Hotel Owners Look to Cash in on Industry's Favorable Fundamentals and Higher Yields

HOT FOR HOTELS: Private Equity Buyers Eye Hospitality Leaders

Only a few years ago, with the hospitality industry in full boom, hotel IPOs were all the rage with companies like Sunstone and Strategic Hotel Capital making their debuts as REITs as investors who had carried hotel properties through the downturn following 9-11 turned to the public markets to cash out.

Now the capital cycle has turned and the private equity buyers rule the roost. Blackstone Group's acquisition last year of MeriStar Hospitality Corp. signaled the arrival of the private equity players. Several other hotel REITs and chains have since traded hands and the signs indicate that more may be sold soon.

The market is buzzing that Starwood Hotels & Resorts Worldwide Inc. (NYSE: HOT) might be the latest REIT -- and one of the biggest in the hospitality sector -- to be the next take-over target for private equity players.

Earlier in the week, Steven J. Heyer, the CEO of the White Plains, NY-based REIT, was asked to resign by the board of directors over issues stemming from his management style. That's led to rampant speculation that the REIT is positioning itself for a possible sale.

That news coincided with the announcement that Winston Hotels (NYSE: WXH), a Raleigh, NC-based REIT with 53 hotel properties in 18 states, struck a definitive agreement to be acquired by Inland American Real Estate Trust Inc., a public, non-traded REIT that is an affiliate of The Inland Real Estate Group of Cos. Inland outbid Wilbur Acquisition Holding Co. with an offer of $15 per share or roughly $458 million.

Meanwhile, shareholders of Four Seasons Inc. (NYSE: FS) voted today in favor of selling the Toronto-based hotel company for about $3.37 billion, including debt, to an unlikely trio consisting of Microsoft's Bill Gates, Saudi Prince Alwaleed Bin Talal and the company's CEO, Isadore Sharp. The transaction is expected to be completed in the second quarter of 2007.

It's not surprising that the industry is flush with M&A activity and take-private deals right now. There's still plenty of capital chasing real estate deals and the hotel sector has performed extremely well over the past few years, bouncing back stupendously from the woes that plagued the travel industry following the terrorist attacks on 9-11.

The industry had a record-breaking year last year in investment sales, reaching $70 billion in worldwide property trades, according to Jones Lang LaSalle Hotels. But, the large company-level and chain sales reflect the appetite of private equity players to efficiently park their capital -- a hunger matched by REITs to get more bang for their buck.

"The smart-money guys, private equity, think that certain assets and businesses are undervalued. They are value players. They think the hospitality industry and hotel assets, the public market is simply not valuing those businesses or assets correctly and therefore they can buy them cheaply by taking them private and they'll harvest the value later," said Jim Butler, author of Hotel Law Blog and chairman of the Global Hospitality Group at Jeffer Mangels Butler & Marmaro LLP.

Private equity players are also able to raise virtually unlimited amount of money for these colossal purchases, which has altered the game somewhat. Blame it on Blackstone -- the New York private equity king kicked off its phenomenal buying spree with its $2.6 billion acquisition of MeriStar Hospitality Corp. and its portfolio of 57 luxury, full-service hotels last year.

Then there's Morgan Stanley Real Estate's acquisition of CNL Hotels & Resorts for about $6.6 billion or $20.50 per share in cash. As part of that deal, CNL agreed to sell a portfolio of 51 properties in that deal to Ashford Hospitality Trust (NYSE: AHT) for $2.4 billion.

Other deals include the $3.9 billion sale of the Fairmont Hotels & Resorts Inc. chain to a venture between Kingdom Hotels International, which is owned by a trust for a Saudi Prince and his family, and Colony Capital. Cleveland-based REIT Boykin Lodging Co. (NYSE: BOY) last year for $416 million to a venture between Westmont Hospitality Group and Caisse de dépôt et placement du Québec.

More than a few REITs and public hotel companies will continue to go private because investors are chasing returns and hotels have good returns, said Thomas E. Callahan, chief executive officer - West for PKF Consulting Corp. "If they're looking for a place where they can buy large groupings of hotels, the REITs are the first place they'll look,"

Hotel properties typically offer higher yields when compared to other real estate asset types. While good quality office properties are trading at a 5% capitalization rate, comparable hotel properties are trading for cap rates at 6% or 7%, providing a better return, Callahan said. "The threat of new supply is pretty limited, there's a significant uptick in travel, demand is growing favorably and it's extremely expensive to build a hotel right now. Hotels are a favorable place to make an investment over the next three to five years," he added.

Dana Ciraldo, an executive vice president with Atlanta-based hospitality brokerage Hodges Ward Elliott, agrees that the hotel sector has got a three- to five-year window of above-inflationary revenue increases. But, he adds, this expansion may be better than past cycles, because of the favorable supply/demand scenario. Supply is growing at about 1% a year, compared to demand, which is growing close to 4%, he said.

The disparity between supply and demand has been fueled largely by the double-digit growth in construction costs over the last two and a half years and the highest and best-use challenge created by the run-up in values on the residential side, he said. Ciraldo's firm handled close to $6 billion in hotel trades in 2006, a record year for the company.

Of course, there is a bit of risk associated with the hotel sector, too. For one, it is so closely tied to the economy and the GDP. In fact, room demand is almost at a 1:1 ratio with the GDP, Butler said. "It is riskier than other types of real estate because the values depend significantly on an operating business. In other words, you don't have 10- to 20- year leases -- you sell your rooms by the night."

The hotel industry is poised to enjoy a record year in profits with $29.7 billion projected in income before taxes, according to PricewaterhouseCoopers LLC. That would make it the highest amount in at least 25 years.

Operating fundamentals are also expected to remain strong through the year. PWC LLC is forecasting an overall occupancy level of 63.3%, a 5.8% increase in the average daily room rate and a 5.8% increase in revenue per available room (RevPAR).

And investment sales for 2007 are expected to remain strong for the industry, fueled no doubt by big portfolio and M&A deals. In fact, Butler expects the M&A activity, not just to continue, but to accelerate.

"Given the amount of capital available, literally all of the hotel brands could be purchased today. The entire hotel industry could be purchased today," Butler said. "The capital is available, it's an industry that's attractive. Something that was unthinkable a few years ago is now a reality."