An increase in M&A pace is only a matter of time, according to REIT leaders who aren’t shy about saying they’re ready to jump into the fray.
NEW YORK—Hotel real estate investment trusts are ripe for consolidation.
That might be the worst-kept secret in the industry, so it’s only a matter of time for it to happen, according to REIT executives who spoke during a general session “The REITs in 2018: What—or who—is on the menu?” at last week’s 40th annual NYU International Hospitality Industry Investment Conference.
“We’ve seen more activity in the REIT M&A space in lodging than we’ve ever seen,” said Michael Bluhm, EVP and CFO for Host Hotels & Resorts, adding that Pebblebrook Hotel Trust’s continued pursuit of LaSalle Hotel Properties despite Blackstone already having an deal in place has exacerbated interest in the consolidation watch.
“You have to look at targets of those (acquisition) situations before extrapolating what it means for the industry,” he said. “These companies, while still high-quality targets, were fallen angels for whatever reason.”
Tom Baltimore, chairman of the board, president and CEO of Park Hotels & Resorts, agreed. He said Park, which is the second-largest hotel REIT behind Host, is poised to jump into the fray sooner than later. Hotel REITs are the most fragmented industry sub-segment within the REIT industry, he said.
“You can make a strong case for Pebblebrook and LaSalle, given their business models, given their history together, their very compatible strategies … that’s a combination that makes sense. There are others that would make sense as well,” Baltimore said. “It will take time, but I do think it will happen.”
Doug Kessler, president and CEO of Ashford Hospitality Trust, said that the mere fact that Blackstone is interesting in gobbling up a hotel REIT bodes well for the sector.
“The Blackstone bid for LaSalle is almost a validation that there’s a view that there’s more value in lodging REIT platforms today,” he said. “It’s a marker to say smart private equity has a view for the future of lodging and they’re willing to pay that multiple today to achieve their required returns.”
There are plenty of consolidation targets as hotel REITs tend to be smaller, for the most part, than REITs in most other asset classes, speakers said.
“Our industry needs to be consolidated—it’s too fragmented right now,” Kessler said. “There are too many me too-type platforms.”
“If you’re sitting as a REIT at $1 (billion) or $2 (billion) or $3 billion (value) today and looking at the cost of capital which over time is likely going rise, you’ve got to ask yourself, ‘Is this where I want to make a living or is there something better to do with my time?’” Baltimore said. “There are some situational issues right now that lead to some of the activity, but I think that’s only going to increase.
“I have been over the years one of the strongest advocates for consolidation. It’s going to occur in our sector and it should occur. We look forward to being a participant in that process.”
The consolidation process might be a reduction process, according to Kessler, who pointed at the Blackstone-LaSalle situation as an example.
“It’s not necessarily consolidation REIT to REIT, it’s the privatization opportunity,” he said.
The assets are the drivers
The bottom line, according to Bluhm: It’s all about the assets and market conditions.
“There is a very keen focus on the highest quality of assets,” he said. “This re-acceleration that we’re all experiencing in the business has given us from an equity perspective a degree of confidence about the outlook that I don’t think existed up until the past couple of quarters. You add in cheap capital, more optimism around the future … nothing drives M&A more than CEO confidence.”
The consolidation might eventually occur through natural order as panelists were also revved up about the transactions market.
“We’d like to be the consolidator of this sector as there are many private equity shops that have substantial holdings, as well as public market players,” said Jonathan Mehlman, president and CEO of Hospitality Investors Trust, a New York-based non-traded REIT. “That’s going to be our niche for the next three years as we position our portfolio for liquidity through a sale, a merger or a listing—we’re agnostic to that.”
Each of the panelists talked about adding assets to their portfolios while the timing is right. Their strategies often overlap.
RLJ Lodging Trust focuses on margin, which is driven in by rooms revenue, when it looks at properties to add to its 155-hotel, 30,000-guestroom portfolio, said Jeff Dauray, its SVP of acquisitions. The company completed its acquisition of FelCor Lodging Trust in September.
“Our strategy is to acquire and accumulate the best portfolio of rooms-focused hotels in primary and strong secondary markets … where demand is driven largely by corporate transient business,” Dauray said.
“Our strategy is very clear—it’s to buy iconic irreplaceable hotels around generally North America,” Bluhm said of Host. “The largest hotels in the urban cities typically with large amounts of meeting space. … The one unique element we have is we are differentiated by our scale and our balance sheet (which allows it to do billion-dollar deals).”
Baltimore said Park’s strategy is similar to Host’s as it is trying to join Host, which is the only investment-grade hotel REIT. Park targets upper-upscale and luxury properties in top 25 markets in the U.S. and premium resorts. Park wants to focus on deals larger than $200 million.
“In the near term there’s a lot of competition for it, but over the long term if you’ve got the balance sheet, if you’ve got the cost of capital advantage, you can be a formidable competitor in that space,” Baltimore said. “You will see us going on offense, whether it’s the latter part of this year or next year. We expect to be formidable competitors.”
Ashford has been a net seller the last few years as it has focused on refinancing its portfolio, Kessler said.
“We’re not trying to be anything other than purchasing the best possible hotels at a good balance between what the RevPAR is and the yield you can buy them for,” he said. “We’re optimistic that the (transactions) pipeline is going to increase, that there is going to be more opportunities to deploy the capital that we’re sitting on.”
Hospitality Investors Trust, which owns 145 hotels in 33 states, is embarking on recycling its bottom-quartile assets—15 to 20 hotels in markets that don’t drive higher RevPAR, Mehlman said. The company is trying to raise its portfolio-wide RevPAR from its current $94 to between $110 and $115.
“We believe the select-service space in the perimeter, primary and secondary markets is a place to stay and to play,” Mehlman said.
Financing environment plays a big role
The executives spoke a lot about transactions because there’s a plethora of financing in the market to secure deals.
“There’s plenty of capital out there as well as acquisitions out here,” Mehlman said. “The debt capital markets have been white hot.”
“The (financing) market is pistol-hot right now,” Kessler said. “The ability to get debt is very attractive. You can actually achieve 80% LTV today—a floating-rate deal at 275 to 300 (basis points) over (LIBOR), a fixed-rate deal at 50 bps inside of that—that’s at high leverage. If you want low leverage, call it 55% or 60%, it’s probably 175 to 200 (bps) over (LIBOR) for a floating-rate deal.”
That doesn’t mean REITs can go and buy assets at will.
“It’s an incredibly competitive environment,” Bluhm said. “The volume of private equity has never been greater, the debt capital markets have never been more forgiving, and that has created environment where you need to be particularly tactical about how you approach M&A or how you approach different acquisitions.”
Owners also have to weigh the best use of their time and money during a period when debt is plentiful, speakers said.
“The supply pipeline has been low for new transactions because people have the option to refinance,” Kessler said.
“The issue a lot of sellers have today is they look at ‘do I sell or refinance and take the proceeds that I want?” Baltimore said. “That’s a viable option.”
Keeping a low debt ceiling plays into Baltimore’s goal for Park.
“I want to continue to de-lever over time so I can have a strong balance sheet so I can go on the offense and get to that investment grade,” Baltimore said. “As a public REIT, I do think investors really prefer you have that low-levered balance sheet. That’s where we are today, and we expect to take that lower over time.”
At the end of the day, investors in hotel REITs have to consider the adage that hotels are an operating business rather than a real estate business.
“Investors get that there’s a lot of operating leverage in the model, so their willingness to take on the financial leverage is much lower,” Bluhm said.