New York – As the industry rebound started to gain momentum in 2011, the public real estate investment trusts took the lead in acquiring significant lodging assets, including a number of high-profile trophy properties. Given their access to the public markets, they were able to raise capital in the course of doing business.
But within a year, other buyers emerged and began giving the lodging REITs a run for their money. Chief among these buyers were private-equity funds, including such heavyweights as Blackstone Group and Starwood Capital Group.
Fast forward to the second half of 2013: The transactions market has continued to strengthen and funds originated by private-equity firms remain a strong, if not dominant, force in the market. What’s more, private-equity firms in many instances have outstripped their REIT counterparts in the size and scope of their lodging investments, acquiring entire brands and multi-unit portfolios as well as individual assets.
“Going forward, the question really isn’t whether the transactions market has recovered. It has. Rather, the question is how long we can expect the recovery to last,” said Suril Shah, SVP at Starwood Capital Group, during a panel at last month’s NYU International Hospitality Industry Investment Conference entitled “Private Equity: Game On.”
“We feel we’re at the peak of the recovery right now. We’re confident things look good for the next 18 months, but are uncertain after that,” Shah continued, adding that while the lodging industry is performing well, doubts persist about the overall health of the U.S. economy.
One of Starwood Capital’s largest recent deals was the acquisition last fall of the 138-unit InTown Suites extended-stay chain for $735 million. Shah said the transaction was scheduled to close soon. Similarly, Blackstone Group last fall closed on its purchase of Motel 6/Studio 6, with 1,100 hotels in the U.S. and Canada, for $1.9 billion.
Richard Gomel, a partner in Junius Real Estate Partners, a division of JP Morgan Asset Management, who was formerly at Starwood Capital, agreed that an industry recovery is underway. But Gomel felt the industry hasn’t yet reached the high point of the cycle. “Low interest rates set by the Fed have contributed to the success we’ve had in the market,” he said.
Looking for deals
Initially, both the private-equity shops and the REITs focused on the Top 5 or Top 10 MSAs, but as the best inventory has dwindled in those marquee markets, they’ve been forced to look beyond to secondary and even tertiary markets. “Buyers, including the private-equity funds, have had to think beyond the major gateway cities, where they may not have had the same comfort level,” said Phillip Gordon, a partner in the law firm of Perkins Coie, LLP, whose practice areas include private equity. “As a result, many more deals are getting done in the secondary markets.”
Gomel described what he calls the “perception of safety” that often came with investing in the major MSAs. “Buyers, international buyers in particular, were hesitant to look further than the major markets, but now may have fewer options,” he said.
To a degree, the emergence of private-equity firms in the transactions market has been a function of pent-up demand, according to Gary Axelrod, a partner in the law firm of Latham & Watkins, LLP, which also works in the private-equity arena. “The funds have been eager to acquire this class of real estate asset, when the deal makes sense,” Axelrod said.
“In certain instances in the past few years, we’ve even dipped below the Top 25 markets, acquiring select-service hotels across the country, for example, including in locations that are hardly well known,” Shah said.
At the same time, buyers are seeking out deals in a broader of range markets. “Opportunities can still be found in the major markets,” Gomel said. As examples, he cited assets located in a Top 5 or Top 10 market that might require repositioning or extensive renovations in order to be a viable investment, where the location might not be ideal within that market or where the asset is attached to a new under-performing brand.
“We’ll be looking for some degree of distress,” Shah said. “We look to see if there’s some value-add component we can bring in to enhance the property and help turn the asset around.”
A critical decision is the private-equity buyer’s choice of an operating partner. “The firm will need to bring in the right operator, a management company it believes can complete the repositioning or the renovation or whatever work needs to be done in a timely and efficient way,” Axelrod said.
Unlike lodging REITs or institutional buyers, private-equity firms typically have a hold period built into their funds, a provision that spells out how many years the fund managers expect to retain the asset. By that point, the asset has either been sold or taken public. A typical hold period will be six or seven years.
Looking to 2014 and 2015, hospitality will always be an asset class in a large private-equity fund, according to Gomel.
“It would be hard for the fund to achieve its desired results without including the hospitality sector,” he said.
Shah concurred. “While cap rates are low, hospitality real estate is still an asset class that can deliver returns at least through 2015,” he said. “This should be a good year for firms raising funds.”