Sep. 8, 2006 - Chicago has become the hottest hotel real estate market in the country, with prices rising so quickly that some investors are cashing out in a year or less.

The phenomenon of "flipping"--buying a property and selling it quickly at a handsome profit--is cropping up repeatedly in this market, mirroring a national phenomenon stoked by strong growth in hotel performance.

"A lot of these investors become almost unintentional flippers," said Dan Fasulo, director of market analysis for Real Capital Analytics in New York. "They hit their return requirements several years earlier than expected, and the market is hot, so they go back to their investors and say, 'Does it make sense to sell?'

"There's a lot of opportunistic selling going on," he said.

That has helped propel the Chicago metropolitan market to the top spot in transaction volume this year, with $1.45 billion in deals through August, besting San Francisco, Manhattan, Dallas and Orange County, Calif., according to Real Capital Analytics. The Chicago metro market was No. 1 last year, too, with $2.4 billion in deals, skyrocketing from the No. 9 position in 2004, with $409 million in deals.

Contributing to the volume, in the past year and going forward, are a number of quick turnarounds.

On Thursday, an affiliate of JER Partners agreed to sell the Westin O'Hare in Rosemont to Ashford Hospitality Trust for $125 million, just 11 months after JER paid $106 million for it. Earlier this year, JER Partners sold the Westin Michigan Avenue for $215 million, about one year after buying it for $137 million--a deal that stunned local observers.

An investor group that includes real estate magnate Neil G. Bluhm last month agreed to sell the Conrad Chicago for $117.5 million, just 10 months after purchasing it for $86.5 million.

And more such deals are expected. Walton Street Capital LLC, where Bluhm is a principal, plans to sell eight Marriott Renaissance Hotels, including the riverside Renaissance Chicago, which it bought a year ago for $578 million.

Blackstone Group, which this spring bought MeriStar Hospitality Corp., is likely to begin selling some of the properties in that portfolio, observers say, including the Radisson Hotel & Suites at 160 E. Huron, and the Crowne Plaza O'Hare in Rosemont. The company did not respond to a request for comment.

And rumors are swirling that Hotel 71, which is being converted to a Solis condominium hotel, is likely to be sold. Its owners, a group that includes Falor Cos., bought it in April 2005 for $95 million. Robert Falor, head of Falor Cos., declined to comment.

The typical holding period on prime properties is shrinking. Now investors hold onto properties for one to three years, a significant shift from several years ago, when three to five years was more typical, said Melinda McKay, senior vice president of Jones Lang LaSalle Hotels, which handled the Westin Michigan Avenue and Conrad deals.

The windfall in the Westin deal "demonstrated how strongly the [downtown hotel] market recovered in a 12-month window," she said. "The price of the deal was up significantly, but the capitalization rate, or yield on the income the hotel produces, was similar, which shows how much cash-flow growth occurred."

Investors are paying dramatically more per room for hotel properties than they were last year.

Looking at the eight full-service hotels sold downtown this year through August, the average price per key was $233,000, a 36 percent spike over the 2005 average, according to Jones Lang LaSalle Hotels, a unit of the Chicago-based real estate firm of the same name. And the latest Conrad deal pierced the $300,000-per-key threshold for the first time in this market, McKay said.

Deals involving downtown full-service hotels have totaled $880.4 million this year, through August, and are expected to meet or beat last year's record volume of $1.4 billion, according to Jones Lang. In this subset, Chicago is third in the nation in transaction volume so far this year, behind San Francisco and New York.

The Chicago hotel business is in the midst of a positive cycle, fueled by strong convention lineups this year and next, and recovery in corporate business, said Richard Niedbala, vice president of the Midwest region for Plasencia Group Inc., a hotel brokerage and investment firm.

Downtown occupancy rates averaged 72.1 percent through July of this year, up from 65.3 percent in the same period two years ago, while the average daily room rate was $169.62, up from $139.02 in the first seven months of 2004, according to Smith Travel Research Inc. In fact, occupancy rates are in line with 2000, a banner year.

"The Chicago hotel market's recent strengthening and momentum is far from complete with additional gains in [revenue per available room] expected," said Monty Bennett, president and chief executive officer of Dallas-based Ashford Hospitality Trust, which Thursday announced its deal for the Westin O'Hare.

Nationwide, "there's an amazing dynamic of capital markets chasing real estate right now," said Fasulo, of Real Capital Analytics. "It's amplified in these markets everyone wants to be in, the global markets: New York, Washington, D.C., Chicago, Los Angeles, San Francisco."

Chicago was later to the recovery party than major markets on either coast, and its real estate prices remain a relative bargain, which is one factor contributing to the volume of deals, observers say.

Investors paid an average of $166,000 per room for hotels in the Chicago metro area during the 12 months ending June 30, a far cry from the $552,000 paid in Manhattan, the priciest market in the country, according to Real Capital Analytics.

Chicago also has benefited from the availability of some of its most prominent downtown properties, among them the Chicago Marriott Downtown, the Westin Michigan Avenue, the House of Blues Hotel and most recently, the Drake.

And it's part of a nationwide real estate transaction boom, fueled in part by private equity funds looking for a quick pop, and by real estate investment trusts seeking to demonstrate growth.

"Some REITs were formed eight to 10 years ago and haven't been able to show sustained performance," said Ace Lanahan, vice president with Philipsborn Co., a Chicago mortgage banking firm.

Booms don't last forever, and this one could be deflated by another geopolitical upheaval, rising interest rates or rising hotel-room supply. There are more than 3,500 hotel rooms in the pipeline for downtown Chicago, according to Jones Lang.

But some observers think this one still has legs, at least in the short-run.

"Properties are selling at or a little above replacement costs, particularly in urban centers, as a result of what is expected to be two to three more years of good operating growth," said Bruce Ford, senior vice president of Lodging Econometrics, in Portsmouth, N.H.

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