Wall Street invaded the hotel sector with a vengeance in 1996, and the hospitality industry has not been the same since.  The pressure to invest in hotels has been high and the winds of change have blown at gale force for the last twenty four months.  The emergence of public capital triggered a feeding frenzy that began with “one off” hotel asset purchases, evolved into portfolio acquisitions, and then blossomed into mergers or strategic alliances, which have forced industry followers to anticipate “major announcements” as a matter of daily course. 

The hotel industry used to be a menage of publicly and privately operating companies, management companies, and private or institutional investors.  Now, there are C-Corps, REITs, paired share REITs, and “paper clip” REIT/Corporate structures, which have replaced many of the traditional stake holders.  These are the new institutional investors who have taken on the ownership roles, as previously played by insurance companies and pension funds. 

The most successful buyers have been the REITs with more available and less costly capital (50 basis points cheaper at a minimum).  The REITs are more aggressive purchasers than the opportunity buyers or funds, whose return parameters are more clearly structured and limiting. 

The traditional institutional investors, pension funds and insurance companies, have stepped away from owning individual assets.  Now they invest in public companies to diversify, spread their risk, and maintain liquidity.  There is a hint that pension funds are entertaining individual purchase or development opportunities in the resort segment or urban full service settings when either the development serves a distinctive market or is protected by significant and tangible barriers to entry.  These entities are still more selective due to their own stringent underwriting criteria. 

As the frenzy to purchase has escalated, so have prices for highly desirable hotel assets.  Values for hotel assets do seem to be at or close to the top of their current potential.  The last of the high yield opportunities may be fleeting.  Certainly, acquisition strategies are becoming more targeted and selective with regard to product types or market segments. 

There probably has been “too much money chasing too few deals”, and as one institutional investor noted, while wishing to stay anonymous, “increasingly poor spending habits, the re-entry of the commercial lenders, and new supply for the wrong reason must mean that we are at the top of the cycle.” 
 
Current acquisition strategists seem to have sense of urgency to chase assets before equity becomes unavailable, while the targets are clearly full service hotels with the following attributes: 

• 250-350 rooms or more with suitable meeting space 
• upper upscale brand representation or potential
• rebranding or repositioning potential
• locations with barriers to entry of new supply

Additionally, as United States options are lessening, institutional buyers are looking globally to Canada, Asia, and Europe.  Some North American market places such as Dallas, Chicago, Austin, Phoenix (resort segment), Seattle, and Vancouver are either becoming too expensive or too risky due to limited barriers to entry or a slow down in revenue growth. 

As prices for hotel purchases have accelerated risk, other issues have also become factors: 

• Double digit growth potential for public companies may disappear as financial growth becomes limited to “internal growth” from operations rather than “external growth” from mergers or acquisitions.
• Funds from operations may show lower growth potential.  Occupancy rates are peaking due to new supply and the inability to accommodate demand in markets with high occupancies, ex. New York.  Average daily rates will increase but not at current levels, although inevitable inflation will support rate increases at some point.  Increased operations expense efficiencies may begin to harm customer service.
• Unsatisfied demand and the rising cost of acquisitions near or above replacement cost are creating new supply initiatives through development.  One REIT officer stated that “stupid money” paying too much for assets will trigger other “stupid money” to build unnecessary hotels.  Although unsatisfied demand can soften the landing, occupancies will be diluted by new supply by 2000 or 2001.
• Higher airfares may slow travel and hotel room demand.

• The most successful hotel segment will be the upper upscale segment, as this segment has not shown a decrease in demand in a decade.
• Supply will increase in the upper upscale segment whether through conversion or development. 
• Institutional investors will become more conservative buyers to protect capital which may not be as easily forthcoming from secondary offerings in the public markets.
• REITs will begin to optimize their portfolios.  Less desirable hotel assets purchased at lower costs in earlier acquisition waves will be offered for sale in “one off” fashion to raise capital for more desirable assets or to fund investor dividends.
• Further portfolio optimization will take place, as institutions will achieve either segment or geographic balance by recycling assets between themselves.  Some “inter-league” asset for asset trading may be achieved through matching values based on individual hotel asset net operating incomes.
• Sellers will begin to lower their expectations, as institutions begin to slow down or at least become more conservatively selective in their purchasing approach.