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Hotels Rivaling Apartments As Choice Targets for Investors

Cash-Flush Institutions and Private Buyers Alike Are Pulling Off Big-Ticket Deals Across All Lodging Formats -- And in Some Surprising Locales
July 20, 2011
A number of large multi-property hotel acquisitions in recent weeks by Hyatt Hotels, Pebblebrook Hotel Trust and Chatham Lodging Trust illustrate the rising appetite for hospitality investments, a quest that's quickly spreading beyond REITs to other institutional and private investors.

What's more, prospective buyers are trolling for more than just the top-quality inns and resorts on the U.S. coasts, now looking at deals in such large inland metros as Pittsburgh and Denver.

About $11.36 billion in U.S. hospitality properties traded hands in the first half of 2011, up 134% from $4.9 billion in the first half of last year and up eightfold from the market doldrums of first-half-2009, according to preliminary sales volume data from CoStar Group.

That compares with a 79% increase for retail, and 71% and 61% increases for office and multifamily, respectively, in 2011 over the first six months of last year. Total sales for all commercial real estate types has risen 67% this year through June 30 to $129.4 billion.

The upsurge is fueled by not only by upscale purchases such as the trade of the Mondrian Los Angeles, sold in May by Morgan Hotel Group to Pebblebrook for $137 million, but sales such as last week's acquisitions by Hyatt Hotels of Lodgeworks LP's extended-stay portfolio and Chatham's acquisition of five hotels from Innkeepers USA Trust for $195 million as part of a bankruptcy sale.

In an environment of improving operating fundamentals as reported by CoStar last week, REITs, with their ability to raise vast sums of equity and their low cost of capital, have been the most aggressive buyers of hotels over the last 18 months, particularly in the top U.S. markets of New York, Washington, D.C., San Francisco, Los Angeles and Miami.

"Big-ticket sales are back," said Bob Webster, managing director of Jones Lang LaSalle Hotels, who noted that the number of transactions exceeding $100 million in the first six months of the year rose to the third-highest amount on record for that time period.

Growth by acquisition is reflected in the second-quarter results of Host Hotels & Resorts, Inc. (NYSE: HST). Host's purchase of 14 properties over the last year helped drive revenues and earnings in the most recent quarter, the Bethesda, MD-based company reported Wednesday. Host revealed it has agreed to acquire the 888-room Grand Hyatt Washington, D.C. for $442 million.

Those hotel companies that don't already have acquisition partnerships in place are forming them at an increasing clip. North Palm Beach, FL-based Driftwood Hospitality Management, LLC, this month announced a $400 million joint venture with a real estate investment fund managed and advised by affiliates of Apollo Global Management, LLC to capitalize on the recovering hotel sector by purchasing, renovating and reflagging full-service hotels across the country.

"Investors are aggressively re-entering the hotel market. [REITs] have been trading at strong multiples and have been able to access the equity markets, while private equity funds have raised significant sums of capital and the debt markets are more active, which has led to the significant increase in activity," said Arthur Adler, managing director and CEO-Americas of Jones Lang LaSalle Hotels.

While single-asset sales drove most transaction activity in the first six months, accounting for 90% of deal volume -- mostly sales of high-end properties in major urban areas with strong in-place cash flows -- large portfolio and M&A transactions could dominate in the second half.

The brisk sales pace seen so far, combined with several large pending multi-property deals scheduled to close before the end of the year, should push total 2011 transactions valued at $10 million and above to at least $16 billion for the year, up from JLL’s previous forecast of $13 billion, Adler said.

"The significant increases we continue to see are a very bullish sign that the sales activity among hospitality assets continues to broaden," said Chris Macke, senior real estate strategist for CoStar.

Hyatt Hotels Corp. (NYSE: H) last week said it agreed to buy 24 properties for about $802 million in cash from private developer LodgeWorks and its private-equity partners to expand its extended-stay lodging business.

Other recent mega transactions include Pebblebrook and Denihan Hospitality Group’s $910 million investment in six Manhattan hotels, and Palm Beach, FL-based Chatham and Cerberus Capital Management, L.P.’s winning bid of $1.13 billion in a bankruptcy auction in early May to acquire 64 assets from Innkeepers USA Trust.

The bankruptcy court approved the Innkeepers reorganization in late June and the transaction is scheduled by close by the end of the month. Also approved by the court was last week’s other large multi-hotel sale, Chatham nearly doubled its holdings in the $195 million acquisition at $255,235 per key of five additional properties from Innkeepers, a subsidiary of Apollo Investment Corp. The properties totaling 764 rooms are in Orange County, CA, San Diego, Washington, D.C., Tyson’s Corner, VA and San Antonio.

That said, distress seems to be easing somewhat in hotel financing. Although CMBS loan delinquencies for hotels are still second-highest among all property types next to multifamily, lodging delinquencies plunged 150 basis points to 13.87% in June, according to Trepp.

While investors have been able to buy hotels at an attractive price per key relative to replacement costs in those markets, limited new supply and high barriers to entry are starting to produce a high uptick in net operating income (NOI) performance, said Jones Lang LaSalle Hotels Executive Vice President Adam McGaughy during this week’s Midwest Lodging Investors Summit at the Hyatt Regency McCormick Place in Chicago.

Keen competition, limited availability of product and compressed yield in the largest metros are sending REITs and other buyers afield looking for deals in other markets such as Philadelphia, Pittsburgh and Denver, McGaughy said.

While REITs accounted for 45% of the sales volume during the first half, private equity investors -- relatively silent during the downturn -- have re-emerged this year as debt markets have loosened. Private equity groups accounted for 25% of purchase volume in the first quarter, a figure which jumped to 46% in the second quarter, JLL reported.

W. Edward Walter, chief executive and president of Host Hotels & Resorts, told analysts on Wednesday that some transactions the company has looked at indicate that "private capital has become a more aggressive player" in bidding for properties.

"As the debt markets improve, we would expect to see private capital become an increasingly competitive player in the acquisition world," Walter said.

The debt market has improved palpably -- even for new construction in certain top markets. Cushman & Wakefield Sonnenblick Goldman and Starwood Property Trust (NYSE: STWD) last month announced the completion of a $23 million refinancing and arrangement of up to $13 million in construction financing for the City Club Hotel in Midtown Manhattan, allowing for the construction of up to 66 additional rooms to be built above the existing small luxury hotel.

"The availability of creative capital for the hospitality sector continues to increase with each passing month," said Jared Kelso, a Cushman & Wakefield Sonnenblick Goldman senior director, adding the lender's ability to structure a non-recourse construction financing loan "speaks volumes about the outlook and availability of capital for high quality hospitality assets, particularly in major markets."
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