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REITs watch fundamentals, cost of capital rise
February 1 2013

Some REIT executives during ALIS said it’s a good time to buy while others cited a rising cost of capital as reason to focus investment internally.

Highlights
  • Sunstone’s President and CEO Kenneth Cruse said the company is entering acquisition mode.
  • Hotel values coupled with a higher cost of capital isn’t making 2013 a good time to buy for Ashford.
  • FelCor is not doing deals because it is “focused organically on our own portfolio.”
By Jason Q. Freed
Contributing Editor, Tech Impact Report

LOS ANGELES—While real-estate-investment-trust hotel-buying activity comes in spurts—mostly dependent on the cost of capital for private companies versus the ease of raising public funds—the timing of this most recent cycle is proving to be a bit more complicated.

The REIT outlook for 2013 appears to be all over the map. Some REIT executives during last week’s Americas Lodging Investment Summit said they are eagerly looking to add assets to their portfolio while others said they are focused on investing internally to improve what they already have.

“We’re all being selective, critical and playing to our strategies,” said Mike DeNicola, executive VP and chief investment officer at FelCor Lodging Trust.

However, FelCor’s specific strategy appears radically different than that of, say, Sunstone Hotel Investors. While DeNicola said FelCor continues to market its non-core assets and refinance existing loans to decrease the amount of debt on its balance sheet, Sunstone’s President and CEO Ken Cruse said the company is entering acquisition mode.

“We think it’s time to buy hotels,” Cruse said, offering little detail other than the fact that the specific amount of activity will depend on what comes to market and how bid-ask spreads shape up.

“Sunstone’s four pillars of strategy are largely unchanged during different points of the cycle,” he said. “Right now, our acquisition strategy is more prominent. Last year, a lot of the reason the market wasn’t there was because of the dysfunction in Washington, (D.C.).”

R.W. Baird Senior Research Analyst David Loeb called Sunstone in a recent research note a “stock to watch” because of the company’s potential acquisition activity.
 
“After completing the sale of its four-hotel Rochester (New York) portfolio (net proceeds of $165 million) and a follow-on equity issuance that generated over $100 million in net proceeds, we estimate Sunstone has over $550 million of investment capacity (inclusive of its $150 million line of credit),” Loeb wrote. “We expect the company to announce a major acquisition in the near term.”

For Ashford Hospitality Trust, however, hotel values coupled with the REIT’s higher cost of capital isn’t making 2013 a good time to buy.

“It’s a challenge for us to make numbers accretive in our model,” said Doug Kessler, president of Ashford.

DeNicola said FelCor traditionally has had a lower cost of capital, but the REIT is not doing deals because it is “focused organically on our own portfolio.”

“We’re making investments in the hotel industry but in the product that we already own,” he said.

“Are we buying? Yes, we’re all generally chasing the same type of opportunities,” Kessler added. “The main differentiator is our cost of capital and what amount of leverage do we want to use to acquire assets. We feel our cost of capital is high, so we haven’t bought anything in two years. By comparison to what’s trading today, what we bought two years ago looks like a great buy. We don’t feel like we have to grow for growth sakes.”

Clearing hurdles
While macro headwinds remain, particularly uncertainly surrounding the remaining fiscal cliff and debt ceiling issues, most REIT executives at ALIS said near-term optimism is outweighing worry.

“Investors love to worry about risk. Today it’s Washington; three years ago it was Greece,” said Michael Barnello, president and CEO of LaSalle Hotel Properties. “We had the auto industry that was going to go belly up and that was a crisis. We had BP that was going to cripple the lodging industry in the Gulf.

“Not that those things aren’t real, they are real, but lodging as a backdrop has done quite well over the past three years,” he continued. “Yes, the Washington fears are real, but our perspective is that it’s a good time in the cycle to be investing.”

Barnello said, as far as month-in, month-out booking of events, LaSalle hasn’t seen any impact at all of continued fiscal cliff concern.

DeNicola said the U.S. hotel recovery has been constant despite some events that would typically derail a recovery.

Economic uncertainty can have an impact on the availability of debt, he said, but despite Washington’s woes, the debt markets have been loosening.

Commercial mortgage-backed securities debt “is returning,” he said.

Also, the recovery has been steady despite the jobs market not showing much of a recovery. “Traditionally, the jobs market had returned first,” DeNicola said.

Kessler attributed that to the type of jobs that were lost in the recent recession. It wasn’t the heavily traveling employment groups that saw the most cuts, he said.

“There has been disjunction in Washington since the constitution was written,” Cruse added. “However, REITs are not trading at peak multiples, and the main reason is because we have these macro headwinds. They weigh down hospitality because hospitality as a class of real estate is more risky.

“As those fears dissipate, we’ll see more cash flow; more cash flow will lead to higher multiples, which will generate transaction activity.”

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