|by Rick Swig - 1998
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
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:
The limited service economy and mid-priced segments are out of favor with
most institutional investors, as supply is too plentiful and barriers to
entry have diminished.
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:
Most crystal balls seem to be cloudy or slightly distorted, but if one
would venture a vision for the immediate future, the sights would reveal
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 new institutional buyers are pioneers. New ownership structures
and acquisition patterns are entering new territory, where there is no
historical reference. There are danger zones to be entered.
There is a risk of acquisition absurdity or synonymous development.
New development is not all bad, as there is certainly unsatisfied demand.
The question remains, however, about Wall Street’s satisfaction level and
the opportunity for both new capitalization and increased share value.
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
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