San Diego Risks Deal Slowdown

REPORT FROM THE U.S.—After a frenzied transactions environment in which San Diego saw its highest ever number of sales and dollar volume in a six-month period, the bustling hotel market is finally facing a hurdle: Who will fill the void left by the real-estate investment trusts that have gone silent?

Hotel REITs, led by the likes of Host Hotels & Resorts and Chesapeake Lodging Trust, previously had a cost-of-capital advantage that allowed them to outbid competitors—driving hotel values to record-setting heights in the process.

For the first six months of the year, hotel sales in San Diego County increased 475% with total dollar volume up 6,428.4% to approximately US$1.5 billion, according to Atlas Hospitality Group’s 2011 Mid-Year California Hotel Sales Survey. The market was second only to New York in terms of dollar and sales volume, the survey found.

The largest and most expensive hotel sale in San Diego for the first half of the year was the US$570 million paid for the 1,625-room Manchester Grand Hyatt in San Diego, which Host bought from Manchester Resorts in February.

But market volatility has taken its toll on the stock markets thus far into the second half of the year, and the public hotel REITs largely have been forced to the sidelines.

“San Diego’s a target market for us. We like the fundamentals in the market. We think the underlying demand and supply fundamentals that we see today just works for future investment,” said Doug Vicari, CFO and executive VP at Chesapeake. “… But as a public company with a stock price that has been devalued by what‘s happening the market, it will be difficult to continue to make investments in the short term until our currencies rebound a little bit.”

Chesapeake in June acquired the San Diego Gaslamp Quarter hotel from InterContinental Hotels Group for US$55.5 million, or approximately US$264,000 per key.

The departure of Chesapeake and other public REITs has created an opening for private equity buyers, many of which were unable to compete with the public players for much of the year. But they’re going to have to overcome a group of sellers spoiled by lofty, REIT-driven valuations, said Alan Reay, president of Atlas Hospitality Group.

“Private equity has been waiting on the sidelines, but the concern is that sellers have been spoiled by the prices that REITs have been paying, which runs anywhere from 20 to 25% above where private equity players are at,” he told the Hotel Investment Barometer via email.

“If the sellers still expect to get REIT prices, then there will be a slowdown in the sales market. If the seller is motivated then they will have to be realistic on their price expectations,” he added.Whether sellers’ pricing expectations come back to earth has yet to be seen. While REITs are unlikely to re-enter the buying game, at least in the short term, the San Diego market itself is almost as unlikely to see a slowdown in performance given its diverse demand drivers, Reay said. 

“San Diego is a desirable hotel market, with year-round, favorable climate, beaches, diverse economic base, expanded Convention Center, Gas Lamp District and Ballpark downtown and proximity to Mexico,” he said.

Through August, the city’s posted a 3.5% gain in occupancy to 71.5%, a 3.4% increase in average daily rate to US$128.12, and a 7% rise in revenue per available room to US$91.65, according to STR, parent company of the Hotel Investment Barometer.

Key deals
Other than the aforementioned sale of the Manchester Grand Hyatt, there was one other hotel that sold for more than US$100 million during the first half of the year: the Westin San Diego Gaslamp Quarter, which Pebblebrook Hotel Trust bought for US$110 million in April from Starwood Hotels & Resorts Worldwide, according to STR Analytics, sister company of the Hotel Investment Barometer.

Other deals larger than US$20 million include:

Source: STR Analytics

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