REPORT FROM THE U.S.—The profile of hotel investors today has some experts predicting a long-term shift in the way hotel real estate will be asset managed and the frequency by which hotel transactions occur.
Activity throughout the hotel investment landscape is being driven by more traditional traders of assets, and there is less activity from those groups who are typically long-term holders, said Art Adler, managing director and CEO of the Americas region for Jones Lang LaSalle’s Hotel & Hospitality Group.
Adler said that shift in hotel ownership composition consistently will lead to more transaction volume.
“There are many more hotels today in the hands of traders versus holders,” Adler said. “If you go back 20 years, hotels were in the hands of financial institutions that held forever, hotel companies, c-corps that held forever. Now there is more in the hands of institutional investors that trade and private equity firms that trade.”
Adler said even real estate investment trusts—traditionally longer-term holders—trade hotel assets today more frequently than they did in the past because they’re constantly trying to upgrade their portfolio.
Although private equity hotel investment is traditionally cyclical in nature, Adler said the ownership composition is shifting long term.
“When you look at the amount of money private equity is investing in the industry, they are not long-term holders,” he said, citing JLL data that shows $7 billion in private equity investment in 2012 alone.
Source: JLL
Nuts and bolts
For as long as hotels have been a real estate asset class, private equity investors traditionally have been shorter-term holders of assets for many varying reasons.
Private equity investors generally are paid a bonus if they hit high returns, said David Loeb, senior research analyst with R.W. Baird. Bonuses are usually calculated in congruence with internal rates of return. In addition, the longer an owner holds onto an asset, the more difficult it is to sell at higher values, Loeb said.
Public companies have lower return expectations from their investors, Loeb said. They look to take less risk with their investments and look for assets that will generate stable annual cash flows.
In particular, REITs are obligated to follow strict rules that prevent them from being frequent traders of assets, said FelCor Lodging Trust VP of Investor Relations Stephen Schafer.
“The public companies by nature have to be long-term holders and take a longer-term view partly because of the tax consequences related to being a REIT,” he said. “For private equity, if you’re willing to time the market—buy in the early cycles and sell in the late cycles—then you can make a lot of money.”
Schafer said private companies can “go out on the risk spectrum,” maybe in markets with lower barriers to entry because the investment won’t be through a whole cycle.
REITs “have a low cost of capital and can keep their investors happy with cash-on-cash returns,” added Suzanne Mellen, managing director of the San Francisco office of HVS International. “They also have that tax advantage that they’ve got being a REIT. They’re literally in the business of owning assets.”
Varying opinions
Whether the shift from public to private ownership is a trend that will spark a sudden boost in transactions volume, however, is up for debate. While experts agree public companies have been divesting of assets, many say it’s nothing new to the industry.
“This is a trend that has been going on for a long time,” Mellen said. “In the hotel business, you really make your money by opportunistic buying and selling.”
Mellen said private equity investors always have been looking for yield, and the only way to bring in those high yields is by selling assets. REITS, however, can attract mom-and-pop investors interested in cash-on-cash returns.
Loeb said that companies have been recycling assets, rather than treating them as lifelong investments, for a long time now.
“Even in the late ’90s there was a lot of private equity interest,” he said. “I think a lot of the romanticism about ownership in the past was blown out of proportion. Companies didn’t necessarily hold them forever.”
However, he did say there has been “a bit of turnover” that has come out of the most recent financial crisis that has led to a significant amount of foreclosures, and then deals. And a handful of REITs have gone private. But public companies have been buying more than private equity in recent years, he said.
What does it all mean?
The ownership structure—whether owners are short-term or long-term investors—has an effect on the overall hospitality business. But is it a positive or negative effect?
“I’m not sure it’s one or the other; it just is,” Loeb said. “Hotels benefit from stable ownership, but changes of ownership also can create opportunities to upgrade product. New owners can come in and do a lot of interesting things. The worst thing for a hotel is neglect.”
Some argue, though, that private equity investors care so much about yield that they cut labor or forgo capital investment to sustain high rates of return.
“It’s sometimes sad because you see these hotels tortured,” Mellen said. “You’ll go in, and you can see they need money. But because the market is OK they’re not going to put money in right now.
“REITs are more concerned with the long-term health of the asset.”
Loeb said the notion of private equity neglect could be a misnomer.
“I don’t think it works that way in commercial real estate broadly,” he said. “These are real estate assets they’re trying to make money on. They do the things they have to do to bring in customers.”
Blackstone, for example, invests aggressively in its own portfolio, Loeb said.
Regardless, Adler said shorter-term investment, which would lead to more transactions volume, is actually good for the industry.
“When properties turn over, they are reinvented,” he said. “They’re repositioned. New capital goes in. Better management potentially goes in.”