While private equity firms and foreign wealth funds played a role in the surging U.S. hotel transactions market in 2014, publicly traded real estate investment trusts (REITs) held their own steady pace in the market during the year, and are likely to remain an active investor in 2015.
“From our perspective, this has been a good time to buy and sell. Industry fundamentals appear attractive for the next few years and supply growth is in check,” said Deric Eubanks, CFO of REIT Ashford Hospitality Trust, which now consists of two funds: Ashford Hospitality Trust and Ashford Hospitality Prime.
Eubanks described the firm as “looking to buy.” A recent example of its target acquisition was the purchase, completed last August, of the 357-room Fremont Marriott Silicon Valley, in Fremont, Calif., for $50 million. Ashford described the price at the time as 45 percent below replacement cost.
VYING FOR ASSETS
Eubanks noted the bigger role private equity firms have been taking in the transactions market, which has created greater competition across the board. But he quickly added that private equity funds have different underwriting requirements.
Like other REITs, Summit Hotel Properties has taken the current strong industry fundamentals to be both a buyer and a seller. “We’ve been a net buyer, but we’ve taken the opportunity to be a seller as well, redeploying capital from asset sales to make strategic acquisitions, upgrading the overall portfolio in the process,” said President & CEO Dan Hansen.
The focus has been on acquiring premium brands in prime locations in growing markets. Accordingly, last September Summit purchased the 209-room Hampton Inn & Suites in downtown Austin, Texas, a block from the convention center, for $53 million. In announcing the acquisition, Summit described Austin as one of America’s fastest-growing cities. Coincidentally, it is Summit’s headquarters city and its first hotel property there.
Considering that many private equity funds have prescribed hold periods by the end of which they typically have to dispose of assets held in the fund, Peter Willis, EVP and chief investment officer for Chatham Lodging Trust, sees REITs like Chatham having a built-in competitive advantage because they don’t have any such restrictions.
“Any private equity fund that was a buyer three or more years ago should naturally be looking to sell at this point in the cycle,” he said. In addition, this would give the buyer a chance to take advantage of some of the upside.
Chatham, in November, completed the acquisition of Inland American in a joint venture with NorthStar Realty Finance Corp. The JV paid $1.1 billion for 48 hotels. Separate from the JV, Chatham acquired four hotels from Inland American for $107 million, including the 179-room Hilton Garden Inn in Burlington, Mass.
GROWTH THROUGH ACQUISITIONS
As a general rule, publicly traded REITs focus on acquiring existing properties as opposed to getting involved in ground-up construction. “It’s hard for us to invest in deals that aren’t cash generating,” Hansen said.
Pursuing existing properties, a REIT's preference is clearly for assets unencumbered by a management contract. “The presence of a management agreement definitely makes the asset less desirable, especially when the buyer has its own management company,” he said.
Eubanks confirmed that deals unencumbered, not only by a management company but by a brand, tend to trade at a premium. “The buyer’s then free to choose its own brand and operator. At the same time, if the asset is branded with a premium brand we like, obviously it’s not a problem,” he said.
While REITs are generally supportive of the premium brands, there have been—and continue to be—areas of friction. One such area is around the property improvement plan (PIP) that typically accompanies a change in ownership.
“When it comes to PIPs, the seller may well believe it’s current with brand standards, while the brand feels otherwise. The buyer, meanwhile, doesn’t want to have to shoulder the cost, which can be significant,” said Willis.
As the industry has rebounded, the brands are much more likely to take a forceful stance on capital improvements overall, PIPs included, believing owners are in a much better position to bear the expense than they were three or four years ago.
“PIPs can be much more expensive than people imagine,” Hansen said, citing $10,000 a key or more as a realistic number.
At Ashford, PIPs are a constant source of discussion with the brands, Eubanks noted. “We try to keep our assets up-to-date, but at some point we have to ask ourselves, ‘Which upgrades are going to provide a ROI? Why should we invest capital, if the hotel is doing well and guest satisfaction scores are high?’” he said.
Eubanks, Hansen and Willis spoke on a panel on the current state of lodging REITs at the Lodging Conference, in Phoenix, in October.
Looking to 2015 and beyond, Hansen expressed confidence that the supply of viable properties for sale would continue unabated. “There are hundreds of owners who have different reasons for selling,” he said.
When it comes to timing the current cycle, Willis declined to speculate on when the tide might turn. “We feel there’s plenty of runway left,” he said. Among the many factors involved, supply growth is usually cited as a critical one. “But no one can say with any certainty when supply growth will start to take off.”
Similarly, no one can predict the exact magnitude of the next downturn, Hansen said. “Though we do know there’s much more transparency these days. Plus we know hotels have evolved into a much more viable real estate asset type generally.”