Hotel Values Climb as Investors Bet on Imminent Recovery

By ANDY FIXMER
Staff Reporter

Fed in part by low interest rates and a cyclical feeding frenzy, investment firms have been bidding up prices of Los Angeles hotel properties.

Having sat on the sidelines waiting in vain for a hotel industry collapse after the 2001 terrorist attacks, opportunity funds have watched the industry rally in recent months and are moving aggressively not to miss another up cycle.

"There is a big play from a lot of major players that the market is going to rebound and rebound strongly," said Alan Reay, president of Costa Mesa hotel brokerage Atlas Hospitality Group. "There's a tremendous amount of bidders looking at trophy assets."

Suzanne Mellen, managing director of hotel consultancy HVS International's San Francisco office, said that the interest had served to bid up prices nationwide in recent months.

"There was this feeling that we missed out on it last time," she said of the market's rebound in the early 1990s, "so let's get in on it this time around."

Locally, Reay said the per-room values reached at the end of October were nearly 25 percent higher than in the first half of the year.

One benchmark for tracking the rise in prices was the sale of the 436-room Sheraton Universal, purchased in June by Chicago-based Walton Street Capital from Vivendi Universal SA for $49 million, or $112,000 per room.

Two deals now pending the $43 million sale of the Pasadena Hilton to Norwalk, Conn.-based HEI Hospitality Group and Trizec Properties Inc.'s efforts to sell the Hollywood Renaissance Hotel for $88 million are 25 percent higher than the Vivendi deal.

Sources close to the Renaissance sale said Trizec had narrowed its conversations to three potential buyers, all in the $88 million range.

"A lot of the money that was in institutional hands and out of the hotel market is now coming back into the market," said Howard Cohen, executive vice president at Beitler Commercial Realty. "That's why prices are rising."

Some of the funds bidding on local properties have been Walton Street Capital LLC., Angelo Gordon & Co., Blackstone Group and the Carlyle Group, according to hotel brokers.

Markets come back

The activity thus far has been concentrated in premier properties.

Average occupancy at Los Angeles County hotels was 69.5 percent through the first nine months of the year, according to data from PKF Consulting, 2.3 percent higher than in the like period a year ago. The countywide bump has come at the expense of daily room rates, which declined in the January-September period by 3 percent from the year earlier. In Santa Monica, Hollywood and Valencia, however, room rates have risen this year.

But with the two-year downturn in travel many of the region's hotels have posted significantly less revenue than at the height of the travel industry in 1999.

That has prompted some investors to alter the way they value properties. Traditionally, buyers were willing to pay an amount equal to 10 times a property's net operating income. For example, the Hollywood Renaissance Hotel has an annual net operating income of about $3 million, and would normally fetch about $30 million, according to sources who have seen its financials.

"But buyers are bidding over $85 million, which is a huge premium over the net operating income," said one source. "It seems buyers in today's market are willing to pay a premium as long as they are buying below the replacement costs."

Mellen said that by using replacement cost as a guide, rather than a return on net income, some investment funds are simply seeking to justify overpaying.

"Buyers are building the hoped-for recovery into their price, which to me seems like a crazy thing to do," Mellen said. "There is no relationship between replacement cost and a price. They are using replacement cost as an excuse. It's about saving face."

Bill Brewer, a partner in Dallas-based hospitality law firm Bickle & Brewer, agreed that the way buyers evaluate properties hasn't changed and he called the replacement cost argument "good salesmanship" by hotel brokers.

"There has been no major or dramatic shift in how the market evaluates those numbers," he said. "Today's sophisticated buyer is looking at the hotel industry like a commodities broker, and betting the need to travel will increase as the economy heats up."

Part of that bet involves the difficulty of financing new hotel construction in a still-weak travel industry.

Reay and Cohen agreed that whoever buys the Hollywood Renaissance is betting there won't be another hotel built nearby for some time.

"People are not going to come in to the market and overbuild," Reay said. "We're not going to see a spurt in the development of urban center full-service hotels for at least another five years. So they are betting in that time they will be able to make it work."

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