Opportunities Turning into Transactions

Even if RevPAR growth drops to mid- or low-single digits late this year, Fisher’s preference for cash acquisitions rather than relying on debt will help him thrive in today’s thorny market.

“Even if the hotel market goes flat this year, I’m still giving my investors 7% and 8% returns,” he says. And he plans to expand. How big can Chatham Lodging Trust get? “I fully expect to have 50 hotels worth more than $1 billion within three or four years,” he says.

Flippers out, holders in
The hotel transaction market was populated a few years ago with what the industry calls “flippers.” Their strategy was to use heavy leverage to buy and quickly renovate a hotel, upgrade the brand name and install savvy management, all in two or three years. The goal was to boost cash flow 20% or more and exit with a handsome profit.

Alas, in the current environment the flippers have been largely absent. Brokers and investors agree that a different class of dealmaker, the “patient holder,” now dominates the market. Patient holders use little debt, shun risk and often have investment time horizons ranging from five to 10 years.

Many peg their returns to cash flow analyses that presume a return to peak 2007 net operating incomes at properties they acquire by 2013 or 2014. “The REITs are the guys doing deals now because they have the patient money,” says Michael Cahill, CEO of Hospitality Real Estate Counselors in Denver, which represents sellers of some 60 hotel properties.

There is a lot of activity under the REITs’ radar, observes Cahill. In July alone, he sold 10 hotels each priced under $10 million and sporting flags like Comfort Inn and Holiday Inn Express. The buyers weren’t operating with Wall Street money like Chatham Lodging Trust does.

“The buyers are small guys who own two or three hotels — guys like the rich car dealer who dabbles in hotel investing on the side,” says Cahill, who co-chairs an industry group called the Lodging Industry Investment Council. “They can still get loans from their local community bank or even from the SBA (Small Business Administration).”

The market for smaller properties has held up fairly well, adds Cahill. “Valuations haven’t fallen nearly as far as they fell for the big institutional properties.”

Improvements are costly
Still, small-asset deals can get complicated. The Hotel Group, based in Seattle, is conducting due diligence on a Sheraton that it hopes to sell for $12 million, worth $50,000 a key. But the property’s improvement plan calls for up to $7 million in additional investment.

That infusion would push the cost to almost $75,000 a key, says Douglas Dreher, president and CEO of Hotel Group, who did not identify the buyer. It’s a high price tag for an establishment with occupancies at 50%. The first-year cap rate, Dreher reveals, is pegged at 5%.

Dreher, who owns 20 hotels and controls an investment fund with $75 million available, is an eager buyer as well as seller. Still, the thin crop of available assets frustrates him. Some brands are less desirable, or a hotel’s condition has deteriorated, while others are in receivership and even new capital may not stabilize them, explains Dreher.

On the other hand, some fine trophy properties are selling at prices near the peak of a few years ago.

Dreher aims for investment at 60% of replacement cost. “We’ve competed for a few like that, but we’ve been outbid so far.”

Indeed, bidding has become particularly intense for marquee properties. The Sir Francis Drake in San Francisco, offered for sale by San Francisco-based Chartres Lodging Group LLC, reportedly attracted more than 100 interested parties. The winning bidder, Pebblebrook, paid $216,000 a key, equating to just a 2% cap rate.

Jim Butler, founding partner at Los Angeles law firm Jeffer Mangels Butler & Mitchell LLP and head of the firm’s global hospitality group, figures the Drake may require as much as $50 million in remodeling. That would significantly reduce the financial return.
“Values for great hotels like the Drake are a lot higher than they were a year or two ago,” Butler observes. “Unless the flow of new product to the market speeds up soon, we’ll continue to see a line around the block waiting to bid on any decent property that comes up for sale.”

Maybe so, but there is still considerable discipline in the marketplace. Donald Trump’s Trump Hotel Collection has put on hold plans to build new hotels it had announced for New Orleans, the Dominican Republic and Dubai. A Trump hotel in Toronto is still on track to open in February 2011.

Instead of building new hotels from the ground up, as it has in the past, Trump is now looking for older properties it can remake into five-star hotels. That’s a fresh turn for The Donald.

“The world of hotels is much tougher today,” says Jim Petrus, chief operating officer of Trump Hotel Collection. “We’re expanding our horizons, broadening our scope. But the industry is so cyclical that you have to be very careful about where and how you invest.”

H. Lee Murphy is a Chicago-based writer for National Real Estate Investor, a Penton Media publication.

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