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Deal opportunities in US secondary markets
May 11 2012

A lot of transaction activity in the U.S. has been focused on the major gateway markets, but the Bellevue, Washingtons of the world have something to offer investors, too.

  • “The smaller, tertiary markets are where you get double-digit returns,” Apple REIT’s Sam Reynolds said.
  • Lower operating expenses and better pricing are two factors encouraging acquisitions in secondary markets.
  • Financing is available in secondary markets, panelists said.
By Shawn A. Turner
HNN contributor

LOS ANGELES—Secondary and tertiary U.S. markets should be on hotel investors’ wish lists, panelists said during a general session at the Meet the Money Conference.

Listing secondary markets in California as an example, Samuel Reynolds, senior VP and director of acquisitions and dispositions at Apple REIT, said investors could find success in such cities as Sacramento, Riverside and San Bernardino. “The smaller, tertiary markets are where you get double-digit returns,” he said.

Other examples cited by Kevin Mallory, senior managing director at CB Richard Ellis, included Portland, Oregon; and Bellevue, Washington.

“The value-add opportunities live in these markets,” Mallory said.

One reason these smaller markets are attractive is because operating costs are lower, said Christopher Pfohl, senior VP at Pyramid Hotel Group. He is seeing the larger markets pushing into the major suburban areas surrounding Washington, D.C., and New York.

Pricing is also a positive, he said. “You can buy quite often more cheaply as it relates to a per-pound price,” he said.

The continuing improvement of the larger hotel sector also encourages acquisitions, the panelists said.

Kate Henriksen, senior VP of investment analysis and portfolio management at RLJ Development, said her company is likely to be net buyers of hotel assets this year.

“We think the fundamentals outweigh some of the risk factors,” she said.

Acquiring assets in these cities beats development, Pfohl said. “I don’t think there will be an opportunity to build,” he said. “The real opportunity is to buy a full-service asset for 50 cents on the dollar and move into the area.”

Mallory said deals can be made in these markets at capitalization rates between 9% and 11% with financing at 5%.

“Why wouldn’t you be doing it, especially with capital behind you,” he asked. “There’s plenty of product out there that doesn’t have a (property-improvement-plan) problem.”

The panelists agreed that lenders are willing to lend in these markets.

“A lot of this product is being financed through (Small Business Administration) 504 programs,” Mallory said.

Other sources of funding will still have strict underwriting attached, the panelists said.

“It’s all about sponsorship,” said William Sipple, managing director at HVS Capital Corporation. Deals that are not likely to be financed, he said, are the ones where, for instance, the management company is in one state, the equity in another, and the asset in still another. He also said it’s important to have an existing, close relationship with the lender.

Development financing is also challenged, Mallory said. He said CBRE turns down 90% of the development financing proposals the company is pitched.

“Even though it’s out there, I don’t want to make it sound like you can get it,” he said.

However, there is good availability of bridge financing, Sipple said.

“It’s appropriately priced for the risk,” he said. He has seen bridge loan financing at less than 10%, and less than 12% for non cash-flowing hotels, he said.

Potential hotel acquirers might be rewarded for looking beyond the coastal, gateway markets, the panelists said.

“We’ve had great success in these areas,” Sipple said. Markets near universities and military bases help insulate hotels from volatility, he said.

Challenges and risks
Striking a deal isn’t always easy, the panelists said.

“If you are looking at a product attractive to (real-estate investment trusts), it could be difficult to acquire,” Mallory said.

Another major problem facing borrowers is the equity gap that remains even when the financing comes through, the panelists agreed.

“You can only fund some of that (needed renovation),” Sipple said.

Investors should pursue the deals they want, regardless of obstacles, Mallory said. Persistence will get these people to the finish line.

Nine out of 10 times, he said he finishes a bidding process with just one or two qualifying offers. “If there’s a deal out there that fits you, go after it,” he said. “Don’t listen to the brokers.”

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