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The hospitality market: 180-degree turnaround has left the hotel industry in economic bliss

Profits are on the upswing. Occupancy is rising. The value of hotels is increasing. In stark contrast to the early-1990s, the hotels industry is on a roll.

Jack Giacomini sees it in the air. Hotels that used to be re-flagged frequently have remained under one banner. "Owners have finally figured out it's really not the flag that can make or break a property but the marketing and management," explains the chairman and CEO of Santa Fe Management in Carlsbad, Calif. "The nature of the hotel business is long term. You have to build clientele over a three-year cycle. Changing flags is not healthy because you need to provide a quality product with great service for a reasonable price on a continuing basis. Many owners have finally figured it out."

Paul Jones smells it in the air. "Money for buying hotels is all over the place, from private investment funds like those backing Bedrock Partners, to pension funds and other sources," says the president of Hotel Partners of Chicago. "Management companies are doing well. They are surviving, prospering and aligning themselves with investment money and obtaining equity in deals. Many have joined forces with pension fund money to buy hotels for their upside potential."

Ken Mason sees it in his mail. The president of Mason Hospitality isn't receiving as many unsolicited resumes as he did six months ago. "There is not nearly as much job-hopping," he says. "If managers have something steady that looks like it will be a good future, they're not going to jump ship for a few thousand dollars. And the people in senior management positions who weren't qualified are now doing something else."

Welcome to the hospitality industry, 1995-style. Guests are flocking to properties, management companies are becoming more stable, and owners are gaining renewed confidence in the industry. Kirk Kinsell, president of franchise for ITT Sheraton Corp., Boston, says, "We are currently enjoying the most favorable economic conditions that the hotel industry has seen in the last 10 to 13 years." Kinsell says the properties enjoying profitability are those with the right mix of product, quality, price and service. He says the hotel industry recognizes the value of branding, and that consumers will eventually gravitate toward the better brand.

Marcus and Millichap's Adam Petriella, regional manager, says that continuing strength in occupancies and average daily rates will prompt new construction by the end of the decade, and we should see greater product differentiation. He also says improving local economies and growing touring bases are prompting new construction of hospitality properties in Phoenix, Scottsdale, Ariz., and Atlanta.

"The industry had its most profitable year in 1979 with $1.1 billion, and we're predicting a $2.3 billion profit in 1995," says Dr. Bjorn Hanson, national industry chairman-hospitality at Coopers & Lybrand in New York. "This industry is no longer in recovery, it is in the most profitable period in history. During the next two years, there will be a further escalation of profit, with 1997 posting $11.7 billion in profit."

Spurring this trend is increased occupancy: 65.9% this year, 66.5% the next and 67.2% in 1997. Since the industry breakeven point is 63.4%, Hanson says, "We are way above breakeven in occupancy, way above any profitable period previously. So the question is, `Could we withstand a recession and still remain profitable?' I think the answer is yes."

Increased occupancy

While the industry might not be "recession proof," its profit and occupancy levels can withstand an economic downturn. "If the industry loosens up and starts to build hotels that are too large or adds amenities guests don't want, there could be a problem," continues Hanson. "But now we have self policing, not from the hospitality industry but from the financial community. There is a lot of good financial data out there, and once lenders see too many hotel starts being planned, they might get cautious."

Occupancy is increasing primarily for two reasons: there is a loosening of travel budgets and a price compression between the various segments of the market, analysts say. A few years ago, a mid level manager who gave pink slips to 30% of the work force started staying in limited-service properties instead of full-service ones. But now that has changed. "Part of it is that the current economic environment makes it appropriate to trade up rather than down," says Hanson. "It might only be a small amount to go from an economy hotel to a full-service property, and travelers are saying `Gee, for an extra $4 or $5, 1 can stay in a hotel with a swimming pool, room service and a bigger room."

Added to this is the fact that more rooms are being built in primarily the limited-service segment. Renovation of hotels that had long lost their luster is increasing, and management companies are willing to enter the public financing arena via real estate investment trusts or IPOs.

"The industry is doing extremely well, and the next few years should remain that way," says Stephen Taylor, president of Brookshire Hotels Inc. He says with a high demand and stable supply within the industry, the hotels are staying full. "Most of the owners now are voluntary," he adds. "They are in the business because they want to be. The future is bright for hotels. What was once a dirty word now looks like a shining star."

Michael Lipson, president of Lexington Mortgage Co. in Vienna, Va., points out that the major turnaround in the hospitality market is resulting in the building of not only limited-service but full-service hotels as well. "We're seeing new construction having some impact in particular areas, especially in growth markets through the Sun Belt," he says. "We're seeing new construction in smaller submarkets, such as Panama City and Pensacola in Florida and San Antonio and Lubbock in Texas."

Among the new products entering the marketplace is Wingate Inns, a limited-service, mid-price chain. Hospitality Franchise Systems is general partner. Frederick W. Mosser, president and chief operating officer, notes that Wingate, based in Parsippany, N. J., is building the Inns to make people more productive when they are traveling for business and offer features and amenities that leisure travelers appreciate. For instance, Wingate Inns will have a business center for guests to send and receive faxes, make photocopies and use a laser printer.

"We think Wingate will attract the customers who are now staying at mid-market hotels, because those properties are very vulnerable to having customers taken away with a new contemporary product," says Mosser. "The mid-market segment was largely ignored during the building boom of the mid- to late- 1980s. A lot of the supply is old and tired. We plan to have 30 Wingate Inns open by end of 1996, 100 by end of 1998 and 300 by the year 2000."

Convention hotels

One of the bright spots for the hospitality industry is convention hotels. In the last 10 to 15 years, a number of cities have built or expanded existing centers and have discovered that to adequately market the centers, they need nearby convention hotels.

"They are now in the process of scrambling to get those hotels," says John M. Keeling, senior vice president Hospitality Advisory Services for PKF Consulting in Houston. "A number of convention hotels are planned in Tampa, Miami Beach, Wichita, Houston and Chicago. All are public/private joint ventures. Loews has been chosen in Miami; Tampa hasn't selected a hotel company yet. Hyatt will be at McCormick Place in Chicago and in Wichita, and Houston is considering a Marriott or Hilton."

Still, the hotel market overall is stronger than it has been for several years, although there are some weak pockets, explains Mason of Mason Hospitality, which operates hotels in five states. "Those weak pockets are due to the weather and other natural problems," he cautions."

While new hotels are being built, the once frenzied pace of changes in hotel ownership is slowing somewhat. "We're seeing certainly less inventory available for purchase. Our feeling is that it's probably a combination of factors, including an improved market," explains Paul Novak, president and CEO of Bedrock Partners, a hotel investment company based in Dallas. "We're also seeing sellers of older products taking properties off the market because they see the market improving and think their properties will be able to take advantage of that. My bet is that it's not going to happen."

Such a strategy might be flawed, since travelers could be reluctant to patronize a place that obviously needs physical attention. "Three years ago, there were lots of hotels that were 15 to 20 years old, all in pretty much the same condition," Novak says. "The ones that have been improved significantly are the ones that are going to reap the benefits of an improving market. Those not renovated are falling further and further behind, even with the market swinging up. Customers are smart enough to demand quality facilities and will move to those competitors who have upgraded."

Upgrading chain hotels

In other words, travelers today are demanding new and improved lodgings while a number of hotel chains are now requiring upgrades if properties don't meet their new, tougher criteria.

ITT Sheraton's Kinsell says that his company has launched two strategies in order to keep its promise of delivering value to its customers. The "Luxury Collection" offers an upscale, five-star hotel collection for groups and individuals in corporate travel. The other strategy, "Four Points," is a mid-scale option for full vice hotels. Kinsell says that Sheraton expects to have 40 property conversions to the Four Points project by year's end, and he expects the total number of conversions to be around 100 by the end of 1996.

Chains have begun to winnow out properties that don't meet established standards. Many hotels were over-leveraged, and there was no money available for renovation. Since they didn't have the funds to refurbish, guests stayed away and the hotel didn't bring in the revenues needed to cover debt.

"It was a vicious cycle because a number of owners would not re-invest in their hotels," says Mason of Mason Hospitality. "Those are the ones you see signs changing three and four times in the last three or four years."

A year ago, those properties, particularly full-service hotels, were considered an excellent opportunity, but it was difficult to get funds. It required a leap of faith, and those who had that faith benefited handsomely.

Hotel Partners, for instance, participated in the sale of the former Holiday Inn in Oak Brook Terrace near Chicago, a property that required massive amounts of money for renovations. "It was in a good market where this kind of product was needed, but most people considered it to be an old Holiday Inn and a dinosaur," explains Jones. "Bedrock purchased it reasonably, it $30,000 a room to renovate it and turned it around. It looks like a brand new hotel."

Even so, the acquisition game has changed. PKF's Keeling notes that the prices of hotels are increasing and cap rates are falling "simply because there is less and less quality product and more and more buyers with money, so there is a supply/demand imbalance driving prices up. Cap rates used to be 12%, now they're 10%. The lower cap rate means more people are willing to pay for the same cashflow, because it's so competitive."

Timothy Aho, senior vice president of development for Prime Hospitality Corp., says that along with the new brand created by his company, Amerisuites, Prime Hospitality will also be acquiring other brands and repositioning them into full-service hotels. The long-term destination of Aho's company is fully-owned properties (as opposed to third-party management).

While purchases have slowed somewhat, there is still investment money chasing hotels, but the deals aren't a "slam dunk" any more. "We aren't seeing people buying as much," says Lipson of Lexington Mort, gage. "The heydays when you could acquire a hotel for 20% to 40% of replacement cost are few and far between. Right now, most of the buying is in the repositioning of properties. Some people can pick off a deal here or there, and there is some restructuring with notes being sold."

Financing purchases

To finance purchases as well as fund renovations, hotel companies are converging on Wall Street. Dana Michael Ciraldo, president and managing director of Mineola, N.Y.-based HVS Financial Services, which specializes in hotel brokerage and investment advisory services, adds that the rush to REITs in the hospitality industry continues, albeit more slowly now than in the past. The Patriot American Hospitality REIT, which completed its $305 million IPO on Sept. 27, now has a market cap of $400 million and is debt free.

"Companies are looking to tap the public market through IPOs, and the hospitality IPO volume seems a little heavier in activity," he says. "The market is dictating that there is a limited appetite for hotel REITs. Because the universe of REIT stocks is much smaller, REIT stocks are subjected to pressure of herd mentality: if a few REIT stocks perform poorly, other REIT stocks may be affected. An oder problem with REITs is that they are unable to retain earnings for growth, to provide cushion for downturns."

Ciraldo says that while there are a few REITs still on the sidelines watching the Patriot American IPO, Wall Street is providing new capital in a variety of ways. "Renaissance Hotels is in the market selling $120 million of debt and is in the process of selling nine million shares for 20% of the company's equity," he points out. "Innkeepers USA REIT is doing a secondary offering, Promus completed a debt offering, and Morgan Stanley is trying to sell Omni Hotels and Travelodge. Red Lion and Studio Plus both completed IPOs, and Smith Barney located a new credit line of $130 million for Equity Inns, a REIT. Most of the Crown Sterling Hotel chain is under contract to be sold."

Added to this is the fact that some markets that many would not go near are now tantalizing investors. In Southern California, the market has definitely hit bottom and is bounding upward reports Thomas F. Morone, vice president of Collier's International Hotel Realty in Los Angeles. "People are still looking to steal properties, but it's getting harder and harder. Sellers who have held on this long are saying, 'I'll wait, it'll get better for me.' That is having an effect on the market."

Accordingly, Morone sees a decrease in transactions this year compared to last. "The market improved, cashflow improved, and there's a pretty wide sentiment that if you don't have to sell now, don't do it," he continues. "But the airport area, which was the other problem child, is recording its first year of positive occupancy and rate growth."

Stability in the market

On the financial side of the coin, stability is key. Randy Heller, vice president of commercial real estate for Finova Capital Corp., says the strategy his company follows is consistent lending, whether the hospitality market is on the rise or fall. "Three or four years ago, when there was not a lot of money around, we were still lending," says Heller, commenting on the stability of Finova. "We plan on being there over the long haul."

According to Heller, many lenders enter the market with temporary rates and terms that may seem too good to be true. The problem is that in times of hardship for the hospitality industry, these companies all but disappear. Heller says that although his company may not always be able to compete with these rates and terms, they compete instead through service and track record.

Management stability

Stability is returning to the market for management companies themselves as well. The "change-the-flag-every-two-months" mentality is more common in down markets and not improving ones. That is providing a little more stability for management companies than in the early-1990s, when lenders were more active in their properties.

Santa Fe Management added four new hotels this year and typically has between 12 and 16 properties under contract. "There is always someone going out of system, because the harder you work, the better you do, the more successful the properties become," explains CEO Giacomini. "As the recovery gets stronger, properties do better. We're incentive-based, and sometimes the owner who writes the incentive check looks at it and says, `Gee this business is easy. I can do it, and that money could be in my pocket.' But they find out it's not that easy."

So whither goest the hospitality industry?

More profits, more occupancy and conceivably more sales. "In 1996 we'll see more transactions, but it will be a turnover of assets that have already sold and have proven that they are worth more intrinsically than they were purchased for," says Morone of Collier's International Hotel Realty. "Basically, it's profit-taking."

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