Special Topics on Hotel Investment Finance

1
Special Topics on Hotel Investment Finance

• Based on Raleigh Roginsky
• By American Hotel Lodging Educational Institute
• Tad Hara, Associate Professor
• Rosen College of Hospitality Management
• University of Central Florida

2
Overview of US Lodging Industry1990 to present
(Ch12)

• Room Rates declined in 1991
• Gulf War, Recession
• Industry Lost 5.7B in 90 and 2.8B in 91
• Massive Over-Supply of new Rooms
• Steady comeback of revenue
• Sharp increase in Income GOP ratio (Ex34 p27)

3
Source of Financing for Hotels

• 80s ?banks, Savings Loans, Pension Funds,
  insurance Companies
• 90s ?Plus, Public Debt Equity market (Ex35
  P29)
• 2000s ?Supply slowed down.
• 9/11?Delinquencies peaked in May 2002
• Lodging markets gets heated as demand increases.

4
Overview of Basic Data

• Interest Expense to Total Revenue
• 14 in 1990 to 4 in 2002 (Ex40 P 36)
• Breakeven Occupancy
• 66 in 1990 to 50 in 2002 (Ex42 P37)

5
Special Topics on Hotel Investment Finance (2)

• Based on Raleigh Roginsky
• By American Hotel Lodging Educational Institute

6
90s to Present Hotel as InvestmentCh 2 of the
textbook

• 1991 was the worst year for hotel operation in
  three decades.
• Oversupply of rooms and excessive debt
• Default ?Resolution Trust Corporation (RTC)
• New Opportunities for Shrewd investors
• Investors who want 20 IRR over 5 years
• REITs (Real Estate Investment Trust)
• Starwood, Patriot American, Blackstone, etc.

7
Hotel Investors/Owners in 90s

• Hotel Chains are accustomed to dealing with
  individual or institutional owners, but now they
  were faced with professional, economic-driven,
  unemotional investors with real asset managers
  who came from the operating side of the lodging
  industry. (P41)

8
2000 Winners and losers of hotel investment

• The big winner Wall Street
• The lodging investment market today is led by the
  investment banking industry.They now will issue
  stock, take a company public, develop convertible
  paper, arranger a merger, and buy or sell a
  company for its clients.
• Another winner
• investor who came into the lodging industry by
  the mid-90s.

9
00s Winners and losers of Hotel Investment

• The big loser
• Some banks
• The biggest losers
• American Taxpayer who picked up the losses that
  were incurred from FDIC-backed loans and the
  bail-out of the savings and loan industry

10
Present situation (p49)

• Hotel industry is surviving and prospering, why?
• Financial markets prevented a repeat of the
  oversupply debacle of the early 90s.
• Debt and Equity markets are self-regulated.
• It is very challenging to convince lenders to
  provide a loan on 60 to 70 of the acquisition
  cost, using a 4 cap rate. (P46)
• Owners are taking significantly more risk, with
  lower IRR.

11
Special Topics on Hotel Investment Finance (3)

• Based on Raleigh Roginsky
• By American Hotel Lodging Educational Institute

12
Lodging Real Estate Investment Trusts (Ch 9)

• 80 of hotel rooms privately held
• 20 of hotel rooms publicly traded
• 55 of this is C-Corporation
• 45 are REIT (p167)
• 2 REITs for less than 100 million in 1993 ?
• 13 REITs for 9,000 million in 2002, 237,000 rooms

13
Brief History of REITs

• 1960 Real Estate Investment Trust Act
• 1970 Most of REITs are mortgage REITs
• invested shareholders funds through direct
  lending to RE projects
• When market interest rates rose sharply, their
  fixed rate loans plummeted in value. It took 20
  years for them to come back
• 1990 Equity REITs

14
90s Come back of REITs

• Equity REITs
• Overbuilt RE markets of the late 80s and early
  90s plunged further in value with the Gulf War
  and recession, leading to many defaults.
• REITs picked up those at bottom-fishing.
• Distressed properties ?Cost of capital decreased,
  then REIT shares went up.
• REIT offered chance to participate in the
  economics of real estate without massive
  investments.

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Basics of REITs

• Be established as a corporation, trust or
  association that, absent its REIT status, would
  be a taxable entity
• Have a diverse ownership, with at least 100
  persons holding beneficial interest and no group
  of 5 or fewer individuals collectively
  controlling a majority interest
• Derive substantially all its income from real
  estate assets held as passive investment, and
• Distribute to shareholders at least 95 of it
  taxable income each year.

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REIT (2)

• One of the unique aspects of a REIT is that the
  corporation typically does not pay corporate
  income tax to the IRS. Instead, the REIT is
  required to distribute 95 of its income to
  shareholders. This income component (which is
  further discussed in the full report below) has
  made REITs an attractive investment vehicle.
• Characteristics of a REIT To qualify as a REIT,
  certain provisions within the IRS code must be
  met. A REIT must
• Be a corporation, business trust, or similar
  association
• Be managed by a board of directors or trustees
• Have shares that are fully transferable
• Have a minimum of 100 shareholders
• Have no more than 50 of the shares held by five
  or fewer individuals during the last half of each
  taxable year
• Invest at least 75 of the total assets in real
  estate assets
• Derive at least 75 of gross income from rents
  from real estate property or interest on
  mortgages on real property
• Derive no more than 30 of gross income from
  sales of real property held for less than four
  years, securities held for less than one year, or
  certain prohibited transactions
• Pay a dividend of at lest 95 of the REIT's
  taxable income.

http//www.smithbarney.com/products_services/inves
tor_education/ssb_university/reit.html
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REIT (3)

• Paired-Share REIT
• Starwood, Patriot America (Wyndham International)
  
• A REIT company receives rent from the Hotel
  Operating company
• Two companies are traded as if stapled together
• Taxable profit of the operating company will be
  paid out as rent ? No tax
• Hotel C-corporation used the Washington DC
  lobbyist ?Starwood and PA abandoned this scheme
  and converted to C-corporation.
• REIT Modernization Act 1/1/2001

18
REIT (4)

• REIT in perspective
• TAX
• C/f from operations are NOT taxed, investment
  value can be higher for REIT
• Appeal to income investors
• REIT produce steady dividend stream which has
  inflation protection, unlike bonds.
• Cannot compete against private equity finds in
  terms of risk/return
• An asset intensive sector like real estate cannot
  expand earnings rapidly and does not warrant the
  lofty multipliers of a growth stock. Good for
  Patient but cheap capital.