Hotel Investors Inflate Property Prices Past Demand for Lodging
Record prices being paid by investors for U.S. hotels may be outpacing gains in room rates and stays as the slow economic recovery damps a lodging revival.
Prices for lodging properties climbed to about $185,000 a room in the first quarter, according to research firm Real Capital Analytics Inc. Values had peaked at $153,000 per room in 2006, then plunged 37 percent to a low two years ago.
This year’s jump is the result of a surge in luxury-hotel transactions and more purchases by real estate investment trusts, particularly in large cities. While lodging occupancies and rates are climbing, the gains aren’t enough to keep up with prices being paid for some full-service properties, said Rick Kleeman, managing partner at Wheelock Street Capital LLC, a real estate investment firm in Greenwich, Connecticut.
“Asset prices on average have led fundamentals,” said Kleeman, whose company bought the Courtyard San Diego Downtown and the Hyatt Westlake Plaza, both in California, this year. “Obviously you have fundamentals improving, but clearly the economy is not picking up as fast as we had hoped. It’s not the ’06 or ‘07 crazy market but, on average, the market has run ahead of itself.”
Occupancies in the top 25 U.S. markets climbed to 63 percent in the first quarter from 60 percent a year earlier, according to Smith Travel Research Inc. of Hendersonville, Tennessee. At hotels with the costliest rooms, stays rose to 67 percent from 63 percent.
The U.S. recovery is showing signs of slowing. The Standard & Poor’s 500 Index has tumbled 5.9 percent from an almost three- year high in April, and manufacturing, employment and housing are trailing economists’ estimates.
Increases Since Lehman
In the 24 months following September 2008, when Lehman Brothers Holdings Inc. failed, contributing to the U.S. recession, hotels fetched prices as much as 71 percent higher than during the lodging industry’s peak, according to New York- based Real Capital.
The JW Marriott New Orleans sold in February of this year for $94.3 million, up from the $55 million price paid in January 2008. The Hilton Garden Inn Chelsea in New York City sold in September 2010 for $68.4 million, 24 percent higher than its $55 million price in October 2007, Real Capital said.
Values have gained even outside major cities. The Holiday Inn in Oak Hill, West Virginia, sold for $3.5 million in July 2010, up 40 percent from when it last sold, in September 2007.
“Pricing is pretty aggressive,” Barry Sternlicht, founder of real estate investor Starwood Property Trust Inc. (STWD), said in an interview at the New York University International Hospitality Industry Investment Conference in New York on June 6. “Even for generic hotels you get 20, 30 bids.”
‘Well Below’ Peaks
Daily room rates averaged $94.05 last year, and revenue per available room, an industry measure of occupancy and rate, was $42.40, according to Real Capital. That’s “well below” the 2008 peaks of $106.65 and $54.42, said Ben Thypin, an analyst at the firm.
Hotel sales in the Americas are likely to jump as much as 25 percent this year, Jones Lang LaSalle Inc.’s hotel investment-services unit said on Jan. 4.
Values have been driven up chiefly by demand from REITs, which purchased $1.6 billion of hotels in the first quarter. That’s 44 percent of those traded and five times the total of REIT purchases in all of 2007, the peak year for hotel sales, Real Capital said.
Mondrian Los Angeles
REITs are focusing on full-service properties in large cities. This week, Pebblebrook Hotel Trust (PEB) agreed to buy stakes in six New York boutique hotels for $152 million, and earlier this year bought the Mondrian Los Angeles for $137 million and the W Hotel in Boston for $89.5 million. Pebblebrook planned to spend $400 million to $600 million on hotels during the balance of 2011, Chief Executive Officer Jon Bortz said in April.
Sunstone Hotel Investors Inc. (SHO), the Aliso Viejo, California- based owner of 33 lodging properties across the U.S., in March agreed to buy a majority stake in the Hilton San Diego Bayfront hotel, valuing it at $475 million. The property, completed in December 2008, originally cost $350 million, according to its developer, Atlanta-based Portman Holdings LLC.
Sunstone acquired the hotel at a valuation of 13.4 times 2010 earnings before interest, taxes, depreciation and amortization, “meaningfully below our corporate EBITDA multiple,” Sunstone President Kenneth Cruse said in an e-mail.
“Our valuation of the hotel is a function of its in-place cash flows, protected location, future growth potential and competitive supply trends -- all of which are very attractive,” he said.
‘Justify a Price’
“If people are buying at par or a slight premium, they can justify a price with future growth,” said Charles Pinkham III, vice president of development at Portman.
That reasoning has contributed to hotel capitalization rates, a measure of investment yield, falling to record lows of 4 percent last year, according to Steve Rushmore, president and founder of HVS, a hospitality-consulting firm. He expects rates of 3 percent to 5 percent in the luxury tier, and 4 percent to 7 percent for upper-upscale properties, the segment one level below luxury.
“Pricing even at midscale hotels is pretty aggressive at a 6 percent cap rate,” Sternlicht said during a panel discussion at the NYU hospitality conference. “Usually it’s more around 9 to 10 percent.”
New York Hotels
In April, FelCor Lodging Trust Inc. (FCH) agreed to buy the Royalton and Morgans boutique hotels in New York City from Morgans Hotel Group Co. (MHGC) for $140 million, or about $500,000 per room. FelCor expects a minimum cap rate of 5 percent at the hotels, said Stephen Schafer, a company spokesman.
FelCor, based in Irving, Texas, looks for acquisitions that, “purchased at a substantial discount to replacement cost, will earn a 10 percent cash yield within a short time,” he said in an e-mail.
Some buyers say the prices being paid for hotels are justified as long as they’re below what it would cost to build the same property at the same location from the ground up.
“When you buy below physical replacement cost at a time nobody is building, it’s usually a good investment,” Jonathan Gray, co-head of real estate at Blackstone Group LP (BX), said at the New York conference.
Pebblebrook, based in Bethesda, Maryland, seeks properties priced at 20 percent to 50 percent below the cost of building new, CEO Bortz said in an April interview.
In some cases, hotel values have begun to creep ahead of even replacement costs, Mark Elliott, a partner at Atlanta-based brokerage Hodges Ward Elliott Inc., said at the NYU conference. That may be the first step toward a resumption of hotel construction. In such cities as New York, “hotels are routinely trading at $200,000 per key above what it would cost to replace them,” he said.
“Hotel demand is closely correlated with overall economic growth, so if you think you know what 2014 hotel demand is going to be, you’d have to know what 2014 GDP is going to be,” said Kleeman of Wheelock. “We are less certain we have that answer. One thing you can say for sure for hotels is things can change overnight.”
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