray jump in, but I think they're very substantial. I think they're significant offsets to what will continue to be, we expect, and where historically in our industry, wages and benefits that have gone up faster than inflation, so we do think that we have some significant benefits from these programs. We're really at the early stages of many of them. The technology is developing extremely rapidly, almost mind-boggling fast. And so we do think it's going to be a big offset. What's the exact number? I mean, it's going to depend upon where inflation settles down, where if we get back down to that sort of 3% wage increase and benefits have historically gone up more than that each year. But yes, I would hope that we can more than offset the wage and benefit side. We also have some very significant real estate tax reductions to come. We just don't -- we just can't predict exactly when they're going to hit. But for the long term, it will be very significant.

And Aryeh, in addition to all the efficiency tools and the AI programs that we're piloting, which we're very excited about, you must also remember that a lot of the cost increases in these labor contracts from a lot of these cities that went through the union renegotiation last year, the large hit is really this year, and the rate of change will be a little bit less in the outer years in these 2, 3, and 4 of these contracts. So that's also another benefit that gives us confidence. But there's a lot of areas that we're pulling and looking at, and again, as Jon mentioned, we're looking at every single line item. Our hotel teams have been great, our asset managers have been great looking at this, and we think there's a lot more that will come in, especially we'll start seeing that in '26.

The next question is coming from Gregory Miller of Truist Securities.

I also have a couple of questions on AI. To start with, do you expect certain hotels in your portfolio likely to see better opportunities, say, bigger key count hotels or branded hotels versus independents?

That's a very broad question. Look, I think some of the areas that we're certainly looking at, actually, in some ways, it's the more complicated the operations of the hotels, that could be where there's some of the bigger opportunities because you think of a lot of our resorts where there's a lot of demand from the hotel teams because of different services and outlets and all the different venues and services we provide the properties, the AI areas we're looking at, we can do a lot of those -- handling a lot of those calls because one of our properties that we tracked, I think, in certain days of the week, 40% to 50% of the calls were just to the front desk asking about to get their valet car. Well, that's an easy thing to use AI to reduce the pressure on the teams. And then our front desk agents can service the guests. It makes them happy. So there's a lot of -- it's not just the productivity. It keeps the guests happy, it gets to other areas. And what we're really learning as we go through this is the more complicated the property, some of the bigger benefits are to be had there. So there's a lot of different areas we're looking at. Some will work better than others, and we'll look at it. But the good things are with our independent operators, they're very open to change and very flexible, and we're making a lot of progress there, and we'll continue to keep you apprised.

I do think, Greg, and to add on to that, I do think what we're finding is because of some of the legacy systems that the brands have, it's just going to take them longer to incorporate AI into their systems, whereas a lot of the independents that we have are using third-party systems that are being much more quickly to adapt and incorporate AI into their software and their systems. So I do think it'll happen probably a little quicker at most of our independents. But I think ultimately, it's going to be pervasive through the industry.

The next question is coming from Cooper Clark of Wells Fargo.

Wondering how you're thinking about potential wage pressure in both L.A. and San Diego, considering some of the moving pieces on the policy side in both markets and how those potential wage increases would affect margins and outlook for long-term ownership?

Well, the industry has mounted quite a major effort to influence those outcomes in both L.A. and in San Diego. In L.A., there were over 140,000 signatures collected to put that legislation on the ballot for the people to decide in the next election, which is the June of next year. And assuming that those are ultimately verified and that we achieve the number of signatures required to put it on the ballot, which needs to be around 93,000 or more, then again, the increases are stayed from the legislation until the vote of the people. At the same time, we've introduced a ballot initiative that we believe motivates the city to have some reasonable conversations with the business community, both not just the hotel and the airline industry, which are specific to the legislation they passed, but other industry groups that have been affected by the high taxes and industry-focused legislation that the city has been passing. And so, I think I'd like to say that the tide is turning as it ultimately did in San Francisco, where we can move towards more rational legislation that doesn't favor one industry and doesn't work against any other industry. We have a very large group assembled in San Diego with a lot of money raised there. And again, we'll be an active participant, we believe, ultimately, in where legislation goes in that city, if anywhere. And so...

And then just switching to the CapEx program. You completed the multiyear CapEx program. But in terms of timing on the next project, would you think about starting the Paradise Point conversion in early '26? Or fair to assume any free cash flow will be saved for the convert over the coming months?

Yes. So I think as it relates to Paradise Point, I mean, we just don't control the timing of that. We're still working with California Coastal. We don't have approvals yet. And we don't know the timing of that at this point. So it's unlikely that we'd be beginning this in certainly the first half of '26. We did get a waiver from California Coastal so that we can move ahead with the renovations in the meeting space, the conference center there. Those were done and completed earlier this year. And so that's one piece of the ultimate program. And it's possible we may get a waiver for a couple of other smaller pieces prior to final approval. And those might move forward next year. But in terms of major capital related to the property, I wouldn't expect it to be a major user of capital next year.

The next question is coming from Daniel Hogan of Baird.

I just want to touch on your comments about leisure pricing sensitivity. Is it getting worse or staying the same into the summer? And then are customers booking through different channels? Or is it being marketed differently? And is any promotions or discounting being used more or less at this time?

Yes. I mean I think that -- it's sort of you've got to define what's going on. There's more discounting, there are more promotions going on. It has -- I don't know that it's gotten worse as the summer has gone on, but it definitely has impacted the summer fairly completely. And we're probably at least halfway through the summer. I'm not sure it's going to get worse in August. It's possible towards the end when kids are back in school, we could see a little bit more price competition and discounting and promotions going on and some people booking through discount channels. But our guess is that by September and the early Labor Day that, that will dissipate. But we'll see what happens. That's primarily what we're seeing in the market.

And Dan, please let Mike know that we're really excited for him, the birth of his third daughter yesterday, and tell him good luck because he's going to need it.

Certainly will do.

[Operator Instructions] The next question is coming from Ken Billingsley of Compass Point.

My first question is follow-up on the Paradise Point. You talked about you got approvals to work on some of the buildings there. Are those within the Margaritaville plan? Or when you do a conversion, would you actually have to put more capital in there to develop that?

Yes. They're within the plan for Margaritaville. But if the property never became Margaritaville, it would work perfectly for the property because the property is sort of a perfect Paradise resort. So our designs that we're using with Margaritaville are fairly sophisticated, but they're reflective of the local environment. They're not a standard Margaritaville, I don't know if brand standard would be the word. So they fit the property and the property fits being a Margaritaville. So there wouldn't be additional dollars invested in the parts that we've already done.

Okay. And then for the -- your fourth quarter outlook, obviously, there's some confidence of that and definitely more confidence going into 2026. What are you tracking that you think would most negatively impact that outlook? I understand a lot of it is outside of your control. So like outside of weather, what are one or two of the major items that you are tracking that could impact what you think could be shaping up to be a good 2026?

I mean the things that could impact it that we look at on the negative side or the positive side, which are you asking about?

Well, obviously, we're going to be more concerned about the negative side. But if there's positive -- obviously, if there's some positive ones, I'd love to hear those as well.

Sure. So in terms of what we look for, I mean, we're looking at cancellation -- group cancellations. It's great when we have group on the books, but it can cancel. And the further out it cancels, the less income we get from that cancellation. So we're always looking at cancellations. And as I mentioned in my comments, we haven't seen an increase in cancellations yet, but that's what we watch for, and that would be a negative, obviously. A slowdown in booking pickup. That's the second thing we look for. That's always an indication that businesses are changing their approach to meetings and travel, and we would see that in the booking pace, both what gets put on the books and then and how far out they're booking and how confident they are in booking further out, which we're always looking at. So we're looking at '27 already for our larger conferences. And so far, those are looking good. I think in terms of the positives, I mean, it's certainly the pace at which we book. It's also our ability to push up price. Those are always things that we look at. I guess the one other positive and negative we look at it because it can be on both sides, obviously, is what's the spend outside of the room, how many dinners are they having, how many welcome receptions, how much are they spending on food, are they spending at the upper end of our menus, are they spending in the middle of the menus, or at the bottom of the menus as an example. So we're always looking at those items. That gives you a really good idea of the sort of economic confidence that these businesses have on a go-forward basis.

Our final question today is going to be coming from Chris Darling of Green Street.

Just want to circle back to Paradise Point just for a second. What's your level of flexibility to either buy out or extend the ground lease there? And how does that influence your willingness to allocate more capital to that property over time?

Yes. I mean the ground lease is with the city of San Diego, I was going to say San Francisco, but the city of San Diego. And historically, we've extended those, as was done for Mission Bay a few years back. Those can get extended as far out as, I think, 49 or 50 years. And so, typically, what goes along with that is major investments that we're making in the property. So it's always important to us in order to make major investments to be able to have enough time to get an adequate and attractive return on that investment, and that would continue to be the case on a go-forward basis with Paradise Point.

Okay. That makes sense. Helpful. And then maybe just more broadly, can you talk about what you're seeing in the transaction market today? Realize it's still slow, maybe there's not a ton of pricing clarity, but anything incremental you're observing these days would be interesting to hear.

Well, thanks for that question, because we can wake Tom up so he can participate, Chris.

Chris, so I think, as you know, we started the year with optimism. Obviously, it was interrupted with some of the macro and policy uncertainty late first quarter, second quarter. But we've seen some renewed interest certainly within the last 60 days. Our investor inquiries are up. Brokers are feeling better. I think there's kind of a shifting sentiment. The debt markets are functioning and open. And there seems to be obviously a little more clarity on the macro policy front. So I think there's kind of a shift in the tide here, and I would anticipate that over the course of the next few quarters, we'll see increased transaction activity.

I'm glad I was able to get you in there, Tom.

Thank you. At this time, I'd like to turn the floor back over to Mr. Bortz for closing comments.

Thank you, Donna. Thanks, everyone, for participating. We look forward to catching up with you in 90 days, and we hope you enjoy the rest of your summer.