Boykin/AEW strategic j.v.signals trend in equity sources Even before the capital crunch hit, Boykin Lodging Co. hired Los Angeles-based investment banking firm Chadwick, Saylor & Co. early last summer to explore financing options for the Cleveland-based multitenant hotel REIT. That effort came to fruition when Boykin (NYSE:BOY), with a portfolio of 31 full-service hotels, formed a joint venture for the purpose of taking advantage of acquisition opportunities in the lodging industry with AEW Partners III L.P., an investment partnership managed by AEW Capital Management L.P., a Boston-based real estate investment firm that manages a portfolio of approximately $6 billion.

Under terms of the 75%/25% joint venture, AEW will provide $50 million of equity capital, and Boykin will provide approximately $17 million and serve as the operating partner of the joint venture. Combined with debt financing, the initial capital commitments would allow the joint venture to complete up to approximately $175 million of acquisitions over a 24-month period, although the partners could double their capital commitments, which could result in total acquisitions of up to $350 million.

This joint venture may only be the tip of the iceberg as the hotel industry seeks alternatives to public equity markets.

"I think it is a structure that we're going to see more of with operating companies who had previously been dependent on publicly traded REITs for growing their systems," says Frank Nardozza, partner and national hospitality industry director with KPMG LLP, Miami.

In the case of the Boykin/AEW joint venture, AEW would be the private capital source to provide a base level of equity funding for acquisitions as opposed to working through the REIT as they might have done in the past for acquisitions.

"I think a large number of hotel companies are looking at this structure," Nardozza says. "Even the one transaction that's being most talked about is Patriot American - they're looking to a private capital source to come in and help them pay down some debt. This private capital source would presumably take an equity position in the REIT, but more importantly, either inside the REIT or outside the REIT, provide additional capital to pursue business."

The down side, according to Nardozza, "is that the private equity sources are typically looking for higher returns on their money than some of the institutional sources may have been looking for in buying REIT shares. So it's, generally speaking, more expensive equity money.

"The other issue, too, is that as these ventures are put together these private equity sources still will be interested in an exit strategy somewhere down the pike, and probably more likely a two- or three-year window if not sooner, probably once the public equity markets become robust again," he says.

In the case of the Boykin/AEW deal, after the two-year investment period, AEW has the option to convert its capital invested in the joint venture into Boykin convertible preferred shares. The thinking is that this aligns the respective interests of the partners toward the fundamental goals of executing quality real estate acquisitions for the joint venture and increasing the value of Boykin's common shares.

For other companies looking at similar deals, Nardozza warns, "The capital sources, two years out, if they can't sell the assets at their targeted exit price and have the public equity markets to take the deals, then it's probably going to be not a real comfortable situation."