Events North American Commercial Real Estate Congress and the Office Building Show July 21-24, 2007 New York, NY 2nd Annual Global Diversity Summit in Commercial Real Estate July 16-18, 2007 Atlanta, GA

	1,900 employees 45 offices, 28 countries $59 billion in assets $78 billion served assets

 

Comfy Place to Invest

Hotel sector offers value-added opportunities

Last month, basketball legend Magic Johnson and a group of Los Angeles-based investors paid $290 million for the Hilton Washington D.C. The new owners plan to spend $100 million renovating the landmark property.

Farther south, Westbridge Hospitality Fund acquired the 1,226-room Hilton Hotel in downtown Atlanta, along with a nearby office tower and parking garage, for $180 million. Westbridge, which is a partnership between Westmont Hospitality Group and a number of Canadian pension funds, will invest another $40 million to renovate and reposition the 1970s-era hotel including the addition of 10,000 square feet of new meeting space.

"Westbridge definitely was looking at a value-added opportunity," says Greg O'Stean, managing director of hospitality for GE Real Estate, which provided the acquisition financing to Westbridge. "They bought the hotel at the right price per key to provide attractive equity returns after their renovation."

Today, hotel investors are very interested in value-added opportunities, particularly those in major markets. Even though some of these hotel assets are trading at record prices, the discount to replacement cost is still significant. For example, experts estimate it would cost $250,000 to $300,000 per key to build a property like the Hilton Atlanta from the ground up today – a total of $306 million to $367 million.

"A lot of the private equity firms and large institutions have seen cap rates drop significantly in other types of real estate and see opportunities in hospitality, particularly in repositioning or renovating to add value," says Tom Hamm, managing director of Sperry Van Ness' hospitality group.

Hamm points to a California-based private investor that has allocated $100 million for hotel investments. "They've never invested in hotels before, but they're looking for higher yields," he explains.

Globetrotters

Investors know a good thing when they see it. Last year, hotel investors achieved an average return of 23.57 percent, according the National Council of Real Estate Investment Fiduciaries. 

The sector outperformed all the other core property groups, primarily because demand for hotel rooms has grown a total of 9 percent over the past three years, while supply has expanded by only 2.4 percent, according to Smith Travel Research. The imbalance has resulted in average daily rate (ADR) growth of more than 5.4 percent since 2005 and revenue per available room (RevPAR) increases of more than 7.5 percent.

Demand is strong across most hotel segments, with luxury, upscale and mid-scale chains reporting the highest occupancies, according to Smith Travel Research. Business travel – including convention and meeting activity – has increased substantially since 2001. Leisure travel also has spiked, experts note.

The economy and the value of the U.S. dollar has a lot to do with the amount of leisure travel that's going on, explains Stephen Brandman, co-owner & COO of Thompson Hotels, a New York-based management company. Most Americans are choosing to vacation in the U.S. because the exchange rate in Europe doesn't favor U.S. currency. "Our dollars are very stretched and minimal when we leave this country," he says. 

At the same time, many international travelers are visiting the U.S. because they can get a bigger bang for their buck. As a result, international cities like New York, Chicago, Los Angeles and San Francisco are experiencing extremely high occupancy and ADR.

Brandman hopes to take advantage of the strong domestic and international demand in Los Angeles. His company, along with partner The Pomeranc Group, is in the midst of a $16 million renovation of the 110-room Beverly Pavilion Hotel in Beverly Hills. The venture purchased the vintage hotel for $21 million about 18 months ago.

"A lot of people would have been turned off by the fact that it is an older structure," Brandman says.  "But, the location is excellent – right off Rodeo Drive – and we can reposition it to be a luxury property."

Checking in

From March 2006 to March 2007, roughly $32.6 billion worth of hotel assets traded hands, according to Real Capital Analytics, a New York-based research firm. The biggest transaction during that period was Rockwood Capital's $250 million acquisition of the Renaissance Mayflower in Washington D.C.

The average price per room was $162,000, an increase of 11 percent over the previous 12-month period. The average cap rate was 7 percent, virtually unchanged from the previous period, according to Real Capital Analytics. 

"Now is a good time to be investing in hotels, but only under qualified circumstances," asserts Dave Pollin, president of The Buccini/Pollin Group, a Washington, D.C.-based hotel owner, manager and developer. "Several billion dollars of private equity and hedge fund money is focusing on hotels, so we've got very smart people with billions of dollars trying to get into the hospitality space."

Over the past 15 months, roughly 40 percent of buyers have been institutional investors or funds. Another 30 percent were private buyers, and REITs represented only 20 percent of the investment activity.

Chicago-based Strategic Hotels, for example, is focused on improving its existing assets rather than adding to its portfolio, says CEO Laurence Geller. The REIT is adding to its room stock by six percent through the expansion of several hotels including the Four Seasons Hotel in Washington D.C. and the Ritz-Carlton in Laguna Nigel, Calif.

"There appears to be a shift as many REITs are becoming more conservative with cap rates and owner operators are getting more aggressive," says Robert Habeeb, president of First Hospitality Group Inc. The Roseville, Ill.-based management firm recently partnered with Broadway Partners to convert the upper floors of the former Shubert Theatre in Chicago into a Hampton Inn & Suites.

Most buyers have plans to improve the property either through physical upgrades, changes in brand or new management, says Aik Hong Tan, president of Richfield Hospitality, a Greenwood Village, Colo.-based company that recently acquired a Doubletree-flagged hotel in Charlottesville, Va. 

The Buccini/Pollin Group, for example, has invested $18 million in the 250-room Sheraton Meadowlands in northern New Jersey. The top-to-bottom renovation included new chillers, redesigned public areas and a new restaurant. "We just love to find a big, broken box that has the potential to be updated and reflagged," Pollin says. "There are still some really challenged properties available."

In fact, many hotel properties need updating simply because their flags have raised their brand standards, believing that higher standards correlate directly to higher guest satisfaction and higher room rental rates – finer linens and flat panel TVs are examples of the recent evolution in franchisor requirements.

Supply concerns

Today, there are about 190,000 hotel rooms under construction, a 56.4 percent over 2006, according to Smith Travel Research. Another 355,000 rooms are in the planning stages and roughly 81,000 are in the pre-planning stages.

New brands such as Hyatt Place and aloft, in addition to redesigned existing flags, have caught the eye of developers and are catalysts for an increasing pipeline of construction projects, says Adam Valente, vice president of RockBridge Capital LLC. 

The new construction, however, is something that the hotel investors must watch carefully, Valente says, noting that occupancy pressure and expense inflation should create some regulation of prices. "We anticipate prices on a per key basis to stagnant where market fundamentals sputter," he adds.

And, if the economy experiences a significant downturn or a geopolitical event like terrorism, hotel investors who overpaid for their assets will likely suffer losses, warns Rick Takach, president & CEO of Vesta Hospitality. "On the other hand, if a significant downturn does occur, it will create a great buying opportunity for careful investors," he concludes.

Yet most hotel players feel good about the future. "I believe we have a couple more good years ahead of us," says Fred Cerrone, CEO of Hotel Equities, an Atlanta-based firm that owns 16 hotels in the Southeast and has another five under development. "I think hospitality is one of the best sectors you can invest in right now."

Copyright 2007, Penton Media.. All rights reserved. This article is protected by United States copyright and other intellectual property laws and may not be reproduced, rewritten, distributed, re-disseminated, transmitted, displayed, published or broadcast, directly or indirectly, in any medium without the prior written permission of Penton Media.