Host Hotels & Resorts, the US REIT that part owns a portfolio of Starwood hotels in Europe, is expected to seek further overseas acquisitions as it seeks to smooth out the business cycle by diversification.
But it is unlikely to significantly reduce its highly leveraged position on US hotel property and, like many other real estate players, has taken a big bet on a soft landing as the cycle turns.
And the cycle will turn. Yesterday the Dow Jones Industrial Average fell by 546 points, the most it has fallen in a day since the terrorist attacks on September 11. It closed 416 points lower.
Terrible Tuesday may prove just a blip but it is a big one and one that has reached across the globe, hitting China particularly hard. The hope is that it is sufficient to take a little of the heat out of a very hot market.
The fundamentals of the economy still look relatively benign although it is clear that the current bull-run has slowed. The hotel sector, which is historically strongly correlated with corporate profitability, has similarly seen the rate of growth take a breath.
But it is just that, a slowing of the rate of growth, rather than a sharp about turn in performance. Were interest rates to keep rising (unlikely according to most economists), unemployment to rise (again improbable) or the asset bubble finally to burst (probably the most likely, or, more accurately, least unlikely) then we could be in for a sharp correction.
In the absence of severe economic malaise, however, it seems that asset prices will eventually correct themselves over time, in a long drawn out period. The outcome of the current wobble in the US housing market is a key factor to watch but in the meantime, there is money to be made.
Certainly, Host’s numbers support the gradual slowdown thesis. It indicated in its full-year results that revpar at its hotels in the first quarter of this year would be at the lower end of expectations, nearer 6.5% than the 8.5% at the top of the range. It reiterated this range as guidance for the full-year, however.
The fourth quarter figures showed a 32% rise in funds from operations per share (the eps equivalent for REITs). FFO per share was up 33% for the full-year. Fourth quarter revpar was 8.1% higher and full-year 8.5% higher.
Thanks to the acquisition of the Starwood portfolio, fourth quarter net income rose from $122m to $196m. The full-year saw a rise from $572m to $738m.
A key part of Host’s strategy going forward is to spread outside of the US to diversify its income and make it less vulnerable to swings in individual markets. The $1.5bn joint venture with GIC and Dutch pension fund Stichting is crucial.
During the conference call to discuss the latest results, Host said that it might raise a fund as big or even bigger to make acquisitions outside of the US. This is tipped to happen at some point in 2007.
Morgan Stanley analysts said they expected the company to focus in the US on investing in existing owned assets. The company was also thought likely to explore timeshare and residential opportunities.
It will be a long while until such efforts move the needle, however. Host’s share of the $1.5bn European JV is less than 1% of its total asset value. Even if it raises a fund of similar size and takes a similar stake, the total in such funds will still be barely above 1% of its total asset value.
Host is therefore set to remain much more wedded to the US hotel cycle than the operating companies from whom it has acquired much of its assets.
The good news for the operating companies who manage Host’s hotels is that although the company is highly leveraged to the hotel cycle its financial leverage is extremely modest compared to private equity.
At Host, the net value of property and equipment is $10.5bn but debt is just $5.9bn, giving a property gearing of just 56%. With 90% increasingly the norm for private equity, Host looks positively conservative.
And the lack of leverage available to REITs has been a key factor in so many being taken over by private equity. The latest deal, announced last week, was the $850m offer for Winston Hotels, the US owner of 53 limited service hotels.