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Memphis Marriott

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The Lodge & Spa at Cordillera

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The Chase Park Plaza

After a surprisingly strong Q4 of 2012 (7.3% overall increase), RevPAR has continued to accelerate during the first quarter of 2013. Week to week results are choppy due to holiday timing, but US average RevPAR increased 8.2% through February 16. Luxury, Resort and Urban properties have led the way so far in 2013, with RevPAR increases of 14.5%, 13.6% and 11.1% respectively. Economy and midscale have generally lagged the overall averages, posting numbers in the 5% range YTD, consistent with the notion that lower-income travelers continue to be most affected by the sluggish economy, while the other scales (Upper Upscale, Upscale and Upper Midscale), which accommodate the vast majority of business travel, have performed near the overall average. Suburban properties, however, have lagged the averages, for reasons discussed below.

Although not shown on the chart below due to space limitations, a very important factor beginning to show up in the numbers is group vs. transient. Group has been significantly off for several months as continuing economic uncertainty make advance booking decisions difficult. Year to date transient RevPAR is up 13.5%, while group is up only 2.1%. This is the primary reason that suburban upper upscale hotels have been underperforming, as midweek mid-size corporate group has been a tough sell; the independent upper-tier hotels have also been lagging in this area.

The strongest markets YTD have been New York (which is actually being helped by Hurricane Sandy), New Orleans (helped by the Super Bowl), Miami and Oahu, which are running in the 20% range. Washington DC was also solid due to the inaugural, as were Nashville and Houston. Laggards included Norfolk, Philadelphia and Chicago, as well as San Francisco, which was one of the top performers last year.

Source: Smith Travel Research, Deutsche Bank, Sun Trust Robinson Humphries

As usual, the public company higher-end brands follow the overall trends. In Q4, the luxury brands were weaker than the upscale ones. Starwood’s mid-priced brands such as Four Points and aloft/element actually did much better, gaining 8-10% for the quarter, and the best performing Marriott brand was Spring Hill Suites (a mid price extended stay brand) at 7.7% for the quarter and 7.8% for the year. It is noteworthy that Le Meridien is the first high end brand to show a quarterly decline in RevPAR since Q1 of 2010. However, all major brands are continuing to show guidance of 4-7% for 2013 RevPAR, which is consistent with PKF, STR and PWC forecasts; as will be discussed, the wide range is primarily due to uncertainty about the direction of US economic policy.

Source: Company earnings releases

Outlook

The general sentiment of the industry continues positive although clouds are still gathering on the horizon. At the recent annual ALIS conference held in LA which was attended by thousands of hospitality executives, seldom was heard a discouraging word. The unexpected drop in GDP during Q4 was shrugged off, as it was attributed to Hurricane Sandy, which was probably a net positive for the industry due to displacement of homeowners and mobilization of FEMA workers, and cutbacks in government spending, which currently only affect a handful of markets. However, at least on the surface, the fundamentals are still strong, as supply growth is still well below historical levels (although as noted below it is starting to pick up), and the demand from corporations and higher end individual travelers is persistent. Occupancy is generally fully recovered, which means that compression during peak periods can support higher room rates, and hotel revenue and yield management is becoming more sophisticated in order to take advantage of these opportunities.

As is normal in this part of the cycle, new supply is starting to catch up, especially for urban select service, generally 200 keys or less. These hotels have high operating margins compared to full service properties, and ADR’s have recovered enough to justify new development especially in the current low interest rate environment. Markets such as New York City, Washington DC, Denver and Nashville are seeing above-average construction activity, and new hotels will be opening soon in Boston, Philadelphia, Orlando, Miami and Chicago as well as many smaller markets. On the other hand, Hawaii, Atlanta, Seattle, San Francisco and Dallas are seeing minimal present activity, in some cases due to the scarcity of available sites but in other cases (Dallas and Atlanta) it is because the markets are not fully recovered and numbers still do not pencil for new construction.

Even though the “fiscal cliff” was averted by a last-minute deal, fights over the debt ceiling and spending will continue to create uncertainty for the financial community, which is bound to have some effect on hotel demand, particularly from the government sector and for large group meetings. On the operations side, rising healthcare and energy costs are a matter of concern, although the industry may have dodged a bullet with the recent favorable court decision on the NLRB recess appointees, which means that new rules designed to encourage unionization may not be implemented.

Transactions

2012 finished the year at about the same level as 2011, with about $17.5 billion of transactions in the Americas (per Jones Lang LaSalle). However, single asset transactions were down, as the mix leaned more towards portfolio sales including Blackstone’s purchases of Motel 6 ($1.9 billion), Apple REIT Six ($1.2 billion) and Eagle Hospitality Properties ($600MM). Another major transaction was Starwood Capital’s acquisition of In-Town Suites for $735MM. Some of the more noteworthy single property acquisitions in the 4^th quarter included:

• Plaza Hotel (New York): $575MM (Elad Group to Sahara India Pariwar)
• Dream Downtown (New York): $220MM (Hampshire Hotels & Resorts to Sahara India Pariwar)
• The Madison (Washington DC): $145MM (Jamestown Properties to Loews Hotels)
• Sofitel Chicago Water Tower: $125MM (GEM Realty Capital to Blackstone Group)
• Beekman Tower (New York): $85MM (Lone Star Funds to Silverstein Properties et al); possible residential conversion.

As has previously been noted, most of the buying is being done by private entities, although a couple of the REIT’s, most notably LaSalle, Pebblebrook and Summit (in the limited service sector), have been very active lately. Chesapeake is also back in the game, having completed its equity issuance, and Sunstone has disposed of some properties and completed a new equity offering which will give it more dry powder.

The outlook for 2013 is expected to be more of the same. Most experts think that transaction volume will be up a little, but will still be concentrated in the gateway markets (New York, Chicago, Washington and Miami accounted for over 1/3 of the volume in 2012). Everyone is still waiting for the “great deleveraging” when the lenders and servicers finally pull the plug on the vintage 2006-07 CMBS deals that are still cluttering up the pipeline, but there is still a very large gap between seller’s expectations and what buyers are willing to pay. Much of this is because of product type and location. The suburban upper-upscale product is not in great demand right now because of changes in corporate meeting patterns leading to significant reduction in group occupancy, and these hotels are also becoming tired and in need of extensive PIP renovations to maintain their brand affiliation. They are also being targeted by some of the new select-service products that have entered some of these markets, especially the “hipper” boutique brands such as aloft that appeal more to younger business travelers (who are notoriously less brand loyal than their older counterparts).

In any event, 2013 is off to a busy start, with several deals announced in the first seven weeks of the year, including:

• $293MM Marriott Marquis Atlanta (1,663 keys) sold by Host Hotels to an Abu Dhabi investor
• $210MM portfolio of hotels in Rochester MN (home of the Mayo Clinic) sold by Sunstone to a private investor
• $180MM sale of the Flatotel (New York) out of bankruptcy to a group that will probably convert it to residential use; this buyer (Chetrit Group) also bought a Miami Beach hotel for $117MM from Blackstone last month
• $170MM sale of the Liberty Hotel in Boston from the local developer to LaSalle REIT
• $120MM sale of the Clift San Francisco to HPT, who continues to grow through their Sonesta acquisition into the upscale segments
• $112.5MM sale of the Embassy Suites San Diego to Pebblebrook
• $104MM sale of five limited service Hiltons in the South (avg. price a surprisingly high $165K/key), acquired by Carey Watermark Investors from a private fund

A schedule of transactions from the past few months is shown below:

Public Company News

IPO, Financing, Mergers and Acquisitions

• Chesapeake Lodging Trust issued 8.3MM common shares, raising $166MM of net proceeds to be used for acquisitions; this is significant because the offering size was increased (in addition to the shoe being executed) and the price was above its IPO price. This stock is now trading close to its all time high of $22. Lead underwriters were JP Morgan, Deutsche Bank, Wells Fargo and RBC Capital Markets. They also closed on a $32MM mortgage loan on the Hilton Checkers Los Angeles, which is a 30 year amortizing loan at a 10 year fixed rate of 4.11%. This represented a 70% loan to cost ratio.
• Choice hotels announced a marketing alliance with Bluegreen Vacation Club, marking their first entry into the world of timeshare, as they too seek to move up the chain scale away from pure economy brands.
• Diamondrock Hotels announced that their COO, John L. Williams will be retiring and has engaged a national search for a successor. They also expanded their Board of Directors and appointed Bruce Wardinski to fill the new slot. Wardinski is CEO of Playa Hotels and Resorts. He was formerly CEO of Barcelo Crestline and has an extensive hospitality industry background.
• FelCor extended its $225MM secured line of credit at substantially improved terms; interest is at L+337.5 (no floor), with an unused line fee of only 10 bp. The facility is secured by 8 hotels and runs through 2017; JP Morgan and Merrill Lynch were the lead bookrunners.
• Starwood has authorized the repurchase of about $680MM worth of common stock, comprised of $500MM new plus $180MM left over from last year, when they bought back $320MM worth. Although such repurchases are generally good news for shareholders, it indicates a very conservative strategy by management, as they apparently do not have a better use for the capital, most of which was generated from asset sales.
• Marriott has also increased its buyback authorization to a total of 34 million shares, worth about $1.3 billion at current prices, which is approximately 12% of its float. It repurchased 31.2 million shares for $1.2 billion in 2012.
• Hersha also authorized a $75MM share buyback, which is interesting because they have been in acquisition mode. However, their balance sheet is relatively weak.
• A major shareholder of Strategic Hotels & Resorts sent a letter to the company pushing for its sale, citing the departure of its founder and long-time CEO Laurence Geller. The company views the letter as a means to incite a short-term lift in the stock price, which it has- it is up 13% in the last 3 weeks.
• Pebblebrook refinanced its New York portfolio (a JV with Denihan) with a $410MM non recourse 5 year fixed rate 3.67% loan.
• Red Lion appointed Jim Evans (former Brand USA director and Best Western CEO) to their board, along with Dave Johnson (who was their CEO when they were owned by KKR back in the 90′s), Mike Vernon (who was their CFO at that time) and Robert Wolfe, an investment banker.
• Sunstone had a follow on offering of 22 million shares (plus a green shoe of 3.3 million), priced at $11.80, which it used to redeem $179MM of  8% coupon convertible preferred stock and also provide some dry powder for acquisitions. Citigroup was the sole manager of the offering.
• Wyndham announced tender offers and mandatory redemption on some of its debt securities, looking to reduce their cost of capital in light of the currently favorable interest rate climate

Earnings

This is a summary of Q4 2012 earnings reported by major public hospitality companies:

*Generally excludes unusual items; figures are for FFO on REITS

Stock prices

Hotel stock prices have generally increased in line with the overall stock market so far in 2013, but they strongly outperformed in Q4 of 2012. Strong performers YTD include Strategic (rumored buyout), HPT (upscale acquisitions) and Ashford (improving balance sheet), while La Salle (overweighted in DC) and Diamondrock (renovation issues) have lagged. These same stocks have led and lagged for the period since bottoming out last November; in addition,

Publicly traded hotel company stock performance (US based companies with market capitalization in excess of $1 Billion plus selected companies over $500 Million)

 Source: Yahoo! Finance

 Other Industry News

• Penny Pritzker, a billionaire whose family founded Hyatt Hotels, is being considered for the post of US Secretary of Commerce. She is a long time Chicago associate of President Obama and was a key part of fundraising for his 2008 campaign.
• A controversy has erupted over the ground lease between the City of New York and the Marriott Marquis Times Square (owned by Host Hotels). The City contends that the Marriott got a sweetheart deal when they renegotiated the lease in 1998, which allows them to buy the ground for $20MM when the lease expires in 2017 (probably less than 5% of what it is worth). The City’s controller (who is possibly running for Mayor in the next election) says that Marriott has breached their contract by not providing certain financial records and owes interest on back rent, so he wants to use this as a lever to force renegotiation. Marriott officials, in turn, responded that the hotel anchored Times Square when the area was considered unsavory, created 1,500 jobs, paid a billion dollars in property taxes over the years and have paid every penny of rent that was owed.
• Red Lion Hotels announced that it was creating a new “soft brand,” called Leo Hotels. No one took them seriously until a few days later when it was announced that the first hotel to join Leo was the Las Vegas Hotel & Casino, the 3,000 room former Hilton property. However, ownership of this asset is in play and it is not clear whether Leo is a long term fit.
• Four Seasons Hotels announced the retirement of CEO Kathleen Taylor, a 25 year company veteran and one of the most prominent female executives in the lodging industry.
• Marriott is moving ahead with the development of a 1,500 room Gaylord resort near Denver, which had been on hold for several years due to economic conditions.
•  Drury Hotels, a relatively small (130 unit) upper midscale chain, has posted the world’s highest customer satisfaction rating in a survey from Market Metrix, edging out the likes of Ritz-Carlton and JW Marriott. Drury has won the J. D. Power and Associates midscale award for each of the last seven years.
• America’s Best Franchising has acquired the Jameson brand. Jameson, once an independent public company, has over 100 economy properties, primarily in the Southeast, and together with its affiliated management companies and other economy brands, has been fighting through a foreclosure attempt for the last two years.
• Former Molinaro Koger COO Jonathan Propp pled guilty in federal court to conspiracy charges stemming from a $20MM hotel “flipping” scheme that defrauded Host Hotels.
• The ADA mandated pool lift requirements went into effect January 31, after a mad scramble by hotels to comply. While most chain-affiliated properties were able to meet the deadline, there are anecdotal reports of smaller independent hotels being forced to close their pools. No reports have yet been received about enforcement or claims of discrimination being filed, but this is being watched closely, especially in California where there is a history of “drive-by” ADA filings that lead hotel owners to settle rather than face a lengthy, expensive court process.

Special Feature- Who is behind the brands?

Not to be confused with ownership of the real estate or day-to-day management of the properties, the franchising/branding of hotels is extremely concentrated. The top companies in terms of world-wide property count (not rooms count) are shown on the chart below. Figures are based on company websites and press releases and are approximate as of December 31, 2012.

Sources: National Bureau of Economic Research; various government agencies including US Department of Commerce

View Web Site:
Hyatt Place Lake Mary Orlando-North

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Hilton Garden Inn Phoenix Airport North

View Web Site:
Hampton Inn & Suites Tilton

HOTEL INDUSTRY OVERVIEW: Fall 2012

Summary of Key Performance Indicators

RevPAR trends have been decelerating. September’s 3.8% growth marked the lowest year over year change since the recovery began, although it was partly due to the timing of Labor Day and the Jewish holidays. October has been better (up 5.6%), but it is still lagging the performance of the first half of the year. There was also an impact due to Hurricane Sandy, with major Eastern markets taking a hit during the last week in October and first week of November. The consensus for full year 2012 has now edged down towards 6.0%, but still with more than half of the growth coming from average daily rate (ADR). No significant movement has been seen recently across the various chain scales or locations, as luxury and upper midscale (e.g. Hampton Inn) have continued to outperform, as have resort and urban locations, while small town markets and the lower end chains have not kept up. Regionally, Chicago and Los Angeles have accelerated in recent weeks, while the major Eastern markets (NY, Boston, Washington) have declined. New Orleans also continues its strong performance despite Hurricane Isaac. Florida, particularly Orlando, has slipped a bit as demand is lagging, while the Western markets have been steady.

Source: Smith Travel Research, JP Morgan North American Equity Research

The performance of major brands that are operated by publicly traded hotel companies lagged a bit during the 3^rd quarter (overall RevPAR for this group up 5.1% vs. 7.8% for comparable chain scales nationally). Bucking recent trends, Marriott brands including Ritz-Carlton, outperformed Hyatt and the Starwood brands, particularly the Luxury Collection, which went from 12.2% RevPAR growth in Q2 down to 5.1% in Q3. One of the reasons for this is the concentration of these brands in the major Eastern markets, which as mentioned previously are currently not doing as well. Note that there are several major upscale and upper upscale brands that are not part of public companies, most notably the Hilton family (including Doubletree, Embassy Suites and Homewood), and those are reportedly performing well.

Source: Company earnings releases

Outlook

Although the lodging industry has recovered significantly better than the overall US economy, the cycle has now matured to the point where a more normal growth rate would be expected. During the summer, the absolute level of hotel room demand (i.e. the total number of occupied hotel rooms) reached all time high levels, and due to stagnant supply growth (especially in the full service segments), occupancy is pretty much back to where it was pre-recession. ADR growth has been slower to rebound, and although it will be close to 2007-2008 peak levels in many markets by next year, it will still be lagging significantly if expressed in real (adjusting for inflation) dollars. As shown in the graphic on the next page, real ADR in 2011 is actually lower than it was in 1987, and is considerably below its 2008 peak. This graph also illustrates a couple of other trends in terms of recovery. Note that from its peak in 1987, it took 10 years for ADR to recover in real dollar terms, and this was during a period of steady economic growth, although there were large supply increases during this period. The recovery time from the 2000 peak only took 6 years, as this was more of a “V-shaped” recovery for both the economy and the industry. Now, however, the 2008 peak was much higher and we are nearly 4 years past it and there has been virtually no growth. Most industry experts feel that we will not see real ADR fully recovered for at least another 4 to 5 years, which is problematic on several levels. First of all, it is likely that at some point during this time the overall economy will contract, which will impact demand, and most importantly, at a time that rates are lagging, growth in expenses keeps chugging along. Going back to the earlier example, outside of consumer electronics, can you think of anything else that is even remotely close in price to what it was 25 years ago? To refresh your memory, in 1987:

• Price of a gallon of gasoline: 95 cents
• Price of a gallon of milk: $1.98
• Price of first class postage stamp: 22 cents
• Price of a new car: $13,000
• Minimum wage was $3.35 per hour
• Cost of one year at an Ivy league college: $17,000

What this means is that unless ADR growth continues at a rate that outpaces inflation, profit margins will necessarily fall.

The outlook for RevPAR growth in 2013 is still showing a wide spread, as the impact of the election results is still not entirely clear. The good news is that almost everyone believes that the “fiscal cliff” will be averted, as some sort of compromise will be reached to remove or delay the most serious consequences, namely sequesterization of spending and massive middle-class tax hikes (although the FICA tax holiday and extension of unemployment benefits will almost certainly come to an end). On the other hand, there are still lingering issues weighing down the economy, including (in no particular order), Eurozone uncertainty, slowing of growth in China, the impact of Hurricane Sandy (both short term and long term, including its effects on insurance premiums) and, as a result of the recent election, the impact of more regulations and a strengthened organized labor presence. The consensus seems to be settling in the 4% to 6% range, with virtually all growth on the ADR side, but there is optimism for the later part of the year and into 2014 as long as supply growth continues to be constrained.

Transactions

Once again, several high-profile sales (especially in New York) dominate the transaction news. It is also rumored that the Four Seasons hotel, currently owned by Beanie Babies magnate Ty Warner, is for sale at $900MM ($2.4MM per key). However, the overall pace continues to be sluggish. Total sales volume in 2012 ran at less than half of the 2011 pace during the first half of the year ($6 billion vs. $13 billion), but the second half of 2011 was very slow due to the collapse of REIT stock prices, which as shown later on, are still below last years’ levels. Whereas REIT’s accounted for about 35% of the volume in 2011, through August of this year they are only at about half that level (18%). Distressed asset sales as a percentage of total volume has also shrunk dramatically (from 31% last year to 12%), as improving fundamentals have helped sellers. What is also interesting is the continuing trend of the REIT’s (especially FelCor and Sunstone) to re-juggle their portfolios, typically moving from smaller markets to larger ones, as well as the continuing shedding of real estate assets by Starwood, Hyatt and Red Lion.

The good news is that pricing has improved (at least if you are a seller). Average price per key has increased by about 5% (although this may be influenced more by weighting towards urban locations), and cap rates have declined by almost 100 bp (national average is now in the range of 8.5% to 9%). Financing is much more readily available than it was last year, at least for well-located assets in major markets that are not over levered. Typical terms are 65% LTV, with interest in the 5% range (either fixed or variable). Amortization (typically on a 30 year schedule) is still common, but guarantees are becoming more negotiable.

Some of the highlights of deals made over the past few months are listed below. Additional details on these and other transactions in the past three months can be found on the chart on the following page.

• The 518 room Essex House on Central Park in New York was purchased by a joint venture between Strategic Hotels & Resorts and KSL for $362MM ($700K per key). It will be converted to a JW Marriott.
• Manhattan at Times Square (formerly Sheraton Manhattan): $275MM ($413K/key)- sold by Starwood, bought by Rockpoint
• Setai New York 5^th Avenue: $229MM (1.1MM/key)- private sale
• Ritz-Carlton Reynolds Plantation (Georgia): $160MM ($637K/key)- bought by Met Life at auction; price includes real estate, golf and other assets besides the hotel.
• W Chicago Lakeshore at $126MM/$242K per key and W Los Angeles at $125MM/$485K/key, both sold by Starwood and acquired by Chesapeake and Pebblebrook respectively
• Hotel Palomar San Francisco $58MM/$296K per key acquired by Pebblebrook
• In select service land, Summit Properties acquired a portfolio of 10 hotels, including 8 Hyatt Place hotels from Hyatt, for a total price of $115MM ($84K per key).

Public Company News

IPO, Financing, Mergers and Acquisitions

Recent activity included the following:

• Ashford replaced a $154MM non recourse mortgage loan which was at 12.72% interest with a $211MM facility at LIBOR + 615, representing a substantial cash savings.
• FelCor also improved its cash flow by refinancing about $160MM of 9% debt with sub 5% fixed rate debt.
• Strategic closed on a $90MM mortgage for the Hyatt La Jolla from Met Life. The $72MM A note is at L+400 interest only, and the B note is fixed at 10% with principal paid down from swept cash flow. They also had a major management change (see below).
• Chesapeake completed a follow on offering of 7.5MM common shares, which raised $132MM. Deutsche Bank, JP Morgan and Wells Fargo were the joint book runners.
• DiamondRock announced that they had reached a settlement in the bankruptcy of the Allerton Hotel in Chicago. They had purchased the debt of this distressed asset in the hope of a “loan to own” plan, but the hotel will now be marketed at auction in January 2013. However, they look to make a profit of over $10MM on their loan investment.
• Hersha expanded its credit line from $250MM to $400MM with further options to increase to $550M. The first tranche of the term loan portion of this facility will have a 3.195% interest fixed for four years. The facility was arranged by Citigroup and Wells Fargo.
• Intercontinental plans a $500MM special dividend during Q4 2012 and will also start a $500MM share buyback proceeds, which would be partially funded by the anticipated proceeds of the sale of their Barclay hotel in New York which is back on the market; this property is expected to sell for north of $300MM ($437K per key).
• Summit Hotel Properties, which as noted above has been in acquisition mode, closed a 12MM share offering which will net nearly $100MM. Deutsche Bank, Citigroup, RW Baird and RBC acted as joint book runners.
• LaSalle announced that Denise Coll, former President North America for Starwood, will be joining their board effective in March 2013.
• Red Lion called off its unsuccessful attempt to sell itself, and will continue to concentrate on selling its real estate assets while retaining franchises, as well as continuing to market franchises in the Northwestern US. Two key board members, brothers Donald and Richard Barbieri will retire as of December 31.
• Wyndham announced that it issued $275MM of asset-backed notes related to its timeshare receivables. Weighted average coupon was 2.06%. Note that the availability of financing for timeshare unit purchasers has fueled a resurgence in this market, especially in the moderate price segment (under $20K for a week-equivalent).
• Kayak, who only went public about 4 months ago, agreed to be acquired by Priceline in a $1.8 billion consolidation in the OTA space. The price ($40/share) represented a 57% premium above its IPO price.

Earnings

A summary of major hospitality companies that have reported Q3 earnings so far this season is shown on the chart below. Most companies had solid beats; note that the two exceptions in the chart below (Hersha and LaSalle) both have above average exposure to the East Coast. Guidance for 2013 RevPAR growth generally shows a broad range as would be expected at this juncture, but many companies have reduced guidance below analysts’ prior expectations. Also note that Q4 2012 RevPAR guidance was dramatically affected by Hurricane Sandy for several of these companies, including Hersha, Host, LaSalle and Sunstone.

*Generally excludes unusual items; figures are for FFO on REITS

Stock prices

Prices for large cap full service hotel companies have generally been crushed over the past few weeks, due to a combination of Hurricane Sandy, tepid earnings guidance and overall economic uncertainty. The REIT’s have given up all of their gains for the year, although Marriott (and to a lesser extent, Starwood) are still ahead. By way of comparison, the Dow is down 4.6% so far this quarter and is up 4.9% this year.

Publicly traded hotel company stock performance (US based companies with market capitalization in excess of $1 Billion plus selected companies over $500 Million)

Source: Yahoo! Finance

Other Industry News

• Marriott once again is facing a management contract performance lawsuit, this time at the Eden Roc resort in Miami, which they are managing under the Renaissance flag. The owners claimed mismanagement after they did a major renovation to the property, and attempted to physically remove Marriott from the premises. Marriott successfully obtained a restraining order, and another hearing will be held later this month, with arbitration expected.
• Lawrence Geller, the often controversial head of Strategic Hotels and Resorts, abruptly announced his resignation on November 2^nd, which immediately puts Strategic into play as a takeover candidate, with Host Hotels mentioned as a possible buyer as well as unnamed private equity firms. Geller is precluded from making his own bid for 18 months.
•  In a sign of the times, Choice Hotels closed a call center in Colorado, citing volume declines as their clientele is shifting towards the internet.
• Intercontinental Hotels is introducing a new brand, “EVEN Hotels,” which will have its first US location opening in New York in late 2014. This brand was “created with the frequent traveler in mind who wants to stay healthy while away from home.” They expect to have 100 managed and franchised properties signed up in the next five years.
• Niki Leondakis, former president and COO of Kimpton Hotels has been named CEO of Commune Hotels & Resorts, the company formed as a result of the merger of Joie de Vivre Hospitalilty and Thompson Hotels.
• A series of court rulings have affirmed that on line travel agencies (OTA’s) are not liable for hotel occupancy taxes on the fees that they charge; in other words, the guest must only pay tax on the net (wholesale) rate, not the gross (retail) rate. OTA’s hail this as a victory for their business model, while states and municipalities are concerned about declining revenues.

Special Feature- International Hotel Markets

Normally, we are focused only on the US, as there are still plenty of opportunities in the domestic markets, but global trends are becoming increasingly important as it becomes easier to move capital around. However, there are still many impediments to doing business overseas, including currency fluctuations, regulatory environment and other local customs. To illustrate, several years ago Doubletree was doing due diligence to acquire the Renaissance hotel chain (we were eventually outbid by Marriott), which had interests in several hotels in China. As part of this exercise, we had to review the management contracts, which of course were bulky documents all written in Chinese. When we asked for an English language version, it came out on one page. You think something might have got lost in the translation?

International market conditions vary widely by region. According to Smith Travel, the regions are defined as follows (key countries in parentheses)

• Americas
• North America (US, Canada and Mexico)
• Caribbean (Bahamas, Puerto Rico, Jamaica)
• Central America (Panama)
• South America (Brazil, Argentina)
• Europe
• Eastern Europe (Czech Republic, Russia)
• Northern Europe (UK, Scandinavia)
• Southern Europe (Italy, Greece, Spain)
• Western Europe (France, Germany)
• Middle East and Africa
• Middle East (UAE, Saudi Arabia)
• Northern Africa (Egypt, Libya)
• Southern Africa (Kenya, Nigeria, South Africa)
• Asia Pacific
• Central & South Asia (India, Pakistan)
• Northeastern Asia (China, Japan, Korea)
• Southeastern Asia (Indonesia, Thailand, Singapore)
• Australia/Oceania (New Zealand, Pacific islands)

As would be expected, hotel markets generally follow overall economic growth trends. Right now (as of November 2012), Europe is probably has the weakest economy, with China still experiencing the highest growth rates (although they are not as strong as they were a few years ago). Comparison of RevPAR growth is interesting, and it really shows the effect of currency exchange rates:

Source: Smith Travel Research

Within the regions, the areas showing the strongest growth (using US dollar comparison) include the Caribbean, up 11.3%, Northern Africa (up 10.1%) and the Middle East (up 8.0%), while the weakest areas are Northeastern Asia (down 13.4%), Southern Europe (down 8.9%) and Western Europe (down 6.9%).

The figures for publicly traded hotel companies with large international presences (note that regions may be divided somewhat differently) show some similarities in that Europe is consistently the weakest (especially Starwood for the quarter), but they are showing more strength in Asia than the STR data, which may indicate that upper scale properties are doing better over there.

Starwood (Q3 2012 vs. 2011)

• North America            + 4.8%
• Europe                        – 9.1%
• Asia Pacific                 + 0.7%
• Africa/Middle East     + 3.2%
• Latin America             +3.0%

Intercontinental (Q3 2012 vs. 2011)

• Americas                     + 4.6%
• Europe                         + 3.0%
• Africa/Middle East     +5.0%
• “Greater China”          +9.8%

Marriott (8 mo. ended Aug. 31 2012 vs. 2011)

• Caribbean & Latin America    +5.9%
• Europe                                     +3.3%
• Middle East & Africa             +8.8%
• Asia Pacific                             +10.1%
• North America                        +6.6%

In general, we would have to say that international markets are subject to the same pressures as US markets, but are much more volatile, as the impact of a Eurozone meltdown or slowing Chinese growth would obviously be more immediate. New supply may not be as constrained, as if a government wants to improve its tourism profile or promote new business, for example, it can order new construction. Most of the development activity is in China, where over 300,000 new hotel rooms are under construction and another 100,000 are in active planning. These numbers are by far the largest in the world, according to Lodging Econometrics. Other areas experiencing strong development include Indonesia, Panama and Brazil, while India (which is experiencing an economic downturn), Mexico, the rest of Central America and Europe are lagging.

US Economy General Statistics

There have been positive movements in almost all of the major economic indicators over the past few months:

Sources: National Bureau of Economic Research; various government agencies including US Department of Commerce

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Sheraton Gateway Los Angeles Hotel & Spa

Summary of Key Performance Indicators
RevPAR performance was generally solid across all segments and most major markets for the second quarter, continuing the trend for the past several quarters. Luxury and resort segments continue to outpace the rest of the industry. “Upper Upscale” brands such as Marriott and Hilton, especially those in urban markets, and “Upper Midscale” brands such as Hampton Inn are running about average in terms of RevPAR growth, while lower scale brands are lagging with YTD RevPAR growth in the 5% range, which implies that travelers are still trading up. As shown in the table below, it is becoming increasingly clear that occupancy is approaching peak levels, with ADR picking up more and more of the load, which is good for the industry but may start to be an issue as guest satisfaction levels are starting to trend downwards. A recent study by J.D. Power and Associates showed a 7 point drop in satisfaction since last year, which may indicate that the value proposition is no longer there. One of the biggest concerns was transparency in pricing, particularly for items such as internet service.

The California markets are continuing their strong performance despite concerns about that state’s economy. New Orleans and Chicago have also been steady performers, while Boston is doing very well due to a strong citywide convention calendar. Houston has also done well this year, riding an energy boom, and Nashville has come back, although there is significant new supply on their horizon. Florida is steady, with Miami and Tampa doing well while Orlando is in the middle of the pack as it continues to absorb supply. Washington DC continues to lag as the government cuts back on travel; recent GSA scandals and the threat of lower per diems will continue to create problems for markets that depend on the government sector. Other laggards include Denver, Seattle and Minneapolis. Phoenix’s overall economy is improving, but this is not reflected in the RevPAR numbers as they have a tough comparison with strong 2011 performance. By the way, hoteliers in London are rejoicing at very strong Olympic numbers- occupancy near 90% with citywide ADR the equivalent of about $350.

Source: Smith Travel Research, JP Morgan North American Equity Research

The performance of major brands that are operated by publicly traded hotel companies continues to closely track the national trends. While the upscale and upper upscale brands are relatively balanced between occupancy and ADR growth, luxury brands are skewing more towards rate, for example, even though the Le Meridien chain reported a slight drop in occupancy in Q2, we would not be too concerned as their occupancy rate for the quarter was still over 87%!

Source: Company earnings releases

Outlook
The fundamental picture in the lodging industry has not really changed in the past year or so. Additions to supply are still running well below historical levels (up 0.4% in the past 12 months vs. long term average of close to 3%), while demand continues to grow (up 4.0% in last 12 months vs. long term average which is also around 3%), which leads to occupancy growth which in turn provides the opportunity to raise room rates.

The industry is now hitting on all cylinders, as even the incentive segment that had dropped off the face of the earth during the recession is starting to reappear. Tourism continues to be strong as gas prices have leveled off and even dropped for a while, while corporate travel is also steady. In addition to the statistical barometers, the anecdotal indicators such as number of suits (and walk-up air fares) on the NY-Boston-DC shuttles, attendance at trade shows and openings of trendy restaurants are also positive. The former is a good illustration of sticker shock- it now costs about $900 for a round trip fare between New York and Boston; I may be dating myself, but I can remember when it was $14 full fare ($8 on a student or military discount) on the old Eastern Shuttle, and they would roll out another plane when they filled up the first one. You would just walk on the plane and instead of serving beverages, the flight attendants would walk down the aisle with a credit card machine to collect your fare.

Transactions
A couple of major deals this quarter, including

• Blackstone sale of four hotels (Boston, Washington, San Diego and Burlington VT) to Diamondrock for $495MM
• Host Hotels purchased the Washington DC Grand Hyatt for $400MM ($450K/key) after backing out of the deal last year
• Other REIT transactions by Sunstone, RLJ and Pebblebrook as buyers, while FelCor continues to sell assets
• Loews bought a 632 key hotel in Hollywood CA for an all-in cost of nearly $200MM

Also, it was recently reported that the Plaza Hotel in New York has yet another new owner- a 75% interest (60% from Israel’s Elad group and the rest from a Saudi Prince) was purchased by the Sahara group from India for $570MM. That would equate to about $2.7MM per key, but there are condominiums, retail and other factors which influence the price. The Israeli JV made out pretty well on the deal, reportedly netting almost a billion dollar profit, mostly from sales of condominiums.

Additional details on these and other transactions in the past three months can be found on the chart on the following page. There appears to be a lot of activity in the market, both from public and private buyers, although some industry sources believe that total volume is likely to be lower in 2012 than it was in 2011. The rationale for this is that EBITDA is expected to improve with rising ADR’s in 2013 and 2014 which would make pricing more attractive for sellers. Also, many CMBS extensions were granted over the past year at attractive interest rates (usually in exchange for a 5-10% pay down of loan principal), which freezes out those assets. However, should interest rates or cap rates turn due to changes in economic conditions, this could prove to be a missed opportunity for sellers.

In general, pricing is still very much on a two-tier basis, with prime properties in gateway markets trading in the range of 6% cap rates (12-14X EBITDA), while those in less favorable locations (or those needing significant capital improvements) are still trading “by the pound,” or in the $40-$60K per room range for full service hotels. Most of those do not even make this chart as the total dollar amounts of these transactions are less than the $20MM cut off. While there still may be some “fire sale” opportunities out there as lenders look to streamline their REO portfolios, many of those will require extensive PIPs as the brands are taking advantage of improving market conditions to force prospective owners to upgrade or risk being thrown out of their systems, which would be the kiss of death for many mid market and small market properties.

Public Company News

IPO, Financing, Mergers and Acquisitions
Recent activity included the following:

• Choice Hotels sold $400MM of 5.75% long term notes, the proceeds of which will be used towards paying a $600MM ($10 per share) cash dividend to stockholders, which raised some eyebrows on the Street. The company wants to take advantage of the low interest environment to lever up their balance sheet and pay out the dividend to pump up the share price (which has lagged well behind its peers), but unlike most of the public companies, Choice is a pure-play franchisor, and cannot simply grow through acquisitions. The jury is still out on this one.
• Chesapeake sold $120MM of 7.75% preferred equity, which will be used to pay down its revolver and towards future acquisitions. They have been relatively quiet on the transaction front lately, as they are still constrained by underperforming stock price and low liquidity, but they still reportedly have a solid pipeline, at least according to their bankers; the rest of the Street has a somewhat more conservative view.
• Diamondrock, on the other hand, was successfully able to raise $200MM of new equity which was used to fund a portion of the purchase price of the portfolio recently acquired from Blackstone.
• Breaking News (Aug. 7): The Gaylord deal to sell off its operating and branding business to Marriott while re-inventing itself as a REIT is back on track after it paid $185MM to buy 5 million shares from TRT, who had objected to the move. A shareholder vote scheduled for September 19 is now just a formality.
• Host Hotels took out a $500MM five year term loan. Proceeds will be used to finance its recent Washington acquisition as well as pay down its revolver and redeem senior notes. The note is floating rate with the spread dependent on leverage ratios; currently the rate would be L + 180 (or barely over 2%) with no floor. It was co-underwritten by several major institutions including Wells Fargo, Merrill Lynch and JP Morgan. Comparing these terms with some of the other recent transactions illustrates the gap between the “haves” and “have-nots” in the publicly traded hotel space.
• Hersha took out a $60MM term loan (four years plus a one year extension) at 4.32% to develop land it owns in Miami. Also, industry veteran Mike Leven (currently with gaming operator Las Vegas Sands, but who has held high level positions with US Franchise Systems, Holiday Inn and Days Inn) joined their board, replacing Thomas Capello, a retired bank executive.
• Pebblebrook expanded and lowered the rate on its revolving credit facility, which now is up to $200MM, priced on a grid between 175-250 over LIBOR, and also has commitments for up to $600MM in future term loans. They also did a $100MM secondary share offering in June, which is their third one since they went public in 2009. They are also currently considered to be a “have,” as their stock price has rebounded off a low of $14 last fall up to its current $22-23 range.
• Sunstone netted about $100MM from a secondary share offering, which will be used to fund purchases including recently acquired properties in Chicago (Hilton Garden Inn and Hyatt (formerly Wyndham) Miracle Mile).

Earnings
A summary of major hospitality companies that have reported Q2 earnings so far this season is shown on the chart below. Most companies had solid beats, but with a couple of exceptions generally kept their RevPAR guidance unchanged.

*Generally excludes unusual items; figures are for FFO on REITS

Stock prices
Prices for large cap full service hotel companies have been mixed, with C-Corps generally doing better than the REITs, especially in recent weeks. Choice did get a nice pop over the past few weeks due to its big dividend payout. Several REITs including La Salle (which had an earnings miss for the quarter) and Hersha (which many analysts think is too overexposed to New York City) crossed below their 200 day moving average, which is usually a bad sign for stock prices. By way of comparison, the major indices are up about 1 to 2% this quarter and 10% for the year and are close to their post-recession highs

Publicly traded hotel company stock performance (US based companies with market capitalization in excess of $1 Bn plus selected companies over $500MM)

Source: Yahoo! Finance

Other Industry News

• Hotel loyalty programs are coming under fire, as a recent study claims that these programs are costing  $10 billion in lost business due to travelers feeling that they are not getting sufficiently rewarded for their loyalty.
• In a related story, J.D. Power and Associates released its annual rankings of hotel chains. Overall results were generally not surprising, including perennial winners Ritz Carlton in the luxury end and Drury in the moderate priced segment. They noted that overall guest satisfaction is down, citing trends towards higher costs and fees, particularly for high speed internet, which is increasingly becoming a basic necessity for travelers. They also noted that guests booking through OTA’s generally had lower satisfaction (or higher expectations) than those who booked directly with the hotels or brands.
• Also, AAA has announced that it is changing its methodology in rating hotels and awarding diamonds to penalize hotels that charge resort fees or have excessive charges for high speed internet access. This is in response to an increasing trend in dissatisfaction among hotel guests (see above) that they are being “nickeled and dimed,” as hotels are following the lead of many airlines in piling on charges. It was reported that some airlines make more money from luggage fees, change fees, etc. than they do on the basic tickets.
• European economic concerns are having an impact, as major operators such as Starwood and Marriott have noted a drag on their earnings due to relatively poor performance. For example, RevPAR at Starwood’s European hotels was down 8% last quarter compared to a 7% average increase across the rest of the world. Other foreign markets are also lagging US performance, as China is starting to exhibit signs of a slowing growth rate, although Latin America and the Middle East are still holding up.
• Brokerage firm Molinaro-Koger was ordered to pay nearly $23 million in damages to Host Hotels after being accused of fraud in a property-flipping scheme. The settlement came days before the case was scheduled for a civil trial. Host claimed M-K held the bidding down on hotels they were trying to sell, and the buyers then flipped the hotels at a higher price.
• The pool lift controversy continues. After successfully pushing for an extension until January 2013, the hotel industry is continuing to lobby for relief of the requirement to install permanent pool lifts at all hotel pools, preferring to use portable lifts which they say are safer and less expensive. However, advocates for the disabled are pressing for full compliance and are threatening boycotts. While most of the big chains are prepared to comply (although production of the equipment is a bottleneck), there is a lot of push back from “mom and pop” independents, who are citing this as another example of excessive regulations stifling small business.
• Hyatt Hotels still has an unsettled labor situation. They have claimed that unions have negotiated in bad faith, thus preventing contract agreements to be reached, thereby denying raises to workers. The unions have threatened strikes and promoted boycotts and have also stepped up their organizing efforts at non-union Hyatt properties.
• Industry legend John Q. Hammons (age 93), who retired in 2010 and has been in seclusion since then, is in the news because Atrium Hotels, the owner of many of the hotels managed by his company has filed a lawsuit claiming that the person that Hammons appointed as his successor is incompetent, has conflicts of interest and has diverted company funds.
• On a lighter note, a British hotelier generated some controversy with his plans to replace the Bible in guestrooms with the novel Fifty Shades of Grey, which he felt would be more relevant for his female guests.

Special Feature
From time to time in this newsletter, we try to go inside the hotel industry to provide a glimpse of its workings to outsiders. Today, we are providing this list of commonly used acronyms and abbreviations. Additional definitions of these items and other hotel industry jargon can be found in our June 2010 newsletter (please email Jack Levy at jlevy@pyramidhotelgroup.com to request a copy).

Hotel Abbreviations and Acronyms

AAA:              American Automobile Association
AAHOA:        Asian American Hotel Owners Association
ADR:              Average Daily Rate
AHLA:            American Hotel & Lodging Association
BAR:               Best Available Rate
CRS:               Central Reservation System
CVB:               Convention and Visitors Bureau
DMO:             Destination Marketing Organization
DOS/DOSM: Director of Sales/Director of Sales and Marketing
EB-5:              Loan program to encourage foreign investment in US hotels
EBITDA:        Earnings Before Interest, Taxes, Depreciation and Amortization
EMEA:           Europe, Middle East & Africa (one of the global regions)
EMC:              Executive Meeting Center
Exec Comm:  Executive Committee
FAM:              Familiarization (as in FAM Trips for travel agents)
F&B:               Food and (alcoholic) Beverage
FF&E:             Furnishings (or Furniture), Fixtures and Equipment
FFO:               Funds from Operations (a REIT metric)
FIT:                Free (or frequent) Individual Traveler
GBTA:            Global Business Travel Association
GDS:               Global Distribution System
GM:                 General Manager
GOP:               Gross Operating Profit
GSS:                Guest Satisfaction Score
HOT:               Ticker symbol for Starwood Hotels & Resorts
HSIA:             High Speed Internet Access
HVS:               Hospitality Valuation Services- independent appraisal and industry consultants
IACC:                         International Association of Conference Centers
IBFC:              Income Before Fixed Charges
IBT:                Independent (or Individual) Business Traveler
IHG:               Intercontinental Hotel Group
MOD:             Manager On Duty; also Minor Operated Departments
MTD:             Month To Date
NOI:               Net Operating Income
OSAT:            Overall (guest) Satisfaction
OTA:               On –line Travel Agency
PAR:               Per Available Room
PIP:                Product Improvement Plan
PKF:               Pannell, Kerr & Forster- independent industry consultants
POM/POMEC: Property Operations and Maintenance
POR:               Per Occupied Room
POS:               Point of Sale (computerized cash register system)
PMS:              Property Management System
PTAC:            Packaged Terminal Air Conditioner
PWC:              PricewaterhouseCoopers
REIT:             Real Estate Investment Trust
REO:               Real Estate Owned (by a bank or other institution not normally in the RE business)
REVPAR:       Revenue Per Available Room
REVPOR:       Revenue Per Occupied Room
SALT:             Service And Loyalty Tracking (proprietary Hilton guest satisfaction scoring method)
SMERF:          Social, Military, Educational, Religious and Fraternal
SPG:                Starwood Preferred Guest
STR:                Smith Travel Research
TOT:               Transient Occupancy Tax
TTM:              Trailing Twelve Months
UFOC:            Uniform Franchise Offering Circular
YTD:               Year to Date

US Economy General Statistics

Key Economic Indicators

Sources: National Bureau of Economic Research; various government agencies including US Department of Commerce