Hotel Online   Press Releases 
Real Estate Industry Fundamentals Strong In 1997; KPMG Peat Marwick LLP's
National Real Estate Practice Sounds Cautionary Note
 

CHICAGO, Jan. 29, 1998 -  Nineteen-hundred and ninety-eight likely will be a pivotal year for the U.S.
real estate industry, according to KPMG Peat Marwick LLP's National Real Estate Practice. While fundamentals
remained strong, values for a majority of property types continued to rise and real estate investment trusts
experienced a record year in 1997, there are signs that future imbalance -- if not kept in check -- may signal the
beginning of a downward spiral rather a continuance of the bull real estate market, the Practice observed.
"This past year was stellar for the real estate industry," said Ray Milnes, newly appointed National Industry
Director of Real Estate for KPMG. "Securitization, institutional ownership, globalization of investment and
technology have created an exciting industry that is reshaping itself.

"The positive forces currently at work in the industry might not be sufficient to avert another cyclical downturn
in the future," he added. The near-term health of the real estate industry will be due, in large part, to a continued
healthy, robust economy. "The strong economy has been a significant driver in this current real estate cycle,"
said Milnes. He added that the wild card in the continued bull run of the real estate industry will be the ability of
the economy to remain strong with inflation and interest rates remaining low. The impact of the current
uncertainty surrounding global markets casts a cautionary shadow on the economy's ability to sustain its growth.

"As a result, we are hopeful that there will be selectivity and restraint with regard to speculative development and debt and equity investment practices throughout 1998. Given the abundance of capital searching for deals,
prudent underwriting of investments in real estate by investors and lenders will be needed to sustain the market's
upward trend for the foreseeable future," said Milnes.

Lodging Industry: Year of the Mega-Mergers

The U.S. lodging industry experienced its third consecutive record year in 1997, with industry-wide profits reaching all-time highs, according to KPMG. Property values, particularly in the upscale category, also increased throughout the year.  "Most significantly, however, 1997 will be remembered as the year of the mega-mergers," said Frank Nardozza, partner and national hospitality industry director.

Last year's most notable mergers include Starwood Lodging's announced multi-billion dollar acquisitions of ITT
and Westin to create one of the largest hotel companies in the world; the Promus/Doubletree merger; and Patriot
American's acquisitions throughout the year of Wyndham, Carnival Hotels and Interstate. Nardozza predicted
that these organizations likely will continue making acquisitions in 1998, with Patriot looking to broaden its
international reach in particular.

How will the mergers affect the lodging industry as a whole? Nardozza predicted that small and mid-sized hotel
companies will have a particularly difficult time competing against the hotel goliaths because of their buying
power and lower cost of capital. This will have significant implications for the industry in general.

"In 1998, hotel companies will need to evaluate not only their competitive positions in the marketplace but their
position in the capital markets as well," said Nardozza. He predicted many companies -- Hyatt and Omni included
-- will be forced to grapple with the question of 'acquire or be acquired?'

The outlook for the hotel giants is not all rosy in the coming year, however, said Nardozza. "Analysts will be
carefully studying the Starwoods and Patriots to see how much profit these organizations can deliver to the
bottom line," he remarked. Challenges for these companies in 1998 also will include increasing organizational
efficiencies, cutting overhead and integrating the acquired organizations to deliver and reap the benefits
promised to Wall Street, according to Nardozza.

Nardozza also warned that a potential "construction boom" in the hotel sector over the coming years may
negatively affect the industry's health. He cited newly announced construction projects in the top ten largest U.S. cities in the full-service and upscale categories -- both resort and city-center luxury hotels -- that could threaten
the favorable balance between demand and supply.

Reaching Equilibrium in the Office Market Segment

"Continued decreasing vacancy levels and increasing rents over the past four years have brought the office market back to near equilibrium once again in most major markets," said Milnes.  According to the Practice, the current national downtown average vacancy rate is approximately 11.5%, while the suburban office vacancy rate is faring a bit better at slightly less than 10%, compared to 14% and 11% respectively, one year earlier.

"The strengthening economy and bolstered workforce over the past several years have been the catalysts for the increased demand in office space across the country," Milnes said, adding that net absorption of downtown
space exceeded 29 million square feet in 1997. In turn, according to Milnes, this significant growth has increased
office market rents to the point where some level of development is feasible once again.

"Development in the suburban market appears to be supportable at this point, but only if done so at a reasonable
rate," he said. "Developers and investors must show restraint or we are liable to tip the scale back to the scary
levels of overbuilding we experienced in the late 80's-early 90's," he added.

"Currently, the industry is already seeing some controlled spec building in suburban office markets, such as
Dallas, where absorption has been strong," reports Milnes.

Given the current economic climate, Milnes expects to see the strength of the downtown and suburban office
markets continue for at least one to two years, with a general tightening in major markets as large, class A space
is absorbed. Overall, cities characterized as information technology and financial centers, such as Chicago,
Boston, New York, Seattle and San Francisco, have faired the best during the industry's long road to recovery.
"As prices for downtown office buildings are still below replacement cost in many markets, this sector is
receiving the greatest attention from investors," Milnes concluded.

REIT Industry Strong

According to KPMG, real estate investment trusts (REITs) are among the strongest segments of the real estate industry today.  The industry raised a record amount of capital in 1997 -- nearly $40 billion -- and more than 20
initial public offerings, compared to six in 1996 and eight in 1995. "Clearly, there is capital out there for the industry to continue to grow," said John H. Davis, national director of REIT services, who predicted that
1998 likely will be another capital-raising record year.

A significant trend occurring in this sector, according to Davis, is securitization. Increasingly, privately-held real
estate is being acquired and managed by REITs. With approximately ten percent of this 1.5 trillion market
currently under REIT control, the securitization of real estate will be a major trend over the coming years.
With the maturation of the REIT market, however, new challenges face REIT management, Davis observed. REITs need to continue to address issues such as determining an appropriate capital structure, dealing with rating
agencies and managing the day-to-day operations of a public real estate company. "At the same time, REITs need to demonstrate that they can meet analysts' expectations," he added.

Davis recommended four basic tactics for managing a REIT in a competitive market environment: 1) Focus on
quality properties rather than portfolio size; 2) Reduce cost of raising capital to increase opportunities for growth; 3) Manage the process and act like other public companies against whom you compete for investors' dollars; and
4) Communicate clearly a specific message that articulates a consistent strategy in investor relations, financial
reporting and other positioning tactics.

Demographics Will Drive the Construction Sector

The U.S. construction industry has undergone significant change over the past several years, according to John L. Callan, national director of construction for the Practice.  Although the beneficiary of a strong U.S. economy over the past several years, the industry has been forced to significantly increase productivity, largely as a result of the global marketplace.  "The adoption of improved processes and use of enhanced technology across all sectors of the construction industry will be crucial for sustained growth and improved profitability going forward," said Callan.

Despite these changes, however, the total construction market is expected to decline slightly in 1998, according
to some industry analysts. Residential construction was strong and declining office vacancy rates and rising
rental rates improved commercial construction in 1997. However, as activity matures in both residential and
commercial construction, there will be a decline in new activity in 1998, particularly should interest rates rise
significantly. "Economic uncertainty in the year ahead, including potentially higher interest rates in 1998, is a
large factor in why some forecasts show activity slowing down," observed Callan.

Long-term, demographics will continue to shape the construction industry. The baby-boom generation will
continue to dominate the housing construction market. By the year 2010, the number of households aged 45-64
will increase by 50 percent. "This population largely will be responsible for whatever major construction trends
develop over the next decade," he said.

Callan also cited reports of the population shift toward the South and West and away from the high-density areas of large cities. Approximately 35 percent of the population lives in the South, while the West is home to eight of
the nation's fastest growing states. According to industry analysts, 60 percent of the U.S. population will reside
in the South and West by the year 2010. "We should see significantly greater demand for residential, commercial
and industrial development in these regions within the next five years," Callan added.

Shrinking Spreads Likely to Curb Wall Street Profitability

According to Jeff Oliver, partner-in-charge of KPMG's Mortgage and Asset Finance group, 1997 witnessed the
continued evolution and growth of commercial mortgage backed securities and conduits as viable financing for
commercial mortgages. At the same time, however, Oliver notes that as a result of abundant capital flows and the
run by various conduits to achieve increased volume, the market has begun to witness shrinking spreads, a trend
likely to be the single most significant issue affecting the commercial mortgage market in 1998.

"If this (shrinking of spreads) continues to occur," claims Oliver, "I think we're going to see a role filled by some
of the banks' capital markets entities that have sufficient capital and access to the marketplace. The primary
reason for this is that if the spreads continue to shrink, so will the profitability of these CMBS transactions for
Wall Street," he said.

In light of shrinking margins, Oliver believes there will be increased demand among lenders in 1998 for more and
better quality data on the underlying assets. "The demand for more sophisticated data will enable commercial
mortgage bankers to better assess their sensitivity to the marketplace and, ultimately, their value of holding
various instruments on a long-term basis," he said.

Oliver also contends that for the first time in many years, the commercial/multifamily financing market is
experiencing fundamentals similar to the current residential market. He notes that in 1997, some commercial
mortgage companies simply were breaking even on the origination process with the goal of potentially picking up securitization or, more importantly, servicing revenue.

"That's exactly where the residential market is today," said Oliver. "Residential lenders sell through the market,
subsidize it, etc., on the front end, with the hopes of getting some profitable servicing. So we're seeing some
evidence that the commercial/multifamily lenders are, in fact, mimicking the same trend of what has happened in
the residential world."

The Real Estate Legislative Front

The "Taxpayer Relief Act of 1997" generally was favorable for the real estate industry, according to the Practice. "The enactment of the capital gains reform provision was the industry's biggest legislative accomplishment in 1997," said Chuck Walker, national director of Real Estate Tax Services at KPMG.  In 1998, look for owners to try to lock in as much capital gain as possible for properties being developed, which will be taxed at ordinary
income rates."

In general, real estate executives will be looking at taxes just as hard as other cash expenses such as interest and
utilities in the coming year, Walker observed. With comparatively low interest rates and rising real estate prices,
many real estate owners already have used their tax loss carry forwards and once again are beginning to pay tax.
By employing strategies to maximize depreciation deductions, deferring gain recognition on sales and utilizing
other creative strategies, companies are effectively increasing their after-tax yield on their investments," Walker
said. "And with merger and acquisition activity expected to continue at a rapid pace, tax planning will continue to
play a central -- and often overlooked -- role."

Meanwhile, in the real estate capital markets, investment bankers and sophisticated tax planners continue to look
for the next "holy grail," according to KPMG. "The goal is reducing the cost of capital and increasing overall
yield through the creation of products in response to a market need," said Walker. He cited new structures such
as "paper-clipped" REITs, which simulate the advantages of the few grandfathered "paired share" REITs. Other
examples of creative financial engineering include "synthetic lease" structures that allow corporations to keep
real estate off their balance sheets for financial accounting purposes while enjoying the benefits of owning real
estate for tax purposes.

"Creative tax planners and Wall Street will continue to play 'three dimensional chess' by balancing market
economics with incredibly complex accounting and tax rules to reduce the overall cost of capital or provide
growth strategies," Walker concluded.

KPMG Peat Marwick LLP

As a leading business advisor to the real estate and hospitality industry, nationally as well as internationally, KPMG Peat Marwick LLP's Real Estate, Hospitality and Construction Practice provides a full range of integrated consulting, tax, and assurance services to clients in commercial and residential real estate, hospitality, construction, REIT and REMIC industries, as well as real estate portfolio investors.  Some of the services the Practice's professionals provide their clients throughout the globe include portfolio management, performance improvement, strategic planning, capital market alternatives, acquisitions and dispositions, and financial modeling.

KPMG Peat Marwick LLP is the U.S. member firm of KPMG International, the worldwide professional services
firm. KPMG International has more than 6,000 partners and 76,000 professionals serving clients in 153 countries.
In the U.S., KPMG partners and professionals deliver a wide range of value-added assurance, tax and consulting
services. The firm is moving toward becoming the leader among professional services firms in capturing,
managing, assessing and delivering information to create knowledge that will help its clients maximize shareholder value. Additional information about the firm is available on KPMG's World Wide Web site (http://www.kpmg.com).

KPMG Real Estate Industry Contacts:
For local market focus (more than 25 markets)
Please contact:
Ray Milnes
National Industry Director, Real Estate
(Ph) 312-938-5023
Andy Stankiewicz
 The Financial Relations Board
(Ph) 312-640-6767
John Callan
National Director of Construction
(Ph) 510-419-1275
John Davis
National Director REIT Services
(Ph) 619-525-3212
Frank Nardozza
National Hospitality Industry Director
(305) 789-2642
Jeff Oliver
Partner-in-Charge of KPMG's Mortgage and
Asset Finance Group
(Ph) 202-467-3000
Chuck Walker
National Director Real Estate Tax Services
(Ph) 312-938-5256
 

Back to Hotel.Online Press Releases   Go to Hotel.Online Search