• Dealing with debt

After a quiet year during which a handful of trophy assets were fought over by a handful of high-net-worth individuals, institutional investors and hotel investment companies, a slew of forecasts released during last week's International Hotel Investment Forum suggests that 2011 will see an increase in activity.

Single asset deals in strong markets such as London were the preferred flavour last year, with a limited number of hotels coming to market as banks preferred to ‘pretend and extend'. But this postponement of reality cannot continue indefinitely and when the banks bring assets to market it is those investors who have taken canny positions around the debt structure who will be in the driving seat.

Deloitte, looking at the European hotel market, has forecast "potentially" a 25% to 50% increase in deal activity in the region, with a return of portfolio deals, although said that risks remained on the downside. HVS too, in its ‘2010 Europe Hotel Transactions' report, has pointed to a gradual increase in banks selling distressed assets would see deal volume "gradually pick up", aided in part by "genuine depth to the amount of equity chasing deals".

According to Ernst & Young's Global Hospitality Insights, the improvement in operating performance in 2010 and the positive outlook over the next several years has sparked a resurgence of investor interest, which was likely to see an increase in volume, globally, of 30% to 40%, to reach $30bn. This would represent a return to 2004 levels, off the $120bn transacted at the peak in 2007.

With the flood of distress never materialising, many investors stayed away from the sector (and property generally). However, with improvements in trading fundamentals pulling up values and causing analysts to call the bottom of the market, an increase in investment has been provoked.

Low leveraged players are likely to remain the main investors in the sector, with Ernst & Young confirming that REITs were the most active hotel buyers in the US, representing approximately 46.0% of the hotel transactions, as they took advantage of the relatively lower cost of their capital requirements. By comparison, REITs accounted for only 16.0% of hotel acquisitions in 2009.

This year is expected to see an increase in the number of bank-owned assets coming to market, a state which is coming to pass with a further deal last week by Royal Bank of Scotland, selling the Brighton Hilton Metropole for £39.25m.

For the less cash-rich, one route into the sector has been acquiring distressed debt. According to Fitch Ratings, $22bn of the $48bn in hotel commercial mortgage-backed security loans mature over the next three years, with most maturities occurring in 2011 and 2012, while this year is expected to see financing arrangements on many of the leveraged transactions seen in the EMEA market coming up for renewal.

The most recent debt-triggered deal to be done was Ashford Hospitality Trust's acquisition of the 28-hotel US-based Highland Hospitality portfolio for $1.28bn, through a new joint venture formed with an unnamed institutional partner, thought to be Prudential Financial. Ashford invested $150m and took on $786m of debt in the hotels, giving it 71.74% of the joint venture.

Ashford described the acquisition and restructuring, which includes hotels operated under the Hyatt and Ritz-Carlton brands, as a "consensual foreclosure", a term the sector is likely to become very familiar with. 

Under the terms of the deal, Ashford is investing $150m cash and assuming $786m of debt, with senior lenders providing $530m of three-year financing with two one-year extensions on 25 of the hotels. The venture assumed first mortgages of $146m on three hotels, with those loans maturing in about two years. Unnamed lenders are providing $419m of high-interest mezzanine financing for the estate.

CEO Monty Bennett said that it would be "hard to match the many benefits of this investment. We believe there is a substantial opportunity to improve the hotels' performance with an aggressive asset management strategy".

The REIT, which focuses on upper-upscale and upscale hotels and also looks at mid-scale and luxury sites, favours direct investment but, in keeping with the current state of the market, also considers mezzanine financing, first mortgages, and the purchase of its own debt at a discount.

The deal was thought to have been good news in particular for Blackstone Group, who, according to Bloomberg, earned about $260m on distressed junior loans after paying around $60m for $320m of Highland mezzanine debt, which is now thought to be worth about its face value.


HA Perspective: Even though it is increasing, deal flow is likely to remain subdued compared to the go-go years of 2005-2007.

While debt is coming back, it is a long way short of presenting an opportunity to rescue overleveraged acquisitions made during the boom period.

Difficult and protracted negotiations are likely to be needed for deals to happen. The days of term sheets be faxed through by compliant lenders are long gone.

But deals are being done and more will be done. Debt, in one form or another, will remain the determining factor.

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