Worries about the credit crunch and an economic slowdown are lodged into the minds of hotel investors.

The credit crunch has pressured the companies' asset values, and a weakening economy may cut profits over the next year. That has led real estate investors to wonder just how much profit power hotel owners and operators will have over the next year.

Marriott ( MAR), one of the world's largest hotel operators, saw its shares fall nearly 5% Thursday after the company gave a disappointing earnings outlook for next year.

Marriott said it expects earnings per share of $2.10 to $2.25 in 2008, lower than the average analyst forecast of $2.30, according to Thomson Financial. The estimates are based on 5% to 7% growth in revpar, or revenue per available room, next year.

The Bethesda, Md., company also projected that fourth-quarter earnings for this year would be 61 cents to 63 cents a share, below analysts' mean estimate of 68 cents.

Marriott's tepid outlook "continues to suggest the (hotel) operating cycle is intact, albeit decelerating," says John Arabia, the lodging analyst at Green Street Advisors, an independent research firm that focuses on real estate stocks.

Arabia says the market is concerned about how much the broader economy's weakness -- particularly within financial services firms -- will affect the hotel industry. Financial firms, in particular, are major business-travel customers that have absorbed hotel room rate increases in recent years.

A slowing economy could also hurt hotel development a few years out. Marriott gets nearly all of its hotel-related revenue from managing hotels, rather than owning them. A good piece of the company's profit future growth is predicated on the development of additional hotels worldwide.

For the third quarter, Marriott posted an adjusted profit of $122 million, or 31 cents a share, down from $144 million, or 34 cents a share, a year earlier. The results matched the high end of the company's guidance.

Marriott blamed the year-over-year decline on a higher tax rate and declining timeshare profits.

Owners vs. Operators

So how do you play the hotel sector?

There is a case to be made for owning the major hotel operators, Marriott and Starwood ( HOT), owner of brands like Sheraton and Westin. Both companies have strong balance sheets and large amounts of free cash flow, which allow for easy funding of share buybacks.

Also in the companies' favor, about 50% of their overall profits will come from overseas within the next few years.

Both companies, though, are facing headwinds in their timeshare businesses, which represent about 20% of their total revenue. The timeshare business is at some level tied to residential real estate sales, so could be further damaged by the ongoing housing slowdown.

Some argue a better play today could be buying the hotel real estate investment trusts, which own the hotels that Marriott and Starwood manage.

After Hilton ( HLT) agreed to be purchased by Blackstone ( BX) earlier this year, investors realized public hotel stocks were priced too cheaply.

Now the freeze-up in the credit markets is causing a dearth of hotel property sales, which makes it hard to determine real estate values for hotel stocks, says Arabia, the analyst at Green Street.

"The elephant sitting in the room is, what has happened to real estate values and what has happened to hotel values?" Arabia says.

Green Street recently reduced the asset values of hotel stocks by 5% to 8%. The thinking was that capital has become more restrictive, debt is more expensive and risk has been priced, thus the cost of equity has increased.

Nonetheless, there may be some nice bargains among hotel REITs. Even with revaluations, they trade at larger discounts to NAV than other property sectors, according to Green Street.

For example, Host Hotels ( HST), which owns a top-quality portfolio of hotels in major U.S. cities, has a net asset value of $26, according to Green Street data. The company has a well-regarded management team and a pristine balance sheet.

At around $23, the stock trades at a 13% discount to its private market real estate value, which it does not deserve, Arabia says.

Still, Dean Frankel, a portfolio manager with Urdang Securities Management, which owns numerous hotels operator and REIT stocks, says he likes the operators better right now.

"In this kind of environment, you're not getting that much revpar and EBITDA growth. You want to have other ways to have other growth drivers that don't cost you money," he says, pointing to the ability of Starwood and Marriott to expand their management contracts and brands without employing much capital.

In recent trading, Marriott shares were down 4.6% to $42.30. Starwood was falling 2.8% to $59.67, and Host Hotels was slipping 1.7% to $22.64.

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