Check-In Time for Hotels

Growth has rebounded since 9/11. Now capacity is in short supply.
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Hotel stocks are seeing impressive operating results, and the good times are likely to continue, considering the improving economy and the minimal amount of new construction in hot markets like New York, Los Angeles and Washington D.C.

Fundamentals across the industry have rebounded in the past several years as business travelers returned after the hiatus immediately following the terrorist attacks of 9/11. RevPAR -- a key hotel operating metric that stands for revenue per available room -- is now hovering around the peak 10% growth levels reached in 2000 for upscale hotels.

Moreover, occupancy levels have already passed their historical peak levels -- the mid-70% range -- for full-service hotels in places like Los Angeles and Orange County in California, and Tampa and Fort Lauderdale in Florida, says Abigail Marks, an economist who tracks the hotel industry for Torto Wheaton Research, a unit of

CB Richard Ellis


. In New York City, occupancy levels for full-service hotels reached 74.3% in the first quarter.

In such markets, the future growth will come mostly from higher room rates, but occupancy levels could peak even higher, Marks says.

"The hotel sector is still very, very strong, and the economy is still expanding, so business travel and leisure travel is very strong," Marks says. "The supply is not showing signs yet of being maxed."

LaSalle Hotel Properties


, which owns luxury hotels in attractive markets like Washington D.C. and Southern California, posted a big 13.7% jump in RevPAR growth for its first quarter, driven by a 9.4% increase in average daily rates and a 3.9% increase in occupancy.

Starwood Hotels


, which operates hotels nationally under luxury brand names such as Westin, St. Regis and W Hotels, recently reported a 12.8% increase in RevPAR for its North American hotels.

Upscale Hotels on the Upswing

Source: Smith Travel Research

Using fourth-quarter numbers, Torto Wheaton projects limited-service and full-service hotels will post 4.5% annual RevPAR growth each year in 2006 and 2007. Marks admits that her firm will likely increase its forecast once the full amount of first-quarter data comes in. Starwood recently projected 9% to 11% RevPAR growth at its hotels this year.

"We like the hotel sector because not only are the fundamentals good, but the picture for the future fundamentals looks good as well," says Dean Frankel, portfolio manager with Urdang Securities Management, which owns Starwood,

Host Hotels

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, and

Sunstone Hotel Investors

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, among others.

"We're in the middle of a recovery, but there are plenty of years to grow," he says.

Frankel expects hotel companies to post 20% core earnings growth this year (which excludes the effects of options expensing and other non-core issues). That compares to about 7.8% growth among all real estate investment trusts.

Frankel believes it is a good time to buy full-service hotel owners like Starwood, Host, Sunstone, and


(HLT) - Get Report

. He likes the fundamentals at LaSalle Hotel, but believes the stock is expensive.

He also says the hotel sector is a great hedge against inflation since it has the shortest leases of any real estate sector. "You want to be in short leases right now to attack inflation," he says.

One of the major issues benefiting the group is a lack of new supply. While room revenues are pretty much back to 2000 peak levels -- in some case, above them -- expenses have since shot up. So have land costs, due to the large demand from condo converters. These factors make it a lot less profitable to build hotels. That's great news for hotel owners, and it helps explain why private equity firms and other institutions continue to gobble up hotel properties.

FelCor Lodging Trust

may be the latest hotel owner to be exploring a sale of its assets. Barry Vinocur, editor of REIT Zone Publications, reported Wednesday morning that

General Electric's

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real estate division is close to buying Felcor for $23 to $25 a share in a deal that could be announced next week. Vinocur, who cited unnamed sources for the information, cautioned that the deal could still fall through.

Following up on this news, UBS analyst William Truelove noted in a report that over the past six months, three of the lodging companies he covered -- La Quinta, Fairmont and MeriStar -- have been sold to private equity investors.

Blackstone Group purchased La Quinta and Meristar, while Fairmont was sold to Colony Capital and a Saudi prince.

Truelove believes a reasonable takeover price metric for hotel stocks is an enterprise value of 13 times to 14 times forward earnings before interest, taxes depreciation and amortization. For Felcor, that would equate to a $28 to $33 per-share takeout price based on his second-quarter 2006 to first-quarter 2007 EBITDA estimate of $279 million, he noted.

But Frankel, the portfolio manager, says FelCor is already overvalued. The company's EBITDA doesn't paint a true picture of its cash flow since it excludes capital expenditures, which for Felcor, average about 20% of EBITDA, he says. If you adjust for capital expenditures, Felcor is trading at an expensive value to its cash flow relative to its peers, and the company's high amount of debt makes the valuation too pricey, he says.

"If Felcor gets bought, I don't see much, if any, premium from here," he says, adding that the buyout could occur at either a premium or discount of 3% to 4% from where the stock is trading. Felcor shares have jumped about 5% to $22.43 since the buyout news was announced before the market opened Wednesday.

However, if Felcor does get bought for a decent price, it would only signal good prospects for the rest of the hotel stocks, Frankel says.