It's a time of high revenues and profits in the hotel business, and owners are taking the opportunity to buy more properties, and each other. Mergers and acquisitions have been so brisk lately that a number of companies that appeared on last year's Top 25 Hotel Owners survey have been gobbled up.

For example, MeriStar Hospitality Corp., with 16,500 rooms in 19 states, was recently sold to an affiliate of The Blackstone Group for $2.6 billion. Also, Jameson Inns, with 7,327 rooms as of Dec. 31, 2005, was sold to JER Partners for $181 million and the assumption of $190 million in debt. That deal is expected to close in the near term.

In May, an affiliate of Westmont Hospitality Group and Cadim Inc. announced the acquisition of Boykin Management Co. for $416 million. Boykin has ownership interest in approximately 5,800 rooms.

Transactions have been occurring at a torrid pace. Portfolio deals totaled $9.6 billion in 2005, up from $6.5 billion the previous year, according to Jones Lang LaSalle Hotels. Newcomers are buying big into hotels as well, such as Black Entertainment Television founder Robert L. Johnson's recent purchase of 100 hotels from White Lodging Services for $1.7 billion. The deal is still being finalized.

Driving factors

Sellers are typically motivated by a desire to focus on management, or to take advantage of a peak opportunity to sell. Buyers are interested despite the fact that cap rates have fallen 80 basis points during the past year to an overall rate of 8.89% in the first quarter of 2006, reflecting a range of 7% to 12%, according to PKF Hospitality Research.

“There are very narrow bid-ask spreads right now,” says Jack Cordial, professor of real estate management at the Cornell University School of Hotel Administration, adding that buyers are looking at the cash flows going forward.

They are also attuned to the fact that because of sluggish hotel development, supply currently isn't satisfying demand. “The market will eventually come down from this peak,” says Cordial. “The only the question is when, and that's an open question.”

It may be a while. “Occupancies have been growing rapidly in all segments in most markets,” says Bruce Wiles, CEO of Alcor Acquisition LLC, the affiliate of the Blackstone Group that recently acquired MeriStar. “And it's generally perceived that in the quarters ahead, buyers will realize increasing value.”

In the short run, only a catastrophic event such as 9/11 could hobble the hotel business, which is benefiting from a healthy economy that grew 4.8% in the first quarter of 2006. Over a longer period, some of the barriers to entry for new product — such as high land and construction costs — could ease, and that too would take some of the air out of the market.

But Smith Travel Research is predicting only modest supply addition of 1.2%, or 75,000 rooms, in 2006. For 2007, roughly 158,000 new rooms will come on line, an increase of 2.5%.

Strength in numbers

In the meantime, the hotel owners are enjoying strong fundamentals. According to data compiled by Smith Travel Research, average hotel occupancy climbed from 57.1% in the first three months of 2005 to 60.1% in the same period this year. Meanwhile, average daily rates (ADR) improved from $90.22 in the first quarter of 2005 to $96.09 in the first quarter of 2006, an increase of 6.5%.

Revenue per available room (RevPAR), arguably the most important metric in the industry because it takes into account both occupancy and rates, rose from $52.38 in the first quarter of 2005 to $57.47 a year later, up 9.7%

“Demand spurs occupancy, and once you hit a certain level, managers start raising rates. Now, rates are powering up, and if the economy can support it, consumers will pay those rates,” explains Cordial. “So far, in almost all markets they're paying higher rates without qualms.”

Looking ahead, PKF predicts profits of about $14,800 per available room in 2006 and $15,800 in 2007, which is a little more than the $15,674 recorded at the peak of last cycle in 2000 and considerably more than 2005's total of about $12,800.

However, hotel operating expenses continue to increase at more than twice the rate of inflation, and any acceleration of that trend could eat into profits in the coming years.

HEALTHY HOTEL VITAL SIGNS

The rate of growth for revenue per available room (RevPAR) is expected to begin slowing in 2007 as the hotel industry nears the peak of the cycle.

2004 2005 2006* 2007*
Occupancy 61.3% 63.1% 64.4% 64.8%
% Change 3.6% 2.9% 2.0% 0.6%
RevPAR $50.22 $57.30 $62.46 $66.89
% Change 8.5% 8.4% 8.9% 7.1%
* Projected
Source: Smith Travel Research