What's New In The Hotel Capital Markets? By Thomas W. Lattin - PKF

We attribute the lack of full service hotel activity earlier in 2003 to several factors which we list here in detail:

• 1. Hotel operating performance has declined each year since 2000 and is likely to show a further decline for 2003 when final numbers are released.

• 2. The lackluster economy, Iraqi War, and fears of further terrorist attacks on the U.S. continued to erode hotel investor and lender confidence in the U.S. lodging industry.

• 3. While most hotel companies and industry analysts believe that the U.S. lodging market has bottomed out and will improve next year, few if any are forecasting a rapid turnaround for 2004.

• 4. As lenders continue to require high equity contributions, even though interest rates are at historical lows, the cost of financing is expensive and requires investors to model high rates of return or look to mezzanine loans to fill the gap between first mortgage debt and equity required.

• 5. The investors that are in the market are very selective as to the type of deals they will do. Based on the most popular underwriting criteria, to qualify for consideration as a hotel acquisition, the hotel must:

1. Fly one of the most popular flags or be able to be converted to one.
2. Be located in a major market with very high barriers to entry.
3. Require a major renovation and have a "turn-around story" associated with it.
4. Be managed by a stipulated hotel management company.
5. Project an IRR in the high twenties or low thirties.
6. Have no more than a four-year, and preferably three-year, year exit strategy

For the recent up-tick in capital markets activity to be sustained, we believe several important and related things must happen:

• 1. Investors need to become somewhat less demanding as to their ROI requirements and accept acquisition opportunities that yield internal rates of return in the low to middle 20's.

• 2. The economy must improve quickly and include the expansion of the labor force and an increase in capital spending.

• 3. Significant progress must be made on the war against terror, including the capture or elimination of the major terrorist leaders.

• 4. Significant progress also needs to be made in re-building Iraq and making it a safer place in which to live and do business.

• 5. The stock market must continue to rise and return to its pre-9/11 level.

• 6. Domestic and international airline travel must increase and show sustained growth.

• 7. Convention and group bookings must increase and also show sustained growth.

If the aforementioned seven things happen, we believe that hotel RevPAR will increase nicely in 2004, hotel profits will rise, and activity in the capital markets will return to their pre-9/11 levels.

The PKF Capital Markets Group offers a variety of transaction services to its clients including the following:

• Debt Financing: Securing construction, permanent, and mezzanine loans for clients developing new hotels and acquiring or re-financing existing hotels.
• Equity Financing: Matching clients in need of equity capital with selected equity funds and investors.
• Hotel Asset Sourcing: Identifying potential hotel acquisition candidates for clients based on their specific investment criteria.
• Hotel Disposition: Identifying potential buyers for clients in special situations where the client desires the property to be marketed in a very discreet fashion.
• Merger & Acquisition: Identifying companies to merge with or acquire that would add value to the client's existing business.
• Development Services: Assisting clients in selecting and negotiating agreements with the best brand, management company, and other members of the development team.
• Asset Management: Assisting hotel owners in managing the management company and increasing shareholder value.

Recent representative PKF Capital Markets Group assignments:

• Southern California All Suite Hotel: Assisting a developer client in selecting and negotiating agreements with the brand and management company and securing construction, mezzanine and equity financing for the project.
• Northern California Resort Hotel: Assisting an investor client in underwriting and negotiating the purchase of a five-star resort hotel.
• Los Angeles Boutique Hotels: Identified potential acquisition opportunities for an investor client interested in owning a boutique hotel in a specific sector of Los Angeles, including introductions to the owners.
• Southeast U.S. Public/Private Convention Center Hotel: Assisting a developer client in negotiating an agreement with the county to construct a headquarters hotel in conjunction with the expansion of the convention center; selecting and negotiating agreements with the brand and management company, and securing construction, mezzanine, and equity financing for the project.
• Upscale Full-Service Hotel Portfolio: Assisted an investor client in underwriting the potential purchase of a small portfolio of upscale hotels located in the western half of the U.S.
• Texas Mixed-Use Development: Assisting a developer client in negotiating a joint venture agreement with the land owner and securing the required debt and equity financing to develop a luxury condominium, hotel, office, and retail project.
• Texas Conference Center Resort: Assisting an investor client in underwriting and negotiating the purchase of a large conference center resort.
• Mid-market Hotel Acquisition Program: Helping a publicly traded REIT client identify, underwrite, and finance a portfolio of limited- and full-service hotels that meet the investment criteria and specifications established by the REIT's equity partner.
• Texas Full Service Hotel: Assisting the owner of a mid-priced full service hotel in refinancing and upgrading the subject hotel.
• Southwestern U.S. Portfolio of Extended Stay Hotels: Assisting the owner of a small portfolio of extended stay hotels in replacing their institutional equity partner with a hotel operating partner and converting the hotels to franchises.
• Midwest Emerging Hotel Chain: Assisting the owner client of an emerging full-service hotel brand prepare a strategic development plan; securing a capital partner to facilitate expansion; identifying existing hotels to acquire and convert to the subject brand; and upgrading and expanding the chain's corporate management team.
• Northeast Conference Center Resort: Assisting the owner of a famous historic resort hotel in renovating, expanding, and upgrading the property; securing an operating partner; and securing the necessary debt financing to complete the project.

Mr. Lattin is the Managing Director of The PKF Capital Markets Group. He can be reached in the Houston office of PKF Capital Markets at [email protected] or (281) 580-0295.