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REITs and the Recovery

Last May, Tom Baltimore, president and CEO of RLJ Lodging Trust, and his management team were engrossed in some strategic thinking. Part of the diverse business portfolio of The RLJ Companies, founded by Robert L. Johnson, who is probably best known as founder of Black Entertainment Television (BET) and one-time owner of the NBA’s Charlotte Bobcats, RLJ had mostly operated in the private equity space. But now it was surveying the landscape of the hotel industry and considering its options as a publically traded hotel REIT.

“We thought long and hard about whether or not we wanted to be a public company,” Baltimore says. “At the time we had two funds, one that we needed to de-lever and a second one that was really flush with capital. We thought it made sense for all of our stakeholders to combine the two funds and really take advantage of where the public markets were at the time.”

He says the mood also gave the company an avenue for ease of access to permanent capital. “We thought there was a really great opportunity to be a lead consolidator of what we define as a focused-service or compact-service space,” he continues. As an example, RLJ’s investments tend to brands such as Courtyard by Marriott, Residence Inn by Marriott, Hilton Garden Inn, and Homewood Suites by Hilton.

Late last spring, RLJ was successful in gaining its IPO. As it turns out, it was one of the last hotel REITs to get an IPO last year.

RLJ, like many hotel companies, could have expected what would happen to REITs later in 2011. Last year was not kind to hotel REITS due to the unsettled economy. Rising gas prices and rising airfares took a toll and RevPAR growth underperformed many analysts’ predictions. At that time the capital markets closed down and it became much more difficult to raise capital for the public markets.

In an interview with the website REIT.com last August, Jason Lail, an analyst with SNL Financial, told the website that hotel REITs were one of only two REIT sectors that had a dividend yield of less than 3 percent. However, Lail told the website there were positive signs for future fundamentals.

“We did experience a pretty significant decline in our stock price last year,” Baltimore admits, “but it’s rebounded pretty significantly since the lows of last summer and early fall.”

“I think what’s made activity a lot slower over the last six months was that the stock prices of a lot of the REITs dropped pretty significantly after last July,” adds Jay Shah, CEO of Hersha Hospitality Trust, whose company has been making noise with activity operating in mostly the top markets, such as its base of Philadelphia, New York City, Northern Virginia, and Florida.

Shah says he doesn’t think the drop in stock prices really had much to do with the overall hotel market. “It was just overall global markets, the impact of the European recession, and there was a broader pullback in the market,” he says. “I think hotels and real estate stocks took it maybe worse than others because they are financials and highly volatile.

“We were all a little surprised, because hotel performance was actually picking up steam,” he continues. “There was a 20 to 30 percent correction in prices between July and December, and that made it very difficult to justify raising new capital to buy new opportunities. It wasn’t the worst thing in the world because there weren’t many opportunities out there.”

Nearly a year later, those fundamentals are now being recognized as positives by hotel industry investors. Consumer confidence has risen and pent-up demand for travel has increased occupancy. Rates have begun to tick upward as demand improves and supply holds steady.

A year later, as we head into summer 2012, REITs are getting more active. “We all are clearly more active on the deal front,” Baltimore says. “As I said in our most recent earnings call, I would expect to see more transactions from the middle of the year into the second half of 2012.”

Like many hotel company executives, Baltimore sees that the demand and supply imbalance can work in the REITs’ favor over the next few years. “We would expect supply to be below the long-term average of 2 percent at least for the next three to perhaps four years,” he says. “Construction financing is still difficult to get so I think you’ll see more acquisitions of existing assets than development.”

Hersha’s Shah says that while there hasn’t been much product available, some industry watchers are expecting portfolios to be shaken loose this year because so much CMBS debt is expiring. “There hasn’t been an avalanche of deals,” he says. “That said, and we’re not finding a deal a week by any means, but if you have a focused strategy you can get into deals, and it is a good time to be building a portfolio.”

Hersha does stay focused as far those cities that it deals in, and in those markets, the company digs for off-market opportunities and other creative ways to get into deals.

Baltimore agrees saying one advantage his company has is that it operates in what many believe to be the sector most primed for activity—select service or focused service. “We can expand that to what we call compact full-service hotels. As an example, we have a Hilton in the Fashion District in New York that has 280 keys, largely a rooms operation with food and beverage outsourced and little meeting space. You could also define that as streamlined operations where it operates, in effect, like a limited-service hotel. That’s really our core strategy.”

“As stock prices get better as hotel performance continues to show positive year-over-year growth, and significant growth in a lot of markets, such as urban markets in the U.S., I think there will be a more aggressive buyer appetite and sellers will begin to get closer to the kind of prices they hope to get,” Shah says.

Many analysts are touting hotel REITs again as good buys in the investment community. Hotel industry analysts are predicting more rate gains this year. Other watchers say that steady growth in occupancy coupled with rate gains puts the hotel industry squarely in the recovery phase of the property market cycle.

That sort of news has put hotels in the spotlight for investors once again. That makes public money an attractive option for hotel companies. “Private equity made sense for us during our growth,” Baltimore says. “Taking the company public helps increase valuations and makes it easier to gain permanent capital. Most import, it allows us to gain a long-term, sustainable platform versus a private-equity platform that’s largely somewhat finite and discreet for that investment vehicle.

“In the public markets, depending whether the capital markets are open or not, there’s an opportunity for us to go back to the public markets at the right time and raise additional capital,” he continues.

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