This spring, the Real Estate Report checks in with Paul Whetsell, president chairman, and CEO of CapStar Hotels. His comments that follow indicate his two-pronged business focus, the acquisition and effective management of full-service, first class hotels. He also stresses the need for a watchful eye on the real estate cycle that helps him determine which of these two focuses receives his greatest attention at any given time.

Real Estate Report: EquiStar Hotel Investors was formed approximately two years ago through a joint venture between CapStar Hotels and Acadia Partners, LP-an investment partnership led by Robert M. Bass. EquiStar today owns a geographically diverse portfolio of full-service, first class hotels throughout the U.S. CapStar exists as one of the largest hotel management companies. Can you please provide us with a brief history and background for Acadia and CapStar prior to the formation of EquiStar?

Paul Whetsell: CapStar Hotels started in 1987 and grew to 40 management contracts by 1994. While we had invested in real estate in a small way, we were looking to become more active in the ownership of properties. As we looked for capital, we knew we wanted to stay private and create real value. Acadia Partners is a $1.8 billion investment fund managed by Oak Hill Partners and sponsored by Robert Bass. In January 1995, we partnered with Acadia to form the acquisition fund, EquiStar Investors, to buy full-service, first class hotels.

RER: What were the circumstances or motivations that led to the formation of EquiStar?

Whetsell: It was basically our belief that the real estate values of full-service, first class hotels would rise dramatically, and we wanted to participate in that more than as just a management company.

RER: How is EquiStar currently capitalized?

Whetsell: EquiStar is currently capitalized by debt and equity. The debt is supported by Lehman Brothers.

RER: What are the respective roles of CapStar, Acadia, and EquiStar?

Whetsell: EquiStar is the investment vehicle used to buy hotels. CapStar is the management company that runs the properties and manages the EquiStar portfolio. Acadia is an investment fund managed by Oak Hill Partners; it is a partner to both EquiStar and CapStar

RER: Over a two-year period, EquiStar acquired 11 full-service hotels in an intensely competitive acquisition market. How does EquiStar source acquisition opportunities? Is there a formula or strategy consistently applied by EquiStar in making acquisitions?

Whetsell: First of all, for our sourcing, we have five executives on our development staff who are proactively going into the marketplace seeking acquisitions. Secondly, we work closely with the real estate brokerage community and the large institutional owners of hotels (like insurance companies) to identify acquisition opportunities. As far as a formula or strategy, we've stayed consistent with acquisitions of full-service, first class hotels in markets that offer multiple demand generators. We acquire hotels typically less than 15 years old in active, growing markets and in compliance with environmental, fire, and life-safety requirements. We're looking for an internal rate of return in the low- to mid- 20 percent range.

RER: What new markets is EquiStar currently targeting for growth and expansion? Is international expansion under consideration?

Whetsell: We're targeting major, growing market areas in the United States. We are not considering major international acquisitions at this time because we're finding enough opportunity in the U.S. markets we know well.

RER: With mammoth buyers in the marketplace such as Host Marriott, Hilton Hotels, Starwood Lodging Trust, and Patriot American Hotel REIT, how does EquiStar effectively compete for new hotel deals?

Whetsell: Number one, we are very proactive in seeking out opportunities. Secondly, we are an integrated operating company that can analyze deals from an operating standpoint very quickly. Third, we are an all-cash buyer. And fourth, we can close very quickly. These four elements allow us to compete very favorably against larger organizations.

RER: Now turning to the management side of the business, could you briefly describe CapStar's current portfolio of managed hotels?

Whetsell: Today we are operating 47 hotels nationwide. We manage 36 non EquiStar hotels, they are basically full-service franchise properties, and 11 EquiStar hotels.

RER: Is there an overriding management philosophy followed by CapStar in operating its hotels?

Whetsell: CapStar is a very results-oriented company. We believe we have the ability to analyze operations and put our money to use very quickly through renovation and repositioning of hotels to provide high rates of return on investment. We have what we call an integrated planning process, involving our field operating staff and our corporate staff - all monitored through our comprehensive financial control system.

RER: To what extent is CapStar aggressively pursuing new management opportunities beyond the relationship with EquiStar?

Whetsell: We continue to seek out third-party management opportunities, but that is clearly not as active today as it was in the early 90s . Most of our opportunities include some form of investment in the properties.

RER: The field of independent hotel operators is wide and intensely competitive. To what extent do you believe independent fee management opportunities will exist in the future?

Whetsell: On the answer to that, as I just noted, there's a lot less opportunity today for third-party management than in the late 80s or early 90s. Management opportunity will continue to exist for management companies who have the ability to invest in the deal.

RER: What competitive market forces are most influencing EquiStar's and CapStar's present business plans?

Whetsell: I think, above other factors, we're watching the real estate cycle very closely with regard to purchase opportunities. We still think there are excellent opportunities to buy in the full-service, first class market segrnent, but pricing is becoming more efficient and values are going up. So we're watching that cycle very carefully to determine when we are more likely to focus on more management and less acquisition. But right now, we're still acquiring hotels.

RER: What key challenges will EquiStar and CapStar face over the next few years?

Whetsell: EquiStar and CapStar need to lower their cost of capital in order to stay competitive in the acquisition of hotels. So the sourcing of cheaper capital and a continuing focus on operating effectively as we continue to grow are our key challenges.

RER: Significant amounts of capital are now flowing into the lodging industry from Wall Street and from foreign and domestic pension funds. Do you believe fresh, affordable capital will continue to be readily available in the lodging industry over the next few years?

Whetsell: I believe there will be more than sufficient debt capital for the industry; and I do think you'll see a lot of opportunistic equity starting to leave as the returns go down. This will be replaced by public funds and more patient pension funds on the equity side.

RER: So many innovative ideas have been bantered about the lodging industry in recent months, yet it seems that there really hasn't been any evidence of a hotel company coming up with a truly "breakthrough" strategy that will reshape the future of the lodging industry; What is your vision of the successful, leading-edge hotel company of the year 2000?

Whetsell: I can tell you what we want to be. We want to be known as a great operating company that has the financial skills that allow us to continue to grow. But the key part of being a leading hotel company is being an effective operator. So we're spending our time figuring out what the customer wants today and will want tomorrow, with the belief that this will make us successful and leading edge into the next century.

The Real Estate Report is published by KPMG's National Real Estate, Hospitality, and Construction Practice. © 1996 by KPMG Peat Marwick LLP All rights reserved. For additional information email KPMG.

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