07/11/2012

Institutions Turn Sights to Higher-Yield Hotels

Select-service hotels are attracting increased interest from institutional investors.

Institutional capital has traditionally targeted full-service, high-end hotels in prime markets, but aggressive bidding has driven down returns on such properties. As a result, many investors are broadening their focus to include hotels that offer fewer services, generate higher yields and require less capital to maintain.

Among those that recently started to look at such properties or expanded their appetites are Broadreach Capital of Palo Alto, Calif., Five Mile Capital of Stamford, Conn., and Highgate Hotels of Irving, Texas.

“We’ve certainly jumped wholeheartedly into it,” said one acquisitions specialist at a fund shop. “They make a lot of sense because you don’t need a lot [of equity] to turn around the performance.”

Hotel brands require all operators to upgrade on a regular schedule. That can translate into a hefty capital outlay for the owners of full-service hotels, which must have restaurants and other amenities. The cost is far lower at select-service hotels, also known as limited-service properties.

What’s more, capitalization rates for select-service hotels averaged 9.9% over the first five months of the year, 2.6 percentage points higher than for full-service properties, according to Real Capital Analytics.

Institutional investors generally prefer limited-service hotels that have an upscale flag and are in areas with strong demand from corporate users.

Foreign players are also increasingly jumping into the mix. In the past, such investors usually sought trophy hotels in core markets like San Francisco and New York. Now, they are “more focused on select-service hotels in secondary cities that have strong profit margins,” said Holden Lim, a hotel broker and managing director at HFF in San Francisco. “Unlike foreign buyers who acquired hotels in the last few cycles, current buyers don’t need to acquire the so-called sexy properties. It’s not just ego, it’s about yield as well.”

The growing pool of buyers is fueling listings, including a few large portfolios. One example: Jones Lang LaSalle Hotels is shopping nine Courtyard by Marriott hotels, with 1,261 total rooms. The portfolio, whose owner is unidentified, is projected to generate $2.4 million of net operating income this year, well below its $8.6 million peak in 2007, according to marketing materials. The properties, available unencumbered by management contracts, are in Atlanta (four hotels), Dallas (three), Detroit (one) and Montgomery, Ala. (one).

As affirmation of the push by institutions, market pros point to Blackstone’s pending $1.9 billion buyout of the Motel 6 chain from Accor, a French hotel company. Meanwhile, a number of large investment shops, such as Starwood Capital of Greenwich, Conn., and Fortress Investment of New York, are kicking the tires of Red Lion Hotels, which owns and operates select-service properties. The Spokane, Wash., company has hired Bank of America to advise it on its strategic options, including a possible sale.

Most of the institutional investors seeking out limited-service hotels are looking to buy in bulk, as opposed to one-off transactions, said Al Calhoun, managing director and co-leader of the select-service division at Jones Lang. The firm predicts that the sale of select-service portfolios will double this year.

The limited-service sector also has more opportunities for distressed plays, investors said. Many properties are owned by small independent operators who are overleveraged or short of the capital needed for required improvements. “For institutional guys like us, that’s an opportunity,” said one acquisitions pro.

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