Both public and private Canadian investors are enticed by a favorable exchange rate and the greater breadth of the hotel market in the country across the border.
REPORT FROM CANADA—Canadian hotel investors are steadily looking across their southern border for acquisitions in the U.S., enticed by both a favorable exchange rate and the greater breadth of the nation’s hotel market. From the public REIT sector to private equity investors, the U.S. is indeed a land of opportunity.
Faced with an abundance of domestic supply and few purchase options, Canadian companies often need to search elsewhere for growth. Canada also has been enjoying a favorable exchange rate over the U.S. dollar for some time (presently $1 equals $1.05 Canadian dollars), creating an added incentive for Canadian investors to snap up assets.
“We’re essentially accessing what has been a bullish Canadian market for real estate and taking public funds by offering a decent yield, secured by U.S. revenue. Basically part of the opportunity is to hedge against U.S. currency,” says Rob O’Neill, CEO of American Hotel Income Properties REIT, a Vancouver-based REIT created earlier this year specifically to invest in U.S. hotels. “That has been attractive, because the Canadian dollar over the past six months has been close to par.”
For AHIP and Canada’s only other dedicated hotel REIT—InnVest—as well as private owner-operators, the allure of buying American assets continues to build under the current economic climate. Many of the U.S.-based REITs have slipped in the market in recent weeks, as fears of higher interest rates loom. This both limits the competitive purchasing power of U.S. REITs and paves the way for well-funded Canadian companies to seize opportunities instead.
“We’ve seen pretty substantial pullback in REIT stock prices, and with the decline their cost of capital goes up, which makes it more difficult for REITs to be competitive,” said Ryan Meliker, an analyst with MLV & Company. “There may be more opportunities for Canadian investors in the U.S., between not having to fight with the REITs and also benefitting from a more attractive exchange rate than they normally see.”
That’s why companies like AHIP or large private equity owner-operators like Pacrim Hospitality Services in Nova Scotia are working to jump on those chances now, before the economic climate changes.
“There are some people who view, with the commodity downturn, that the par will spread to the favor of the U.S. as the demand for Canadian commodity declines—or at least the dollar pricing they have to pay for Canadian commodities declines,” O’Neill said. “Canadian currency would become significantly weaker than the U.S.”
Where the deals are
Canadian investors often have no choice but turn toward the U.S. for hotel acquisitions, especially distressed sales.
Pacrim executives say the company has been active in the U.S. acquisitions market partly because Canada didn’t see the same sort of banking upheaval as in the U.S. during the recession, so there weren’t as many distressed properties available.
To boot, in Canada supply continued to grow at around 2% a year, even during the economic downturn.
“A combination of continuing supply growth and a lack of distressed properties in Canada made it attractive to look south,” said Glenn Squires, CEO of Pacrim Hospitality. “We still see the U.S. market as a good acquisition market. There are still some opportunities to acquire assets for well below replacement value, although that window may be beginning to close over the next 12 months or so. But for the balance of this year, that opportunity is still going to exist.”
Fundamental geographical and demographic factors are also at play, particularly when considering the differences in population between the U.S. and Canada (roughly 320 million versus 34 million, respectively) and the smaller number of markets in Canada, as opposed to the U.S., which boasts an endless array of suburban and feeder markets. These are the locations many Canadian investors are specifically targeting.
“We’d like to acquire hotels in secondary and tertiary markets, not primary and large secondary markets,” O’Neill said. “We see ourselves in smaller, more regional markets in the U.S. You have 1,000 communities in the U.S. that are larger than anything but our top 15 communities in Canada. There’s a much wider universe which I’m more comfortable investing in.”
On the hunt
AHIP wasted little time under CEO O’Neill, who previously led one of Canada’s longstanding REITs, Canadian Hotel Income Properties REIT. The newly formed REIT’s February initial public offering was a hot commodity, easily meeting its goal of raising CA$100.1 million.
“We came out to the market for CA$75 million—a small IPO in the context of the U.S.—and we raised CA$274 million,” O’Neill said. “I did not take CA$274 million, I didn’t have use of proceeds for it, but I did take CA$100.1 million, so today we’re on the hunt for hotel investments in the U.S. We’re really targeting select-service suites and extended-stay, and portfolios in the $30 million to $50 million range. We have acquisition capital for that, and attractive debt, because our leverage will be very low, at 50%.”
In March AHIP made its first acquisition, purchasing a portfolio of 32 Oak Tree Inn hotels and 24 Penny’s Diners from Kansas-based Lodging Enterprises LLC. The $127.5-million deal was especially attractive to O’Neill because the Oak Tree hotels primarily cater to freight train crew, a solid niche market he says he’s worked with in the past. The steady demand from these workers singlehandedly drives the hotels’ profitability.
“We are one of the best-performing REITs in Canada this year, simply because there was another aspect to our offering: long-term contracts with large U.S. rail companies,” O’Neill said. “That was very attractive to our investors.”
Pacrim announced a joint venture in June with Driftwood Hospitality Management LLC of North Palm Beach, Florida, which within five years is expected to represent nearly $100 million in hotels. The JV will target 100- to 300-room full-service and extended-stay properties across Canada, the United States and select foreign markets. The move is also intended to give Pacrim a more domestic presence here in the States.
“Working with Driftwood gives us a good platform to work off of,” Squires said. “We’ve got the infrastructure on the ground in Canada, so we can move quickly—we know the lay of the land—and the same thing is true of them in the U.S. When you’re working in 50 states, there are a lot of subtleties, so it helps to have a local partner.”