A new conservative mood

Will the market ever return again to the outsized transaction volumes of 2007, when deal volume globally surpassed $120 billion? Davis laughs at the idea. “In 2007 we had irrational exuberance fueled by easy capital,” he says. “The market will be much more conservative going forward. Maybe by 2011 or 2012 we could be back up to half of what we did in volume in 2006 or 2007.”

But lots of adjustments need to be made before that can occur. Owners of hotel assets must get used to the idea that valuations industry-wide are down 30% or more from their peak in early 2007. Banks must get healthy again, too, though much of the action in coming months is likely to be fueled by seller-based financing. There also has to be a clear sense that the hotel market isn't headed any lower. Nobody wants to do a deal and watch valuations sink another 20%.

“There is still a bid-ask discrepancy, but that gap should close when we reach the bottom of the cycle, and I think we're just about there now,” says Davis of HREC Investment Advisors. “Once at the bottom, you'll see some real transaction movement.”

A new survey by Jones Lang LaSalle Hotels suggests that buyers are poised to act. In the first half of this year, U.S. hotel transactions nosedived 86% to $1 billion compared with the first half of 2008. But the company notes that deal volume has been increasing monthly since May.

The results of a survey of 300 hotel investors in the select-service segment — ranging from Super 8 on the low end to Hilton Garden Inn and Courtyard by Marriott in the upper mid-market — found that 44% of respondents were seeking to make acquisitions in the next six months. This was six percentage points higher than the survey in January and was the highest “buy” sentiment ever expressed in the three-year history of the survey.

What has spurred the rising interest in deals? Bargain prices, mostly. The Jones Lang LaSalle survey found that investors expected to buy hotels at a cap rate of 11.6% and a gross room revenue multiplier of 2.7. A year ago investors were resigned to making deals at a cap rate of 9.5% and a multiplier of 3.05.

“When we did interviews in January, we found investors were on hold and preserving their money,” says Mark Fair, a Jones Lang LaSalle managing director based in Atlanta. “The latest survey tells us that people sense a bottoming of the market and they're more prepared to buy. The majority of the buyers are targeting distressed assets.”

They're not likely to be distressed forever, industry veterans point out. Laurence Geller, chairman of Strategic Hotels & Resorts in Chicago, watched his REIT's stock price sink to under $1 this past year when some of its prime hotels such as the Westin St. Francis in San Francisco and the Ritz-Carlton Half Moon Bay south of San Francisco struggled to fill rooms.

But Geller is remarkably upbeat of late, noting that new hotel room supply will continue to dwindle over the next five years. Most hotel operators, Strategic included, have used the recession as an excuse to cut back on labor and other overhead.

During the recent Midwest Lodging Investors Summit in Chicago, Geller suggested that a rebound for the industry was closer at hand than most people suspect. “People's propensity to consume has not changed. Their ability to consume has changed only temporarily,” Geller remarked. “In 18 months time we'll all be saying this wasn't so bad after all. This too shall pass.”

H. Lee Murphy is based in Chicago.

Hotel Indigo bucks trend, continues expansion

One study after another suggests that hotel developers are rapidly shutting down new construction projects. But there are still pockets of growth all around the industry. Marriott International, for instance, opened 8,000 new rooms in the second quarter of this year alone and has another 110,000 rooms in its development pipeline, with more than half of them under construction. The majority of the rooms are overseas.

InterContinental Hotels Group (IHG), the British lodging giant, has 4,222 hotels open with 622,000 rooms. The company is no shrinking violet these days. It has another 1,700 hotels with 236,000 rooms in its pipeline, with the brands ranging from Holiday Inn to Crowne Plaza and Candlewood Suites.

One of the better-performing segments in the industry at the moment is the boutique property. IHG's Hotel Indigo chain is a classic model of the boutique — it has just 100 to 150 rooms per property — and has been on a tear recently. Since its start in Atlanta in 2004, the chain has grown to 29 hotels, with 17 properties due to open in the face of recession during 2009 alone.

There are nearly 60 more hotel projects in the company's pipeline. The goal is to grow to 250 properties globally inside of 10 years and then keep expanding to ultimately reach 650 hotels. Almost all of the properties, which cost $15 million to $20 million each to open, are owned by franchisees that are somehow still finding financing.

“In 2010, considering the economy, it may take longer to get some deals done,” says Janice Cannon, vice president of global brand management for IHG overseeing the Indigo rollout. “But we're still signing deals and expanding globally. That demonstrates this is still a growth industry.”

Indigo has been opportunistic in converting many of its hotels from older buildings. A new Indigo under construction in Miami's South Beach neighborhood was undertaken from an assemblage of four older structures. A historic office building in Baton Rouge, La., is being converted into an Indigo. In Ottawa, Canada, an old YMCA was turned into a hotel, and in Nashville the company will open a converted bank as its latest hotel by October.

In London, the company has already opened one Indigo and has deals for three more. There is even one planned for Liverpool, the working-class seaport that is birthplace to the Beatles. Cannon predicts that as the chain grows over the next decade, 50% of all Indigo hotels will be built in North America, with the other half equally split between Europe and Asia. “If you've got the right product and the right brand,” explains Cannon, “people are interested in investing in you.”
— H. Lee Murphy