In January of this year, Hospitality Properties Trust, a REIT based in Newton, Mass., paid $1.9 billion to acquire TravelCenters of America, which operates more than 200 truck stops. Holding a $750 million line of credit, Hospitality Properties seemed well positioned to purchase more assets. But in the wake of a subprime lending crunch that rattled the bond market this past summer, the REIT has postponed all acquisitions.

With cheap debt not nearly as plentiful as it once was for today's borrowers, prices of hotel assets are expected to drop in the next year, says Tim Bonang, manager of investor relations for Hospitality Properties Trust. “A lot of sellers are still asking for peak prices,” he says. “We are disciplined investors, and we will wait until the market becomes more realistic.”

At a time when credit markets are recovering from the turmoil of last summer, hotel acquisition activity is largely on pause. Lenders are balking at financing the highly leveraged deals used by private opportunity funds. Meanwhile, public REITs and other traditional buyers are reluctant to make any acquisitions until the credit markets stabilize.

This quiet period represents a sea change from the picture of recent years. In 2006 and the first seven months of 2007, eight public hotel REITs were acquired and taken private, according to the National Association of Real Estate Investment Trusts (NAREIT).

Now 12 hotel REITs remain, and the survivors are not likely to be acquired anytime soon, says Chris Woronka, lodging analyst for Deutsche Bank. “Most of the likely buyers would need leverage, and that is just not available,” he says.

Woronka believes that deal activity will begin to accelerate in 2008, but at lower prices. Capitalization rates on high-quality urban properties, which recently hovered around 6%, should rise to 6.5%, while mid-price properties are projected to climb half a percentage point to 8%, Woronka estimates.

Returns on downward slide

The performance of lodging REITs on Wall Street has been uninspiring to say the least. Total returns year to date through Oct. 17 for lodging REITs were a meager 0.25%, according to NAREIT.

That flatness in total returns comes as the industry fundamentals remain quite healthy, says David Loeb, senior real estate analyst for Robert W. Baird & Co., an investment bank in Milwaukee. Indeed, revenue per available room (RevPAR) rose 5.8% during the first eight months of 2007, but that's below the 7.5% increase for all of 2006 and well under the peak of 8.5% set in 2005, according to Smith Travel Research.

Investors fear that after four strong years of performance, REIT shares may have peaked, says Loeb. “Investors like to go where the pace of growth is improving,” says Loeb. “They look at hotels today, and they see that growth is not as fast as it was a year ago.”

Smith Travel estimates RevPAR growth will moderate to 5.2% in 2008 largely due to a projected 2% increase in room supply next year. With supply climbing, hotels will have less ability to raise room rates, and bottom lines will become thinner.

Still, room demand in the lodging sector also is projected to grow 2% in 2008, according to Smith Travel. “Most of our business is corporate travel, and there is no sign that travel departments are cutting back,” says Stephen Schafer, vice president of strategic planning for FelCor Lodging Trust, a hotel REIT based in Irving, Texas.

The renovation edge

Schafer expects FelCor to report strong growth in 2008, although he sees no acquisitions on the horizon. FelCor is in the midst of a $430 million program to renovate its properties. By the end of this year, 64 properties should be complete, and the rest of the 83 upscale hotels will be whipped into shape by the middle of 2008.

FelCor is spending about $20,000 per room on the renovations. While the ongoing improvements hurt business in the short term, Schafer says that once a property is renovated, sales begin climbing. “We expect to see significant acceleration in RevPAR next year,” he says. “When a property has been renovated, travelers are more willing to consider your hotel.”

With industry demand still growing, public REITs should have the wherewithal to bid on properties in 2008, says Woronka of Deutsche Bank. “The private equity guys have been winning deals by using 90% leverage,” he says. “Since that kind of financing has become too expensive, the public REITs should step forward and make more acquisitions.”
— Stan Luxenberg