May 26, 2010
By Shawn A. Turner
 

REPORT FROM THE U.S.—Prices are low, opportunities are great. These are indeed heady days for the team at Chesapeake Lodging Trust.

The real estate investment trust last month announced it had entered into definitive agreements to purchase a pair of California hotels—the 188-room Hilton Checkers Los Angeles and the 153-room Courtyard Anaheim at Disneyland Resort—for US$71 million.

“We’re seeing opportunities coming from all different (types) of potential sellers: public REITs, brand companies, private equity owners, private owners/operators and distressed assets,” said Chesapeake CFO Douglas W. Vicari during an interview before the California deals were announced. “We see it fitting together nicely.”

Chesapeake isn’t likely to be the only REIT with a wealth of opportunities available, said Andrew Wittman, VP, senior research associate at Robert W. Baird, an international wealth management, capital markets, private equity and asset management firm. So far in 2010, there have been 28 hotel transactions comprising 6,500 rooms.

“If you look at who’s been buying, over half have been purchased by the public REITs,” he said. “Public REITs are very well-positioned to be the best acquirers of hotel real estate because they have capital. The public market has been the most efficient way to raise capital.”

Indeed, DiamondRock Hospitality on 24 May said it planned to sell 20 million shares to help finance its US$155.5-million purchase of the 821-room Hilton Minneapolis, the largest hotel in Minnesota.

And other REITs have expressed their own optimism.

“We continue to see an incremental increase in the volume of acquisition opportunities and remain encouraged by the increasing number of conversations we are having with potential sellers," said Jon Bortz, president, chairman and CEO of Pebblebrook Hotel Trust, in the company’s first-quarter earnings release on 6 May.

"We remain confident that we can acquire high-quality hotels in our targeted urban markets at favorable pricing.”

Improving fundamentals

An improving outlook for the hotel sector has gone a long way toward sparking activity, analysts said.

Booking trends are increasing and the industry should “eek out” revenue per available room gains this year, Wittman said.

“When people saw transient business coming back (in February 2010), they started feeling a little better,” he said.

The payoff?

The improving economy hasn’t been enough to provide a bump, however, to REITs that have recently gone public. Following is the stock-market performance for three REITs that have issued initial public offerings during the past six months:

REIT	Initial stock price and trading date	May 25 stock price	% change
Chatham Lodging Trust	$20.50 - April 19, 2010	$17.61	-14.1%
Chesapeake Lodging Trust	$19.00 - January 25, 2010	$17.47	-8.1%
Pebblebrook Hotel Trust	$20.45 - December 10, 2009	$19.97	-2.4%

  
One challenge facing REITs is that, though the opportunities are there, the deals are complex and take some time to put together, said Rod Petrik, managing director at Stifel Nicolaus, a brokerage and investment banking firm.

“You have a lot of capacity (in blind-pool REITs) sitting on the sidelines,” he said.

Increased competition for assets is another obstacle, Vicari said.

“There is competition,” he said. “Public REITs have stabilized, there are stronger balance sheets, public money is being raised. Improving fundamentals will draw capital.”

Established REITs, by comparison, have fared better. For instance, Strategic Hotels & Resorts is up 138.2 percent year-to-date to US$4.43 per share, and Sunstone Hotel Investors is up 13.4 percent to US$10.07 per share.

Transactions are likely to increase further during the second half of the year, Petrik said. As the economy improves, the bid-ask spreads will close, which will aid transaction activity.

The United States’ industry’s occupancy was up 4.7 percent to 58.4 percent for April, according to STR data. Average daily rate dropped 1.2 percent to US$97.72, but revenue per available room increased by 3.5 percent to US$57.06.

“In 2010, we’re at the bottom of the last cycle, and now we see recovery beginning,” Vicari said. “Over the next 12, 18, 24 months, it will be an ideal time to invest in hotel real estate.”

He added, “The market is coming together on fundamentals.”

Chesapeake is most interested in acquiring upper-upscale, full-service hotels in urban business districts, such as Hyatt, Marriott and Starwood brands. “We’re pretty traditional,” Vicari said. “We’re believers in the brand. We think these are the assets best-positioned to ride the recovery.”

Pricing

The drop in hotel values caused by the downturn is one factor that has led Chesapeake to become active, Vicari said.

“This is a cyclical play for us,” he said, adding he has seen some stabilization in values.

Banks will be more apt to put properties they’ve taken back on the market with the economy showing signs of healing, Petrik said.

“A lot of times these banks can’t mark-to-market,” he said. “If they did that with their whole real estate portfolio, they’d be insolvent.”

With the amount of capital that’s been raised, it’s inevitable deals will eventually get done, Petrik said. Roughly US$13 billion in cash and available lines of credit are on the balance sheets of public companies; US$40 million have been raised by private equity real estate funds; and another US$20 billion of excess capacity is sitting on the sidelines waiting for deals, he said.

The prospect for future transactions activity is bright. Chesapeake could make a handful of purchases during the next few months, and Vicari said the company might raise additional capital if the market stays strong.

“We see opportunities to continue investing through this year and probably into next year,” Vicari said.