The worst is past. That's the consensus of hotel experts who believe that the lodging sector hit bottom in the third or fourth quarter last year and has embarked on a modest, yet steady, recovery. The upturn is marked by rising occupancies and stabilizing room rates after a couple of years of free-fall.

Proof of the improving fundamentals became clear in late May when some 150 investors, sniffing impending upside in the marketplace, gathered in New York for a marathon 18-hour bidding session for the bankrupt Extended Stay Inc. chain of 680 properties.

A consortium that included Blackstone Group and Centerbridge Partners ultimately prevailed, paying a rich $3.93 billion in cash in a deal that would repay nearly all of Extended Stay's $4.1 billion first mortgage.

The price was higher than the low value of $2.8 billion earlier put on the chain by Extended Stay advisors. The winning bid was bolstered by capital contributed by J.P. Morgan Chase & Co. and Deutsche Bank AG, quashing fears that U.S. banks would not be willing to invest in hotels this year.

There is an emerging confidence in the hotel sector this year that the Extended Stay acquisition only confirmed. Investment firm HEI Hotels & Resorts, based in Norwalk, Conn., has purchased four assets since February and is hunting for more. The firm acquired a new W Hotel in Hollywood, the 202-room Le Meridien in Philadelphia, the 222-room Hotel Minneapolis and another Le Meridien in Dallas, using up about 25% of a $515 million investment fund.

“We consider this a very good time to buy. We expect to be active acquirers over the next 18 months,” declares Russell Urban, senior vice president of acquisitions and development at HEI. Urban predicts that bank lending to hotel investors will remain limited this year, but that won't deter private-equity funds with their own capital and REITs that have raised money in public stock offerings from engineering cash-heavy deals.

“We're well capitalized and can do all-equity deals if we have to,” says Urban. The big carrot, he adds, is valuations that have fallen to 40% of replacement cost in some cases.

Delinquencies pose problems

Hotels posted the highest delinquency rate among all property types in May, reports research firm Trepp. The 30-day delinquency rate rose to 18.45%, up from 17.16% in April.

But the industry has had encouraging news. Lodging demand in the first quarter jumped 5.3% over last year, the largest single quarterly increase since 1989 and easily surpassing the 2.6% gain forecast by PKF Hospitality Research of Atlanta.

“We've certainly been surprised at how strong the recovery in demand for rooms has been this year,” says Mark Woodworth, PKF's president. “Lots of travelers — both corporate and leisure — who postponed trips last year are on the road again.”

Daily rates drop

Still, Smith Travel Research based in Hendersonville, Tenn., estimates that daily hotel rates have fallen nearly 4% so far this year to $96.73. “As corporate travel continues to improve we'll see the rates firm up,” says Bobby Bowers, senior vice president of operations.

A drastic cutback in new hotel supply is helping fundamentals. Lodging Econometrics of Portsmouth, N.H., forecasts that 80,830 hotel rooms will open in the U.S. this year, down 55% from the 147,982 opened in 2009. Openings will slide in 2011 to 63,141, the firm projects.

“I think we'll see a growing number of acquisitions in the second half of this year,” says Patrick Ford, president of Lodging Econometrics. More than $6 billion in U.S. hotel assets had traded hands by June 1 this year, well above the $2 billion total for all of 2009, though far less than the $46 billion peak in sales in white-hot 2007. Most observers estimate 2010 sales at about $10 billion.

Arthur Adler, CEO of Jones Lang LaSalle Hotels in New York, says buyers are finding capital for new hotel acquisitions. “We've taken properties to market recently that got between 15 and 30 bids. That's far more than we were getting a year ago.”

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