Optimism ruled the NYU Hospitality conference in New York this week, where participants said the lodging sector is still in the early innings of a recovery that will last several more years.
Across town, at the National Association of Real Estate Investment Trust's conference, the buzz was about whether the recent $8.9 billion buyout of office owner
( TRZ) signals the end to the privatization boom among real estate investment trusts. The future of embattled mall developer
( MLS) was also on most people's minds.
Hotels Still Hot
Given the strong performance of hotel stocks, it's no surprise attendees at the lodging conference were smiling.
"Growth in supply is still well below what the demand growth has been," says David Blackman, managing director of Wachovia Securities.
The hotel industry has now seen 36 consecutive months of demand growth, according to Smith Travel Research. In the past 12 months, demand has grown 3%, while supply has shot up only 0.3%. The research firm expects demand growth, and thus room-rate growth, to continue for most of the industry, while new supply remains minimal.
Most speakers agreed the sector still has another couple of good years left before the cycle turns.
In April, the amount of new rooms under construction rose 22.5%, Smith Travel says. But if you look at the overall number, it's not huge. In the late 1980s, there were 120,000 to 130,000 new rooms being added annually, whereas this year Smith Travel expects 75,000. As well, closings have been increasing, so the net number is "nominal," says Randy Smith, CEO and co-founder of Smith Travel.
His firm projects the industry's revenue will grow from $122.7 billion in 2005 to $133.8 billion in 2006 and $147.9 million in 2007. However, margins will be down from 2000, the last great year for hotels, due to continued cost pressures, Smith says.
More and more buy-side sources have been telling
that they love the lodging sector. One hedge fund manager says a basic strategy of his has been shorting homebuilders, while going long on the hotel sector. The issue boils down to supply, the fund manager says. Another buy-side source pointed to
as a good bet because the company still has a lot of margin improvement ahead, relative to its peers.
As far as
FelCor Lodging Trust
goes, it seems the asset sale process is behind the hotel owner. There has been some speculation that FelCor was shopping a sale of the entire company. JPMorgan analyst Harry Curtis tells
this was unsolicited interest, and that the company turned it down because it believes it can drive value at its hotels over the next few years to reward shareholders.
On a panel at the NYU conference, Curtis picked FelCor to be the top-performing hotel stock over the next year, saying the firm will lead the industry in revenue-per-available-room growth because it sold off a number of older assets.
Deutsche Bank analyst Marc Falcone tapped
as his top pick. He cited the recovery in its European portfolio and the hidden value in its real estate portfolio, especially the resorts business, which would be attractive to private equity firms.
Private Equity and Hotels
There's been a ton of private equity interest in the lodging space of late. At the NYU conference, there was talk that cap rates, or initial rates of return on properties, are not the focus of companies buying hotel properties these days.
Instead, firms are focusing more on the leveraged return of assets. A huge pile of money continues to be available in the commercial mortgage-backed securities market, which provides most of the debt for private equity purchases. Estimates are for the CMBS market to top $200 billion in originations this year, up from $50 billion in 2000. Already, the CMBS market is larger than the corporate debt market, says Jacques Brand, co-head of global banking coverage at Deutsche Bank.
Richard Weissmann, who heads the lodging investment banking group at Goldman Sachs, says several hotel deals are getting done at "initial negative leverage" (meaning the current rate of return is below the interest rate on the debt), so firms are rationalizing the cost by looking at the long-term value of the assets. "I'm not sure it's a great strategy," he says.
Even Jonathan Gray, a senior managing director with the Blackstone Group, an active buyer in the sector, admitted that his firm is making a "fundamental bet" and a "cycle bet" that cash flows at the hotel properties it has been buying will grow faster than interest rates rise.
Blackstone over the past year bought three hotel owners: MeriStar, LaQuinta and Wyndham International. Gray says his firm gets a pricing advantage because it is buying a mix of assets, some of which it later flips at higher prices and some it keeps for the increasing cash flow. In a sense, the firm is buying wholesale and selling retail.
So is the buying game over at Blackstone? "We have a lot of inventory today," Gray says, adding that it will be hard to buy unless the firm sells some assets soon.
But he added that Blackstone does want to add to its resorts portfolio, and beef up the La Quinta limited-service style hotels.
John Putrino, head of lodging investment banking at Credit Suisse, predicts private equity will begin moving into the "brand" or "asset-light" part of the business soon. These are hotel companies like
that don't own many assets but instead make money through management contracts. "We will see one major brand company go private" over the next 12 to 18 months, he says. U.K.-based
Intercontinental Hotels Group
was named by other bankers as the company likely to fetch interest.
Across town at the NAREIT conference, embattled mall developer Mills Corp. did not present but was nonetheless on most people's minds.
The question continues to be whether the company will find a buyer for its entire portfolio. Initial letters of interest are due June 13.
One real estate investment banker source tells
that a deal for the whole company isn't likely unless management is given a very attractive price. "Management doesn't want to sell. They don't have to sell anymore because they recapped the company to run sufficiently in the short term," the source says, pointing to the
$2.23 billion refinancing Mills recently announced.
Another source, who is close to the bidding process for the firm and has worked on a number of major REIT M&A deals, says, "Anytime a company hires three attorneys, it's in trouble." Mills has hired Wachtell, Lipton, Rosen & Katz; Hogan & Hartson LLP; and Willkie Farr & Gallagher LLP as legal advisers to assist in its strategic review.
Trizec and Office REITs
With the $8.9 billion
Trizec deal being announced Monday, attendees were abuzz about whether this signals the end to the privatization boom.
"My thesis is that
Trizec is the last big one," says one source involved in the deal. "Stock prices have stayed relatively strong. Interest rates and borrowing costs have gone up. It's very difficult to get the kinds of returns that investors are looking for on these big-cap names."
This person also said that the deal had been in the works for a year, as Trizec Chairman Peter Munk was a motivated seller. The acquisition was also helped by the fact that
(one of the Trizec buyers) had already raised pension fund money to invest and lost out on the recent CarrAmerica purchase by the Blackstone Group (which teamed up with Brookfield on the Trizec buy). "Deals sometimes beget deals," the source says.
Despite buzz about
Equity Office Properties
( EOP) being the next possible privatization candidate, two sources believe it is unlikely, and especially don't believe CalPERS, the country's largest pension fund, would buy the entire portfolio, as has been speculated.
Equity Office's stock is already trading close to its underlying net asset value, so paying a premium is not an easy feat, especially for CalPERs, one buy-side source said. It's also unlikely to happen, given that CalPERS is still working with an interim real estate officer and would likely have to increase its real estate allocation if it buys the portfolio, sources say.
A privatization of Equity Office would require $6 billion of equity, and about $10 billion in CMBS and $13 billion of bank debt, says one banking source who has run the numbers. That amount of leverage "would potentially strain the capacity of the debt markets," the banker says. With Trizec, only $2 billion of equity is being used. If there is a deal for Equity Office, the equity will likely come from a nondomestic source, like Middle Eastern capital, the banker says.
At the conference, Equity Office CEO Richard Kincaid said he could not comment on the possible CalPERS talks, but didn't deny them.