After three difficult years, the lodging sector is recovering. Cheap debt, a very positive equity market and increasing revenue per available room (RevPAR) are all factors leading many experts to predict that 2004 will see the highest level of IPOs and secondary issuances since 1996 and 1997. However, insiders differ on whether those conditions will also lead to an increase in M&A activity, which has been historically anemic in the sector, especially among real estate investment trusts (REITs).

After a slow IPO market in 2003 that saw just two new public REITs — Ashford Hospitality Trust and Highland Hospitality Corp. — insiders are calling for three to seven new IPOs in 2004. So far, Strategic Hotel Capital Inc., a Chicago-based private owner of more than 30 hotels, has filed for an estimated $325 million REIT IPO. Other IPO candidates include opportunity funds, pension funds, private individuals and private companies coming to the market with high-end and middle-tiered portfolios.

“I do think there will be a fair amount [of IPOs] this year based on the chatter I hear,” says Tom Corcoran, CEO of FelCor Lodging Trust, adding that he's hearing more companies are planning REIT-like IPOs rather than C-Corps. Many speculate that CNL Hospitality Properties Inc., a public unlisted trust that is now the second-largest hotel REIT, will complete an IPO.

PricewaterhouseCoopers estimates there will be 10 or more secondary offerings in the sector in 2004, with the total raised likely to exceed $3 billion. “We've already seen an uptick in the amount of secondary equity offerings in the REIT arena, primarily due to REITs in general trading at a premium to net asset value,” says John Arabia, an analyst with Green Street Advisors.

So far this year, FelCor Lodging Trust Inc., Equity Inns Inc., Winston Hotels Inc., Ashland Hospitality Trust Inc. and Innkeepers USA Trust have all gone to the public markets — to either cash in on low coupons for preferred stock or take advantage of high price to FFO multiples and raise common stock.

Historically, stocks in the sector traded at price/FFO multiples between 4 and 11, with the average being 7, says David Bulger, CFO of Innkeepers USA Trust. Now, many stocks are trading at 12 times FFO.

Arabia says the high multiples are a result of three factors: hotel REITs are at or near trough earnings; alternate investments, from bonds to stocks, are at low yields or high price-to-earnings multiples as well; and the expectation is that hotel REITs should deliver significant growth over the next few years.

The forecast for M&A activity is cloudier, even though PricewaterhouseCoopers is predicting five to 10 M&A transactions this year — the highest level since 1999, when 11 major transactions closed.

One possible roadblock is that major hotel REITs like FelCor and MeriStar Hospitality Corp. will not want to take on any more non-core properties, which they've been selling in waves recently to strengthen their balance sheets. “People will be a little more careful and not gobble up portfolios,” Bulger says.

Recently, the major buyouts involved deals where at least one party was not a REIT. Over the past year, CNL purchased RFS Hotel Investors Inc. and KSL Recreation Corp., and The Blackstone Group, one of the country's leading private equity firms, acquired Extended Stay America Inc. for nearly $2 billion.

But M&A activity between REITs is difficult since share prices are high across the board, meaning there are no cheap deals. Also, REIT structures are prohibitive in that REITs must have third-party operators, and in some instances the CEOs have substantial interests in the management companies.

“I'm not hearing of a lot of M&A activity today,” says FelCor's Corcoran. “If it does occur, it will be very late in the year.”