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Hotels remain a shining star in the real estate universe

Thomas F. Hewitt, the president and chief operating officer of Carnival Hotels and Resorts, is taking a "cautiously aggressive" stance in 1997.

"We're continuing to expand where opportunities present themselves," explains Hewitt, a veteran of the hospitality business for more than three decades. "We're very aggressive, but over the past 24 months, it's gotten a little more challenging to identify real opportunities we can take advantage of. Now we just have to look harder - longer."

Host Marriott's Bob Parsons says his company will continue to focus on acquiring full-service hotels next year, noting that in 1996, Host Marriott bought 20 hotels for about $1.3 billion. "We still continue to see a number of opportunities to acquire quality, full-service hotels at prices below replacement costs," he continues. "Many of them are in downtown locations but some are in strong suburban office markets."

David A. Simon, the chairman, president and CEO of Fairfield, N.J.-based Prime Hospitality Corp., notes that since demand for rooms is growing and rates are increasing nationally, hospitality companies such as Prime are prudently expanding. "We intend to concentrate on our new brand, AmeriSuites, in the year ahead", Simon explains. "We intend to open more than 30 new AmeriSuites nationwide. But while we will concentrate on AmeriSuites, we will also look for `opportunistic acquisition' of full service hotels, particularly where they fit in with our operations and in regions where we're not in."

America's hospitality industry, which earlier in the decade was deeply troubled with too many hotel rooms, too much debt and too few guests, continues its remarkable turn. Buoyed by growing investor interest, continuing heavy demand and little new construction, except in the limited-service and extended-stay sectors, the hospitality sector is expected to be the shining star of the real estate sector again in 1997.

"The industry's four-year-old recovery phase should continue for the next year or two," explains David B. Sinyard, senior vice president/corporate finance and development for Atlanta-based Holiday Inn. "As long as interest rates are low and the stock market remains strong, funds will continue to flow into the industry. Upscale hotels will continue to be attractive investments, though the competition for acquiring such hotels is fierce due to the number of hotel REITs in the market."

One of the hospitality industry's gurus, Randy Smith, CEO of Smith Travel Research in Hendersonville, Tenn., agrees. "We expect supply to increase 2.4%, with demand increasing only 2%, and occupancies declining slightly," he continues. "We're expecting occupancies to be 65.4% in 1997, compared to 65.7% the previous year."

A decline in occupancy? Does that signal the start of a shift in the fortunes of the industry? Not really, Smith hastens to add. "It doesn't mean that much," he continues. "We're going to have a continued record year of profits for the industry. Right now we don't see any problems on the horizon. We're confident, barring something dramatic, it's going to be a pretty good 12 to 18 months."

Profitable year expected

Currently, supply is growing and occupancy stabilizing, Smith adds. "We're not looking at a lot of problems in 1997, it's not going to be a boom time, just another record profitable year," says Smith. "The industry will probably hit records the next couple of years. We fully expect equity investors to continue to show interest. People will be out to buy (hotels) as long as the profits roll in. Even so, at some point, it's going to start slowing down, but we have no idea when it's going to happen."

Bill Gudenau, chairman of Hotel Partners in Chicago, a full-service international hotel real estate company, agrees the hospitality industry is on a roll. "If you look at hotel financials, things are better now than they've been in a long time," he says. "We see continued growth in 1997. Full service and upper-end hotels are going to see strong growth in occupancy rates and REVPAR. Limited service is going to be flat - if not down - because so much new product is coming into the market."

Gudenau notes that while others predicted that 1996 would be a slowdown in sales, "we have not seen it. Our level of transactions have significantly increased. We will start 1997 with in excess of 100 exclusive listings, a 40% increase over 1996. I think right now, the market is strong because there is a lot of capital. Values and prices have significantly increased. People who have been holding onto properties during the downturn are now deciding to take their profits and get out. I would say the market is going to remain strong in terms of pricing. We're going to see stabilized pricing if not continued growth in value."

1997 will see a scarcity of higher end product, Gudenau says, particularly since large hotel companies and public real estate companies have already snapped up hotels and are hung for more. "Real estate investment trusts are very active, so are hotel companies like Marriott, Hilton, Sheraton, and there is a lot of foreign capital coming out of Southeast Asia, Indonesia, Singapore, Hong Kong, Taiwan. There'll be a continued growth in the trading of limited service and the older full service properties that are finding it difficult to compete with all the new products. Prices are increasing, on a per room basis, for full service but in the limited service segment, it'll be flat or maybe even a decrease due to increased competition."

In fact, say those in the industry, the problem could be too little product for investors. Randy Heller, vice president/commercial real estate at Finova Capital Corp., a diversified financial services company based in Phoenix, laments the lack of properties. "There is not enough good product for everyone to finance," he explains. "The hotel business is at the top, and we're seeing some financial competition. A lot of money is available as more companies become comfortable with the industry."

REITs, foreign investors, and others are driving the hospitality investment market, Heller notes. "I see some more foreign money looking for a home," he continues. "Foreign investors know things are so stable here and the industry is on top of the cycle. Every year it seems there are more dollars available for the hospitality industry. Everyone wants the same thing - cashflow, historical performance, etc."

Because of this competition, rates have been squeezed down to a point where they are "as low as they can go," Heller says. "Sooner or later, rates will turn up and be higher. Lenders are now doing some rehab lending and some construction lending. National lenders are getting more comfortable doing more construction lending. And lenders are better at monitoring themselves now than they were in the 1980s. I don't think they'll get crazy and allow developers to over build like the '80s."

Construction of full service hotels will be relatively sparse, adds Paul Novak, president and CEO of Dallas-based Bedrock Partners, one of the success stories of the 1990s, since not a lot of new full service hotels are being contemplated. "In order for something to get out of the ground, projects have to be fairly well along by now," Novak says. "I think that we'll begin to see a lot more discussion and serious projects being considered in 1997, coming out of the ground in the later part of the year or in 1998, not open until late 1999."

Accordingly, caution has become the watchword of the 1990s hospitality industry, notes Bud Cataldo, CEO of Chicago-based Hostmark Hospitality Management. "I think there is a lot of money out there that has to be invested, and some people will over pay," Cataldo explains. "It's a seller's market. Acquisitions are more competitive today because of the opportunity funds, the REITs, and the investors who are paying a high price for product today. We have to be careful to not overpay."

Hostmark is being vigilant because "we don't want to repeat the mistakes of the 1980s. We run all types of hotels with the main concentrations in three and four star hotels. We're looking at certain market niches, but I don't see us doing a grand construction program. New development may be 20% of our efforts next year, not much more."

Economy sector not as encouraging

While 1997 will be a very good year for the industry in general, Cataldo and others are not encouraged in the lower economy sector as with full service and upper level hotels. "We think the economy and extended stay segments will be feeling a downturn the earliest," Cataldo continues. "There's a lot of activity now that has started and will continue to start, especially with all these new extended stay products. We think there could be an over building in the next 18 to 24 months."

Demand will be strong for the right product says Simon of Prime Hospitality. Demand for rooms is growing about 4% and the economy is very strong. Markets such as California and New England that were weak are now rebounding. "We will see continuing improvements in average rates but probably a flattening of occupancy since it's extremely high to begin with," says Simon. "More new supply will be coming on to the market, primarily in limited service, but they'll also be new construction such as casino hotels, maybe some new hotels in Orlando, some other resort hotels."

The industry is seeing a rise in full-service and resort development, says Gudenau of Hotel Partners, but only in select markets. Chicago, for example, has a fair amount of new product coming on line, including the new Hyatt Regency McCormick Place, a new Park Hyatt on Michigan Avenue and a House of Blues 400-room hotel planned in the Windy City's famed Marina Towers complex. "As prices for acquisition ratchet up to near replacement costs, we'll see new development," he adds.

Carnival is constructing two new resort properties: the Grand Bay Resort and Residences on Key Biscayne, Florida, and the Grand Bay Hotel and Resort Puerto de la Navidad between Puerto Vallarta and Manzamillo in Mexico. Currently, Carnival has 82 properties under management or development with more than 18,000 hotel rooms in the U.S., South America, the Caribbean, Bahamas and Mexico.

"We remain bullish on 1997," continues COO Hewitt. "We're committed to growing the Grand Bay line. We have two projects coming out of the ground, and we're very excited. But we recognize that there is limited opportunity in that market, so we have to be very careful."

Host Marriott is clearly in an acquisition mode, and Parsons says the company will acquire as many - or more - properties in 1997 as it did last year. There are still numerous opportunities in the marketplace, he says, noting that the company purchased the 1,300-room San Diego Marriott, three Ritz-Carlton Hotels - including the Naples, Florida, hotel and two in the Atlanta area - and four Marriott Suites in 1996. But such purchases are seeing more interested parties. "There are more players trying to do what we're doing," says Parsons. "There is a little more competition today than a year or two ago. But we've focused on some unique areas where we have some real competitive advantages."

He notes that Host Marriott is general partner in a number of limited partnerships that own hotels in the United States. The company has begun working with those partnerships to acquire hotels, providing liquidity to limited partners that have been in the partnership for some time.

Thus Host Marriott is focusing on utilizing its unique relationships with owners, Parsons continues, noting that "half of the transactions we did in the past year weren't in a competitive situation. We have to pay a fair price, of course, but we went in and negotiated the deal with the owners, who knew us as the general partner."

The company is now actively pursuing opportunities to acquire Ritz-Carlton Hotels and Marriott Hotels managed by Marriott International, but owned by various companies, trusts, or families. "Even with additional competition, we're confident in our ability to grow rapidly, to make major acquisitions over the next couple of years," Parsons says.

Host Marriott is also focusing on purchasing some of the hotels Japanese companies own in the United States. "The Japanese own in excess of 200 hotels in the U.S., and a large percentage of hotels owned by the Japanese are going to be changing hands," he says. "Many of the owners are interested in selling. We'll continue to see an increasing amount of those properties change hands."

Older properties face competition

Probably one of the most active segments of the hospitality market in 1997 will involve older properties that are facing newer competition, say those in the industry. "We'll see some significant weakening in the seasoned, mid-priced product - the older Holiday Inns, HoJos, and the Sheraton Inns that haven't converted to Four Points," explains Bedrock Partners' Novak. "This includes just about any of the properties in the 20- to 30-year-old range."

Novak notes that as the supply of limited-service rooms, particularly the moderate to lower priced extended stay efforts, start to open their doors in 1997, they will take business away from the older, mid-priced supply - even though types of properties appear to perform fairly well.

"You will start to see a rapid decline in their performance," he continues. "Most of renovations at these properties were done three or four years ago and were mostly cosmetic, so they'll be showing more wear and tear in 1997."

Industry observers note there is a large segment of moderate priced hotels built in the late-1960s and 1970s that hasn't been renovating to the level needed to reposition them in their marketplace. This comes as a new influx of properties is hitting the market, ranging from Club Hotels by Doubletree to Hilton Garden Inns.

"Many of these companies have very aggressive franchising programs, so you've got a lot of new generation rooms coming on line or expected in 12 to 18 months," says Novak. "The new rooms are going to give consumers a real alternative at a competitive price. The squeeze will definitely be felt in the middle. It won't be like the late-1980s or early-1990s when everything was a problem. Clearly the full-service side is well protected, because of the limited supply."

Smith acknowledges that the supply of limited-service and extended stay rooms is "growing a little faster than we'd like it to, and occupancies are slowing down a little, but as long as they stay there, at 65%, we'll be okay."

He adds that the typical development mindset has taken over the limited-service segment. "They see their competition in there, and they're convicted they can bring a property and steal away demand from an older property," he continues. "They build a new hotel and usually succeed at stealing away guests from the old hotel. The problem is we don't stop at one hotel in the area. We'll go in with three or four of them. By the time you get a second and third one, you have a problem."

In the early-1990s, those problems turned into opportunities for savvy hotel investors, and the demand for turnarounds hasn't lessened.

Incredible demand for product

Adam J. Petriella, vice president and regional manager for Marcus & Millichap in Newport Beach, Calif., says there is an incredible demand for product. This is occurring at a time when the product pipeline is getting choked off, as lenders' portfolios of bad loans have worked themselves through.

Petriella says there are still some difficulties in Southern California, but the volume of problem properties has decreased, which is good news for owners who want to sell and were afraid to compete with lenders," he adds. "There's a tightening, overall feeling that the market from a value perspective is beginning to firm up. We've seen bank properties sell and then resell within a 12-month period. In one case, an owner cleaned the hotel up, re-flagged, and resold it 25% to 75% higher than the price he paid for it."

He notes that Marcus & Millichap recently brokered a $2 million property that was bought and is now valued at $4 million and another one purchased during the same period for $900,000 and now worth $1.4 million - with no rehab. "We're seeing fantastic buyer demand that I think will continue for another 24 months."

From virtually any angle - occupancy, rates, sales - the hospitality industry is enjoying good times and those times are expected to last into 1998. But as Smith of Smith Travel Research notes, "nothing lasts forever."

Kelleher sees continued change

In the hospitality industry, the only constant thing is change.

Thus the hotel sector will undergo a number of changes in the years ahead, ranging from consolidation and growth to creativity and a return to the basics.

"Substantial changes in ownership will continue as major companies representing real estate and management interests form strategic alliances to acquire existing hotel real estate," explains Richard M. Kelleher, president and CEO of Phoenix-based Doubletree Hotels Corp.

Kelleher should know. Doubletree has formed several of these alliances with major hotel REITs and with private capital sources. Thanks to these moves, the company has access to over $650 million through these arrangements and expects to continue to aggressively pursue acquisitions.

Some three years ago, Kelleher notes, Guest Quarters and Doubletree merged to create the first new national brand in more than two decades. Since then, Doubletree has grown from 96 to 234 properties, including the acquisition of the Red Lion chain. The company is still expanding.

Doubletree recently entered the extended stay market, partnering with well-known hotelier Jack DeBoer, the creator of the extended stay concept and more than half of the extended stay hotels open today. Doubletree also created the Club Hotels by Doubletree brand, which is targeted to "road warriors" who spend some 100 nights a year on the road.

The industry needs new brands and approaches to respond to consumer needs especially to keep pace with the explosive changes in technology.

"But we don't need new brands just for the sake of selling franchises," he adds. "In the past two years, more than 15 new hotel brands have been introduced. Within five years many of those brands either will drive the older, tired brands that have not or will not change with the times out of business or will fail because they didn't have the strength and capability to grow to critical mass."

At the same time, Kelleher notes, there are more than 500 management companies in the marketplace. Within three to five years, that number could easily shrink by as much as 30%, thanks to mergers.

"National management companies offer economies of scale in overhead and purchasing, more sophisticated operating systems and, in today's market, the ability to invest side-by-side with the hotel owner," Kelleher says.

"Smaller, under capitalized companies will find it increasingly difficult to compete without those capabilities through the remainder of the century."

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