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FelCor's formula:buy low and renovate

It is true that if you don't borrow too much money, the likelihood of going broke goes down significantly," quips Thomas J. Corcoran Jr., president and CEO of FelCor Lodging Trust Inc. in Irving, Texas.

That principle is no joke to Corcoran. He has lived by it, imposing a limit on FelCor's indebtedness of 40% and striving to beat the limit in practice. For example, throughout 1998 FelCor carried a consolidated debt-to-investment ratio of 38%.

Low debt represents a key component of FelCor's multi-faceted, conservative financial strategy, which Corcoran credits for the company's swift rise to prominence as one of the nation's three largest real estate investment trusts (REITs).

FelCor currently owns interests in 187 hotels with nearly 50,000 suites and rooms. The company's hotel assets span 34 states and Canada, with concentrations in Florida, Texas and California, primarily in major markets near airports, suburban or downtown areas.

The company owns more Embassy Suites, Crowne Plaza, Holiday Inn and independently-owned Doubletree-branded hotels than any one. Additional leading brands under which FelCor's hotels operate include Sheraton Suites, Sheraton and Westin.

In the beginning FelCor began as a private company in December 1991 with the purchase of the distressed Holiday Inn South at the Dallas-Fort Worth Airport. Then owned by the Federal Deposit Insurance Corporation (FDIC), the property carried a $36 million mortgage that FelCor purchased for $5 million.

"We bought it and fixed it up, which is what we have done with our entire portfolio ever since," says Corcoran.

Between 1992 and 1994, FelCor's principals Hervey A. Feldman and Corcoran - doing business then as FelCor Suite Hotels Inc. - purchased six Embassy Suites hotels and placed them into a REIT.

In July of 1994, the REIT went public as FelCor Suite Hotels Inc. with an initial public offering of $120 million. Over the next three years, FelCor assembled a portfolio of 73 hotels.

The first major transaction occurred with the purchase of 18 Crown Sterling Suites hotels in 1995. Pursuing its buy and renovation strategy, FelCor substantially redeveloped these properties, converting 16 of them to Embassy Suites and the remaining two to Doubletree Guest Suites. Working with the brand owner and manager of the properties, Memphis,Tenn.-based Promus Hotel Corp., FelCor's approach increased the revenue per available room (RevPAR) on these properties by 37.7% by the second quarter of 1998.

In March of 1998, FelCor announced the acquisition, by merger, of the real estate assets of Dallas-based Bristol Hotel Co. The transaction added 109 hotels to the FelCor portfolio and increased the REIT's assets from $2.4 billion to $4.2 billion, while boosting market capitalization to $3.4 billion.

FelCor remains focused Throughout this period of acquisition and asset growth, Corcoran has retained his focus on conservative financial strategies. The company's 1998 annual report lists eight results of that strategy:

* Consolidated debt of $1.6 billion, equal to 38% of assets;

* Interest coverage ratio of 3.8 times;

* Pro forma interest coverage ratio of 3.6 times;

* Total debt to pro forma EBITDA of 4.1 times;

* Borrowing capacity of $114 million under existing credit facilities;

* Fixed interest rate debt equal to 56% of total debt;

* Secured debt equal to 7% of total assets; and

* Debt of only $16 million maturing prior to Dec. 31.

However, conservative financial policies do not necessarily imply stinginess. During 1998, FelCor and Bristol, prior to its merger into FelCor, spent an aggregate of approximately $180 million on the renovation, redevelopment and re-branding of 40 hotels. In addition, FelCor alone spent approximately $40 million on continuing capital replacement and improvement programs related to its previously renovated hotels.

Corcoran believes it takes people who know the hotel business to find appropriate properties, plan appropriate renovation strategies and build profits. "Some real estate companies go public with people who were never in the hotel business," he says. "So you have to think that they are looking for opportunistic transactions that are oriented toward real estate appreciation instead of the hotel business. We believe that whether you own or manage any kind of real estate - hotels or office buildings - there is a direct correlation between buying the real estate right and managing the operating side right.

"Of course, we don't manage day-to-day hotel operations. But we are all hotel people who have operated and managed hotels. We understand what creates value at the hotel level and what increases hotel real estate values," he adds. "Our job is to find ways to blend real estate analysis with plans to create value by thinking like hotel people. This is important, because at the end of the day, you have to take care of the customers. You have to keep cool air coming out of the air conditioner and hot water coming out of the shower."

Cool air and hot water FelCor's essential innovation in providing air conditioning and hot water is apparent in a comparison of renovation and new building costs. According to Corcoran, the company's cost per room averages about $70,000, while building a new Embassy Suites today would likely cost in the range of $120,000 per room.

In many cases, FelCor's renovations have produced better-than-average performance. For example, the average occupancy rate across the hotel industry today runs about 63%, while FelCor's portfolio averages slightly more than 70%. In addition, FelCor's RevPAR - a combination of occupancy rate and average daily rate (ADR) - has been growing at 6.2%, approximately 20% above industry averages.

"These above-average RevPAR performances are a result of our strategy of purchasing primarily upscale and full-service hotels, renovating and re-branding the hotels to the right product, hiring outstanding third-party professional hotel managers, and owning a geographically-diversified hotel portfolio," says Corcoran.

Other elements of the FelCor strategy also contribute to performance. Through the REIT, for example, FelCor has established relationships with brand owners and managers that go beyond that of a typical fran-chisee/owner of branded hotels.

These relationships take two forms: First, FelCor owns enough hotels under each brand to enable it to influence the long-term direction of the brand. Second, most of FelCor's brand partners have made investments back in the company as shareholders. "You'll find significant ownership by the brands inside FelCor that you won't find in other REITs today," he says. "This is true of Promus, Bass, Sheraton and others."

For instance, the FelCor-Bristol merger established a relationship between FelCor and Bass plc and its subsidiary Bass Hotels & Resorts of Atlanta, which acquired approximately 14% of FelCor's common stock in the course of the merger. Corcoran believes that brand ownership of FelCor shares creates a marriage of interests that helps maintain focus on both asset appreciation and operational profits.

To some extent, the REIT's financial performance reflects this. FelCor's historical growth in net income has enabled common stock dividends to grow steadily from an annualized rate of $1.54 per share in 1994 to a total of $2.55 per share in 1998.

Even so, Corcoran says that FelCor's share prices are undervalued by the market. "We continue to believe that the common stock valuation of FelCor is inconsistent with the performance and quality of the underlying hotel assets," he says. "FelCor's common stock is currently trading at approximately 40% below replacement cost, approximately six times 1998 FFO.

"I would say that the overall lodging and REIT industry is trading at a fairly significant discount to replacement costs today. Usually, there is a direct correlation between share-price performance and RevPAR or EBITDA. But today, the performance of some of the lodging REITs doesn't jibe with the cash flow and profits."

A bright future? How does Corcoran see FelCor's future? The company intends to focus on internal growth, tapping its relationships with brand owners and managers to produce new revenue from the current hotel portfolio. The company also intends to redevelop and reposition hotels acquired through the merger with Bristol. Work on 39 of those properties has been completed, with 43 more scheduled for completion this year and next.

In addition to internal growth, FelCor intends to acquire additional hotels suitable for redevelopment and repositioning at less than replacement cost, as appropriate opportunities arise. Along these lines, FelCor is exploring the formation of investment joint ventures with its brand owners and managers.

Corcoran believes that the FelCor approach illustrates a trend toward better economic balance in the real estate industry. "Historically, real estate developers have gone through boom and bust cycles," he says. "Today, I think the industry is coming to realize that you don't have to risk going broke to succeed."

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