Perhaps what’s most significant about Pebblebrook Hotel Trust’s recent victory over BRE Landmark LP, an affiliate of New York-based Blackstone Group, to control Bethesda-based LaSalle Hotel Properties and Bethesda, is that it’s occurring nine years into an economic expansion.
“It’s never happened before,” said Arthur Adler, chairman of Americas hotels and hospitality group with Jones Lang LaSalle, in reference to multiple REITs becoming acquisitive so deep into an economic cycle.
One reason for the activity is the rising share prices of REITS focused on full-service hotels, which rose by more than 15% in the few months before July 2018, according to research by Michael Bellisario, senior research analyst at R.W. Baird. “Their costs of capital have improved meaningfully, and management teams’ focus appears to have shifted from asset recycling to acquisition,” he wrote.
Because the investment market generally rewards hotel REITs for having top brands, many stick with names like Marriott, Hilton or Hyatt, said Sean Hennessy, CEO of consultancy Lodging Advisors. Most also look to full-service, center city assets.
To be sure, the strategy comes with risks. Rising labor costs tend to hit urban locations and full-service hotels harder than other sectors, Hennessy said. Moreover, the growing supply of hotels in many major cities is dampening room rate growth. “I suspect they are going to be selective, or highly selective, in their approach to acquisitions,” he said.
The expansion of intermediaries like Expedia and Booking.com is another concern, given their commissions. Many hotels have had some success promising customers the lowest rate by booking directly through the brand, but it is still not clear how this will play out, Hennessy added.
Interest rates
One school of thought is that rising interest rates signal an expanding economy and strong market for hotels. In addition, hotels can act as hedges against inflation because they can raise room rates as frequently as they choose. “Inflation is not necessarily a bad thing for hotels,” Adler said.
Others said that unless rents jump dramatically, rising interest rates push up the required returns for many investments, including hotels, which dampens asset prices, according to David Loeb, founder of Dirigo Consulting LLC, which advises on capital markets, strategy and communications issues. He added that he’s part of this camp. Still, REITS that enjoy a low cost of capital will remain competitive, Loeb said.
Another shift highlighted in the LaSalle saga is the growing acceptance of REIT-to-REIT M&A, Loeb said. Conventional wisdom had held that while investors wanted bigger companies, they didn’t want to take on the integration and short-term dilution that came with most such transactions. Now, investors appear to see benefits from a larger Pebblebrook and are willing to take the risk that this may be somewhat dilutive for a short period, he said.
Consolidation among corporate hotel companies and hotel REITs is likely, Hennessy said, driven in part by the proliferation of hotel companies over the past 20 years. The Starwood-Marriott merger supports the theory that consolidation has benefits. In its 1Q 2018 results, Marriott credited, in part, a 70-basis point increase in company-operated house profit margins to synergies from the Starwood acquisition.
In the near future, at least, it appears REITs will continue to make headlines as strong buyers or sellers. Take your pick.
