Targeting Limited-Service

Private equity is pouring into hotels, and RLJ Development has joined the flood. Controlled by Robert L. Johnson, the founder of Black Entertainment Television, the Bethesda, Md.-based real estate company last month closed its RLJ Lodging Fund II at $743 million.

News that the fund is fully subscribed comes on the heels of the company's announcement earlier this year that it had acquired 100 hotels from White Lodging Services for $1.7 billion. RLJ currently has a portfolio of 120 hotels valued at more than $2.5 billion.

The RLJ Lodging Fund II will focus on limited-service chains, such as Residence Inn by Marriott and Hilton Garden Inn. The hotels feature small food operations and little meeting space. “The costs are low, but these chains produce nearly as much revenue per room as a full-service hotel does,” says Thomas J. Baltimore, Jr., president of RLJ Development.

RLJ is targeting markets with lots of tourist and business travel, such as New York, Washington, D.C., and Southern California. The company recently bought a Hilton Garden Inn for $78 million in downtown Washington and a Residence Inn for $68 million in Cambridge, Mass.

In such favorable urban areas, the bidding is ferocious for hotels. To turn a sound profit, RLJ looks for situations where it can improve profit margins by renovating or changing the brand. For example, the company bought an office building in downtown Denver in August 2005 and converted it to a Hampton Inn & Suites. “We are always looking for some way to increase the value of a property,” says Baltimore. RLJ's funds are designed to last seven years. The company typically holds a building about five years and then begins looking for a way to sell.

RLJ does some development, but primarily sticks to acquisitions. That approach is common for private funds, says Warren Marr, director of hospitality and leisure consulting for PricewaterhouseCoopers. “With the high cost of construction these days, it is often cheaper to buy than build,” says Marr. “It is almost impossible to build big luxury hotels without some kind of public subsidy.”

Baltimore says it has not been difficult for his fund to finance growth. The Lodging Fund II attracted 15 institutional investors, including pension funds and financial institutions. RLJ typically pays for a property by putting up about 35% equity and using debt for the rest. The company shies away from high-priced mezzanine financing and aims for senior debt that comes on favorable terms.

How much longer can RLJ continue its expansion? Baltimore is confident that the company can continue growing with the company's staff of 50 seasoned real estate professionals. Also, hotel markets should remain healthy for the next several years with little development, growing demand and rising room rates.

RLJ saw its revenue per available room climb by 10% in 2005. The industry as a whole should see a gain of 8.9% in 2006, according to PricewaterhouseCoopers. Such growth has helped private hotel investors realize returns in the mid-teens, results that look rich compared many other investments, says Baltimore. “With performance like we've seen, private investors will remain eager to buy hotels.”

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