The 4th Midwest Lodging Investors Summit, which was held in mid-July at the Hyatt Regency McCormick Place in Chicago, was a watershed event in the hotel business. It was the first industry-wide conference since 2007 in which the prevailing sentiment was overwhelmingly one of optimism. Not wishful thinking; not a wing and prayer; but honest and fact-based belief the worst of the industry’s bad times are behind us and plentiful opportunities are ahead for buyers, sellers, operators and even developers.

Lodging Hospitality, in association with HVS Hotel Management, sponsors MLIS, which was held this year at the Hyatt Regency McCormick Place in Chicago. The School of Hospitality Business at Michigan State University is the Summit academic partner.

The conference, which brought together 300-plus owners, developers, operators and brand executives from across the U.S., featured more than 60 speakers on topics ranging from financing and distressed assets to marketing and operations. Throughout the conversations, the prevailing attitude was one of recovery: The hotel industry faces major challenges but is rapidly improving from a performance standpoint and in the eyes of many investors.

Participants in a general session panel on the opening day of the Summit were particularly bullish about Chicago and the Midwest. Veteran hotel broker John Jameson of Jameson & Co. said he sees a “dark cloud lifting over Chicago.” And Paul Kirwin, CEO of AmericInn parent Northcott Hospitality, spoke glowingly about northwest North Dakota, a market he called “hotter than a firecracker” due to the recent boom in the oil shale business. But he’s also high on Chicagoland, which he sees “improving as the region’s manufacturing base improves.”

Of course, generalities can be misleading, as Sanjeev Misra pointed out. The senior managing director of Paramount Lodging Advisors reminded the audience that this industry rebound, like those in the past, is “very local market centric.” He did predict a significant volume of transactions in the region this year and next.

As optimistic as these statements were, the panel also addressed the new normal in hotel acquisitions and financing. Misra believes there may be a structural shift among investor expectations, from expected internal rates of return in the 18% to 20% range down to 12% to 14%. And while HVS Global Hospitality Services Managing Director Hans Detlefsen agreed yield expectations are lower, he sees the trend as a function of the normal real estate cycle and not a structural shift in the industry.

The panelists all agreed delayed capital improvements at many properties have complicated some hotel transactions. One panelist said 90% of deals involve some kind of product improvement plan, and 60% of the required PIPs are significant.

“An even bigger issue are those 20- to 30-year-old, 500-room properties that really can’t be supported anymore as hotels,” noted Paramount’s Misra. “How can someone make these work? The answer is probably deflagging and finding a suitable alternative use, such as senior living, multi-family or something else.”

Detlefsen said values have returned “quickest for the highest quality assets in gateway cities,” while Misra added that hotel investment is returning to urban areas like Chicago.

LANDS OF OPPORTUNITY
As transaction prices have escalated in those top markets, speakers also talked about opportunities for new development in less-likely locations like North Dakota, where revenue per available room is up approximately 25% this year, according to Jeff Higley of Smith Travel Research. It was leading the country in performance metrics this year, but Higley’s presentation showed almost every segment and nearly all of the top 25 markets have also seen significant improvements in occupancy and even average daily rate this year.

Northwest North Dakota, with its now booming oil business, isn’t alone with opportunity. Mike Muir of Wyndham Hotels said there are other pockets like that, driven by the oil and gas industry, in Montana, Western Pennsylvania, West Virginia and the Carolinas. For the same reason, Mark Williams of Best Western said Alberta, Canada has also been good for the membership organization.

Although Steve Kisielica, founder of Lodging Capital Partners, said “there are no markets that should support new development,” his company has found great success through acquisition. He said of the 45 properties they’ve recently bought, 43 have been significantly below replacement cost.

“In recent years, we bought nearly all of our assets at below replacement costs, so I don’t see any markets with real opportunities for development of full-service upscale and luxury hotels,” he said. “An exception might be if public money is involved in the project.”

Ravi Patel, of Hawkeye Hospitality, disagreed to some extent. “I was a pro development guy three years ago, and that’s starting to pay off now,” he said. “If you have new properties opening now, you’ll do very well.”

“We believe in new hotel development,” said Patel, senior vice president of Hawkeye, owners of nearly 60 mostly select-service properties either open or under development. “There are lots of markets ripe for development and we can get them done because our lenders have trusted us for 20 to 25 years.”

And while construction costs continue to rise, and did even during the recession, Patel said, “We’re able to get better value from our subcontractors and in some cases, better prices on construction materials.”

Finding financing remains the challenge, but many speakers talked about opportunities with regional and local banks. Ron Burgett of AmericInn said financing is still out there for smaller projects, but it’s a tougher sell. “There’s a lot more education and work needed: Those smaller banks that are doing the lending don’t know the hotel business that well.”

Questions still remain, but industry expectations have no doubt risen. Caps rates, at historically low levels, continue to confound many, but it further exemplifies the robust recovery buyers are expecting. “They’re not so low compared with future expectations,” said Detlefsen of the exit cap rates being used to rationalize the prices being paid for many assets “It’s the disparity between the past and future, which is at its largest historic gap.”

TALK OF TRANSACTIONS
With cash-flush buyers increasingly coming off the sidelines, hotels are increasingly trading hands, but the market remains extremely lumpy, according to a panel that focused on the outlook for transactions.

There’s no shortage of bidders for large Class-A assets, the healthiest part of the market. And more distressed deals are taking place. But there’s a hole in the market. Deals in the $3 million to $15 million range are much more difficult to close.

The driving factor in deal activity is the debt side of the equation.

Bidders for large Class-A assets tend to be REITs and private funds —investors that either have lots of cash on hand or ample access to credit markets. These are also the kinds of opportunities that lenders of all types are willing to finance.

Distressed deals, especially for smaller assets that can be had for $3 million or less, are also getting done as all-cash deals. But deals in the $3 million to $15 million range are not happening largely because lenders are conservative in funding such deals, according to Teague Hunter, president of Atlanta-based Hunter Hotels.

“That’s where you need financing, and that’s where the slowness is,” Hunter said. “They can get done, but [lenders are only willing to offer] 50 percent to 60 percent leverage. And with that low level of leverage, buyers cannot hit (their return targets).”

Josh Loftus, vice president of originations at GE Capital agreed, saying it was tough for lenders to work in that range of loan sizes. “At end of the day, we’re going to want the top credits, and the CMBS market is going to go after those guys too. Any kind of turnaround story is tough for a lender to get done. And a 50 percent LTV just isn’t going to help the borrower’s return.”

Overall, approximately $8 billion in hotel deals have taken place so far this year, according to Mitch Miller, founder and CEO of the Miller Law Group, who moderated the session.

REITs acquiring upscale properties account for about half of those deals. And there have been 12 portfolio deals of $100 million or more completed this year.

Dan Beider, chairman and senior managing director with Paramount Lodging Advisors, said there has been an uptick in interest in deals across the board, and the activity from smaller buyers is sometimes getting overlooked.

“When we send something out to notify the investment community, in the last six months we have had a 400-percent increase in executed confidentiality agreements across the board,” Beider said. “Fundamentally, a good sound deal that is priced right is going to sell.”

Going forward, the panelists expect the hotel investment market to continue to recover and for deal volume to grow.

Buyers will have opportunities to add value to an asset and generate net operating income. “Those opportunities are everywhere,” Beider said.“They are on-market and off-market opportunities.”

Bill Hanley, president of Lexington Hotels, added, “REITs are going to top-performing markets … and to guaranteed locations occupied by the top four or five brands. That leaves a whole sector of the market where there is opportunity. The challenge is that the investor needs to understand that value, and where it’s performing at now will not be where it is going to be in three years.”

EXTENDED STAY STAYS HOT
In a lot of ways, the extended-stay segment of the hotel industry reflects the conundrum many lodging owners find themselves in: Demand and occupancy are at near-record levels and new supply is nearly non-existent, but lots of properties can’t realize higher rates?

That existential and realistic conversation dominated a panel discussion among a group of extended-stay hotel executives.

“Extended-stay hotels need to raise their rates,” moderator Mark Skinner declared. According to The Highland Group, at which Skinner is a partner, during the first quarter the segment was only able to raise rates 3% despite a 4.8% jump in occupancy and minimal addition (2.1%) of new rooms. In 2010, demand rose 13.4% but rates fell 2%. “Room demand and revenues are near all-time highs, and the fewest number of extended-stay rooms are under construction than we’ve seen in 15 years.”

The panelists offered several reasons for slow rate growth. Bill Duncan, global head of brand management for Hilton’s Homewood Suites and Home2 Suites flags, said it’s partly due to last year’s cuts in travel per diem by the federal government, which “suppressed rate growth in an important category of business for us.”

And, as is even true for transient-oriented hotels, many extended-stay customers are booking under lower group rate agreements negotiated last year or in 2009 during the economic downturn. “We’re doing what we can to prepare our properties for the upcoming RFP season,” said Duncan, “including scheduling 15 meetings around the country with franchisees and their sales teams.”

Apple REIT Companies, which own nearly 80 extended-stay hotels, invested in high-level aggressive sales people in anticipation of the coming upturn in business. Even so, said Apple Senior Asset Manager Liz Sumner Perkins, “we need to build their confidence to partner with the right accounts and to negotiate the right deals.”

Despite the concern over rates, the panelists remain bullish on the extended-stay segment. As Skinner pointed out, demand for the sector has never gone down on an annual basis and it typically maintains a 10- to 14-point occupancy premium over the rest of the industry. Typical length of stay even climbed by two nights between 2008 and 2010.

Calling it a “nearly dip-proof product,” Perkins of Apple REIT said even though transient business in extended-stay hotels “dried up during the downturn, our typical extended-stay guest got us through the period, and transient is now beginning to come back.”

The panel also believes supply growth will remain muted for the next few years. Kevin Lewis, former head of extended-stay hotels at Choice Hotels and current chairman of the AH&LA Extended Stay Council, said it will be franchisees and not brand companies that will drive new supply growth in this cycle. “Even so, it won’t be until mid-2013 or beyond before supply growth in extended stay shifts upward.”