By Anwar R. Elgonemy Associate PKF Consulting � San Francisco

March  1999 - With occupancies and average daily room rates still strong in most of the nation�s markets, expense efficiencies achieved by hotels have allowed the improved margins to flow into net operating income, heightening the attractiveness of lodging properties as an investment category.  Despite such favorable underlying operating fundamentals, underwriting parameters for hotel acquisitions are very restrictive.  However, such confining parameters have not deferred the turnover of lodging assets in California, the nation�s �nirvana� economy.

Since world bond markets tumbled in mid-August 1998, institutional investors have been seeking havens for their capital, and buyers of commercial mortgage-backed securities � pools of loans sold by investment banks as securities yielding an interest rate to pension, mutual, and hedge funds, comprising close to 70 percent of overall lending in the U.S. - have been demanding greater returns.  The �spread� � the difference between the yield offered on these securities and that paid on Treasury securities � has since widened.  For investment banks, the wider spreads have cut into the profits to be made from reselling the loans as securities.  In reaction, banks have pulled back on making new loans, and investors are finding it harder to get money to buy hotels.  In many cities throughout the nation, the commercial real estate markets have also slowed significantly since last August.  In California, though, no notable slowdown in the number of major hotel transactions has been recognized, highlighting the ongoing strength of the state�s hotel investments climate.

According to a recent survey by PKF Consulting, 23 major full-service hotels (with a selling price above $25 million) were sold in California in 1997.  Of these 23 properties, 13 occurred in Southern California with the balance in Northern California.  Most of the transactions took place in Southern California since there is a larger pool of properties to acquire within this vastly urbanized region of the state.  In 1998, the number of major full-service hotels trading in the state as a whole was 19, with the majority (60 percent) still occurring in Southern California. 

With the abundance of capital flowing around the real estate sector in 1997, any viable property with a scent of upside potential was quickly grabbed.  In 1998, this trend did not change much, and it seems that the available inventory has yet to dry up in Southern California.  However, the selling price of Northern California hotels, on a per guest room basis, is much higher.  The average price per room in 1998 for a major hotel in Southern California was approximately $164,000, compared to $242,000 per hotel room in Northern California.  In 1998, the major hotel sales in Northern California traded at multiples averaging 12 x net operating income (or an 8.0% cap rate), compared to the lower average multiple of 11 x net operating income (9.0% cap rate) in Southern California.  This variance is partially attributed to stricter building codes and the lack of available land in such areas as the San Francisco Bay Area, Napa Valley, and the Monterey Peninsula, making an existing hotel asset more valuable to an investor.

The question is, will this turnover in California�s hotel assets continue in 1999?  Within the hotel industry�s financial sector, there is still a concern that the easy money has already been made, and that the growth and momentum investors have sold their positions and have not yet been replaced by value investors.  Yet, as REIT companies are being forced to sell because of their declining stock prices and expensive capital, more affordable hotels compared to last year�s prices will be placed on the California market over the coming months.  In addition, it is expected that capital should become more available by the second quarter of 1999, as world financial markets stabilize after the Brazilian and Russian contagion, hotel owners� valuation expectations become more realistic, and the dynamics of capital supply and demand once again interact in a more rational manner.  This means that the Golden State will see another strong year for hotel transactions, continuing to be the place where national trends are defied.