Hospitality Industry Outlook: Looking Back on 2006

Industry Outlook: Looking Back on 2006

Jim Butler recently chaired the annual Hospitality Roundtable with some of the industry’s leading experts. As usual, they have plenty to say about where the industry has been, where it is headed, and the opportunities and challenges their companies are facing.

Jim Butler: Welcome, everyone! Let’s start by reviewing 2006—what happened in the hospitality arena this past year?

Peter Connolly: Lodging remains rock solid despite the headlines screaming some variation on the theme, “the sky is falling in real estate.” Real demand growth coupled with limited supply growth has continued to leverage pricing increases for what has certainly been the longest period in my 25 years in this business. That strength in the market is attracting some of the capital which is fleeing the mid-market residential products that are getting flogged in the press.

Frank Anderson: From a capital standpoint, the influx of residential real estate players that are adding hotels to residential mixed-use projects on the equity side of the equation, has been a very interesting development.

Alex Gilbert: Plus, the securitization market has dramatically changed the real estate landscape. For 2006, the amount of conduit new issuance will exceed $150 billion, which is double what it was just two years ago. There will be over 25 different lenders that will each originate over $2 billion in new loans, in comparison to 14 lenders at that same level two years ago.

Monty Bennett: The record pace of transactions is due not only to abundant capital and more lenders, but the industry fundamentals are very strong.

Mark Lomanno: Peter said it well. The supply/demand imbalance is what is driving the sound industry fundamentals. Occupancy growth is slowing, but at a fairly high level and the growth is double the rate of inflation.

Bruce Baltin: Occupancy can’t rise very much, if at all, in many major markets due to capacity constraints. Some are forecasting that Average Daily Room rate growth will moderate—it’s been at high single to double-digit percentage growth in many markets in 2006.

Lomanno: Because of the strong ADR/occupancy fundamentals, our forecast at Smith Travel Research is for accelerated supply growth and steady demand growth.

Lomanno: This leads to flat occupancy growth at a fairly high level.

Kenji Yui: In Hawaii, where Aozora Bank is active, we have seen a continuation of the trends of the last few years: higher value, higher LTV and lower spreads. Due to the super liquidity of the capital markets, we believe this is likely to continue.

Bill Blackham: But while industry conditions have been favorable, the longer-term historical average RevPAR growth is significantly lower than current growth rates. Our underwriting now takes into consideration the possibility of decreasing growth rates.

Jonathan Roth: In the pursuit of yield and of putting large sums of capital to work, many capital providers have departed from sound underwriting principals. Many acquisitions and repositioning transactions have been capitalized utilizing short term bridge loans, often times marrying a senior and a mezzanine loan, or creating a highly leveraged senior loan which is later syndicated into tranches carving up the various layers of risk, all in order to increase the overall amount of leverage on the asset.

Butler: Are you seeing activity in the bankruptcy arena at Canyon Capital?

Roth: People may be surprised to hear that there was actually a need for debtor-in-possession financing in such a robust hospitality marketplace. What it points to is the fact that even in a strong market environment, operators make mistakes, assets are undercapitalized, product becomes obsolete and a market can suffer severely from exogenous events such as hurricanes, floods, earthquakes and acts of terror.

Butler: Are there other noteworthy issues that have emerged in 2006?

Gilbert: Overall, the opportunity that owners have had to either sell or refinance is unprecedented.

Baltin: There are a large number of hotels being put onto the market so that sellers can get peak prices. Buyers and owners have also taken advantage of the low supply growth to reposition existing hotels “up market.”

Rob Stern: Demographic changes, particularly the aging of the baby boom generation, are driving significant activity. As a result, hospitality and hospitality-related industries have become more prominent within our portfolio.

Lomanno: It’s interesting to note that when we adjust for inflation, 2006 rates will not reach the level of the year 2000. Technically, hotel rooms are still a bargain.

Butler: Who wants to put a cap on 2006 before we move on?

Baltin: 2006 has been the “perfect storm” for transaction activity—we have huge buyer interest with an active seller’s market. We have seen a tremendous deal flow this past year—lots of capital chasing too few deals, resulting in lowered capitalization rates and return expectations, especially for trophy and investment grade projects. Even other relatively “vanilla” deals have gotten huge buyer interest and strong cap rates to the seller.

Transactional Activity

Butler: So how has all this activity and change in the industry affected your companies? Steve, I understand that your firm was voted Doubletree Developer of the Year for the Doubletree Memphis. Is that a sign of what is going on at Prism Hotel Management?

Steve Van: Prism joined the big leagues of national third party management companies this past year, adding Embassy Suites Boston, Bishop’s Lodge in Santa Fe, Hilton Baton Rouge, Double-tree Wilmington, The Watersmark—a Preferred resort in the Turks and Caicos—three Radissons: (Ft. Worth North, Ft. Worth South and Richmond), the Holiday Inn Columbus, and was just selected by the University of Southern California to manage its Radisson. More significant announcements will be made soon!

Bennett: 2006 has been a great year for Ashford Hospitality Trust, too. We have now had 6 consecutive quarters of double-digit RevPAR growth.

Gilbert: That is a remarkable achievement! At JER Partners during the past 18 months, our U.S. fund completed the purchase of $3.2 billion of assets of which approximately 40% were hospitality related. Our portfolio now includes 18,000 rooms with the majority of product in the extended stay and limited service categories. We are also participating in transactions that involve re-branding, re-flagging and/or redevelopment. A recent example of this is our purchase of the Great Eastern Hotel in London, which will soon be re-flagged as a Hyatt. We will be closing a similar redevelopment and re-branding next month in the western U.S.

Tom Corcoran: Very impressive, Alex. I became Chairman of the Board of FelCor in 2006 and we kicked off the year with a new direction, which we called “The New FelCor.” New FelCor meant we would be selling more hotels, paying off debt with some of the proceeds and using the remaining proceeds to invest approximately $475 million over three years in our core hotel portfolio.

Anderson: At HSH Nordbank, we are increasingly viewed as a leading provider of construction financing. We fully underwrite our financings, and the market knows we have the capacity to properly execute the loan closing while providing service in ways that some packagers and securitizers cannot. For example, this year we closed on the Montage Beverly Hills Hotel and Residences transaction—as fine a location and asset as you could want in your portfolio.

Blackham: Eagle Hospitality Trust has maintained a high level of discipline in looking at potential investment opportunities in 2006. Our most recent acquisition was the July purchase of the Embassy Suites Boston at Logan Airport, which Steve Van’s Prism manages for us.

Roth: During calendar year 2006, Canyon Capital deployed about $400 million of senior bridge and mezzanine debt of which approximately $100 million was funded into the hospitality industry. It is interesting to look back and see that just about a third of that capital was deployed in the form of debtor-in-possession financing, a third was deployed for the renovation and repositioning of older hotel product to be converted to condo hotel units, and a third was deployed in connection with the ground-up development of new hotel product. I think the diversity of our transactions for 2006 really represents a good cross section of the hospitality industry as a whole.

Bennett: At Ashford, we’ve completed several large deals this year, including the Pan Pacific Hotel in San Francisco (which we’ve re-branded a JW Marriott) and the Marriott Crystal Gateway in Washington, D.C. We also recently announced two large acquisitions: the Westin at the Chicago O’Hare Airport, and a seven-hotel full-service portfolio that we are buying from Blackstone. Our deals this year have been focused in the upper-upscale and luxury segments since we like them as long-term holds.

Connolly: The dichotomy of strong hospitality performance juxtaposed against a more generally declining real estate market creates benefits for a developer like Palladian. First, access to knowledgeable capital is improved, and second, as mid-market projects begin to falter or even be cancelled, construction trades are beginning to pay more attention with sharper pencils to projects that are more likely to be built even in a softening market. We are proving with Mandarin Oriental Tower, Chicago, that “luxury” sells even in a down market, as the people who pay for luxury are, by and large, immune from the economic roller coaster.

Roth: I agree with that, Peter. There seems to be an unmet demand for higher-end luxury product in certain markets. And with the number of transactions where existing 5-star product is trading for in excess of $1.0 million per key, the cost to develop new product can be justified. We have been fortunate to fund a couple of ground up transactions this year both out of our Value Mortgage Funds as well as our Canyon-Johnson Urban Fund.

Stern: One interesting development in the luxury market is the new category of “luxury destination clubs.” The clear leader in this new category—which is akin to belonging to a country club, but is also a melding of hospitality and vacation homes—is Exclusive Resorts. We believe so strongly in this product that earlier this year Perry purchased a sizable ownership stake in this particular company. We think ER has only scratched the surface of its potential.
International Markets

Butler: I know that Perry Real Estate Partners is also involved in a number of international projects.

Stern: Yes, we at Perry are now equity and debt providers throughout the U.S., Europe, Mexico, Central America and the Caribbean. South America and parts of Asia are likely soon to follow. We are big proponents of accessible destinations with good airlift and infrastructure. What’s happening in the Mayan Riviera in Mexico, where we are investors, is phenomenal and we think it will continue. Baja Mexico is in its infancy and development will continue to push north from Los Cabos and south from San Diego. Costa Rica’s offerings will flesh out. Argentina and Brazil are increasingly interesting. Europe is ripe for an expansion of U.S. and international brands, in places like Barcelona, Prague and Budapest. China and India are fascinating, though our platform is not there yet.

Corcoran: When you talk about hot markets, you’d have to say, China, China, China… and India. But investors need to get comfortable with the political situation, which is still risky in both countries, as you pointed out in one of your recent postings on your HotelLawBlog.com, Jim.

Yui: We see lots of development of new city hotels in China and India. There are lots of development projects, but limited lenders, so the opportunities are attractive there. The challenges remain the same: legal systems, enforceability, land title systems, and so forth.

Stern: Not to mention issues with currency and the associated tax structuring, return leakage and hedging, access to reliable contractors, untrained or insufficient local labor, divergent business mores and practices, difficulty finding appropriate local partners, and challenging regulatory environments. But as you point out, Kenji, there is less competition in terms of capital because of these challenges, yet potentially compelling risk-adjusted returns are there. For opportunistic investors like us at Perry, we really need markets to exhibit some imperfections and inefficiencies in order to see the way to opportunity and profit. We do this very carefully though, looking for macro themes but committing capital in a very micro focused way—meaning we look at macro trends, as it’s tough to swim up-stream, but we are definitely “micro investors.” Still, this kind of investment isn’t for the faint of heart.

Butler: Are there other hot markets on the international scene?

Yui: Guam is already a hot market. We also see lots of development of new luxury resorts in Dubai, the Indian Ocean and throughout the Caribbean. You will begin to see some new market entrants from Japan where some real estate investors are beginning to look for assets outside of the country. They are anticipating the future change in regulation for the J-REIT (Japanese Real Estate Investment Trust), enabling investors to sell overseas real estate assets to the J-REIT.

Connolly: I also believe that the relaxation of foreign investment rules in Asian countries like South Korea—combined with the continuation of the current instability of the Korean peninsula—should increase interest in U.S. real estate investment from that region as well. In 2007, I think we will also see that relatively inexpensive dollars—coupled with high real estate values in Western Europe—will increase the amount of capital from that region chasing what are perceived to be inexpensive U.S. real estate purchase opportunities. As a result, cap rates in hospitality, particularly in its current position as the “stable star” of domestic realty, should remain at very aggressive levels in an expanded universe of well-heeled purchasers.

Hotel-Enhanced Mixed-Use

Butler: Our team is involved in a quite a few projects in Latin America. Most of them are hotel-enhanced mixed-use properties. Are the rest of you experiencing that as well?

Stern: Yes! Notwithstanding the fact that many hospitality deals today require a “for-sale” component to make them financially viable, consumer demands are driving the hospitality industry’s evolution. Many of the projects we are participating in incorporate some mixture of traditional hotel rooms, condo hotel or serviced apartments, fractional ownership, pure condos and luxury villas.

Gilbert: I would go even further. We have not considered any new hotel development that did not include a significant mixed-use component. We recently committed $50 million to a 1.2 million square foot development of an open-air regional retail destination encompassing both big box and lifestyle components.

Connolly: Mixed-use has always been part of the business in one form or another. But as an industry, we are now taking a more thoughtful approach to combining the various constituent parts so that they create a consistency of community. For our Chicago project, for example, the renewed interest demonstrated by wealthy individuals in living the hotel lifestyle has influenced our choices on the size and design of the project’s spa, the choice of restaurateurs for the non-hotel dining outlets, the quality and practicality of potential retail uses, and so on. The goal is to piece together the right elements to create a community of activities in which each element has a positive impact on the value of every other element.

Roth: I think most new development will be in the form of hotel mixed-use. They make sense from an end-user standpoint and they represent a way to allocate risk and accordingly, are easier to capitalize. There are now stables of buyers for each of the retail and hotel components of mixed-use products. That said, by definition mixed-use projects are much more difficult to develop because of their size, complexity and cost. As a result, the number of developers that can take on such a project will be limited—which is probably a good thing.

Butler: From our direct experience with more than 80 hotel mixed-use projects over the past five years, all of which involved a condo hotel or hotel condo component, I believe that hotels are gaining recognition as the “ultimate amenity” for mixed-use projects. All the brainpower that many of us here put into condo hotels over the past few years, has contributed greatly to the pool of knowledge that has made hotel-enhanced mixed-use projects viable. I think we should feel good about that!

Connolly: I agree, particularly when you remember it was just a year ago that we were declaiming the hospitality element of a mixed-use project as the evil necessary to enhance the value of the residential components. By the end of 2006, clearly the hospitality component’s status as an element of the project value has been elevated.

Butler: How does the “lifestyle” product fit into our dialogue about hotel-enhanced mixed-use properties?

Stern: The lifestyle operators are innovators that provide an “experience” and value for the money. People want to experience a sense of belonging, but also be surrounded by attributes and experiences important to them individually. So, it seems to me that this is a segment that is not going away, as long as what is offered is unique. The challenge is to figure out how to create scale and critical mass without losing the essence of the brand.

Yui: Yes, there are excellent lifestyle resorts being created in Asia such as Amanresorts and Banyan Tree Resorts. We also see some new entrants such as Bulgari and Armani, born in Europe. These pioneers really do a nice job in the lifestyle category. But when we hear some hotels and resorts saying “lifestyle,” what we experience is “déjà vu.” The difference may be the history of the brand, which is difficult to create in the short term.

New Development

Butler: Construction costs are still prohibitive—what’s getting built these days?

Bennett: It’s difficult to make new projects pencil out, but there are two exceptions. The first is luxury properties that have a residential or condo component to the deal—the hotel mixed-use we have been talking about. We’ve seen these in Dallas recently with the W and the Ritz-Carlton downtown. The second exception is Midscale without F&B properties that are “stick construction.” These are easier and cheaper to build and are usually the first ones to be developed. The upper-upscale properties are very expensive to build right now, so it may be a few years before we see these being developed. I also believe that we will see a good amount of redevelopment occurring in the next few years—people adding rooms, meeting space, spas and the like to their properties.

Roth: With hotel mixed-use product, there are much better ways to protect the downside, by pre-leasing—and in some cases pre-selling—the retail component, and of course, pre-selling either condo hotel or pure condo units. New ground-up development will occur as long as the gap between the cost of purchasing an existing asset and the cost to build a new asset narrows.

Lomanno: Supply always follows demand, so the market will find a way to build. We all know it’s the current supply/ demand imbalance that is fueling the current seller’s market.

Capital

Butler: What is happening with capital pricing and capital providers in general? What’s going on in the marketplace?

Stern: Liquidity, liquidity, liquidity. That’s been the name of the game and it shows no signs of changing anytime soon. There are more capital providers than ever. Some cycle out, but others backfill. Pricing is rich, and in many cases the buyer is basically paying for some of the projected NOI growth up front. That is not a comfortable position to be in as a buyer, but it will likely continue at least until we see a meaningful increase in new full-service hotel supply in many markets.

Roth: Real estate has been one area where yield-hungry hedge funds have found a place to deploy capital over the past few years. Many transactions would not have been accomplished if not for these new providers of capital and their willingness to take on higher levels of risk. That said, we have already started to see some of these funds liquidate their real estate positions as their inexperience in the valuation of real estate assets has already led to losses. For stabilized assets, I believe capital will remain relatively inexpensive and plentiful.

Van: The providers of capital are beginning to resemble the Creosote Man in Monty Python’s The Meaning of Life. They are so immensely full of capital (Blackstone over $25 billion!) that they are in danger of exploding and making a mess of things. Already almost any normal stabilized and healthy hotel for sale gets priced at numbers we feel are bloated.

Roth: Yes, prices are being bid up to extraordinary levels. For stabilized assets, the markets are very efficient and, as a result, cap rates should remain at today’s historic low levels. There is also a strong movement for large funds to aggregate assets with an eye towards a public offering as an exit strategy. As long as the appetite for these IPOs remains strong, the aggressive purchasing should continue as well.

Stern: If you can’t access capital now, there must be something seriously wrong with your project. We don’t do plain vanilla deals and we still expect a risk premium for hotels—but let’s not forget how volatile these cash flow streams can be, so it’s tough to find deals we really like on a risk-adjusted basis. Depending on whether it’s a straight full-service domestic hotel deal involving perhaps a re-flagging/ better management story, or an international resort development with a for-sale component, we’re expecting levered equity returns from anywhere in the high-teens to substantially higher, and profit multiples of around 2 times and up. It’s really case-specific, but our domestic expectations are perhaps a couple hundred basis points lower than we underwrote say 3 years ago. Our international expectations are unchanged.

Bennett: It’s a time of great opportunity—but it is also a time to be cautious and wise because when there is a glut of money, bad deals cannot be far behind.

Anderson: I agree. Construction lenders are increasing in number. Some are trying to “buy” market share through either reduced pricing or eliminating essential structuring protections.

Bennett: In terms of deals and pricing, I don’t think much will change in the near future. Cap rates are starting to hold pretty steady and will most likely stay there for a while. In a few cases we’ve even seen some pushback from buyers on pricing, so I think cap rates have found the bottom.

Baltin: Capital will continue to flow into the hotel industry because there are limited alternative outlets for it. That’s why capitalization rates will stay down.

Anderson: The most savvy and experienced players are sticking to disciplined underwriting and staying out of overpriced acquisitions or selling in many cases their existing properties at these price points. Ironically, the hotel companies have been big sellers as they try to emerge as management, rather than real estate companies. However, it appears their move is extremely well timed based on current market conditions. I would be shocked if they were not buyers during the next downturn.

Butler: Tom, you advise client on hotel management issues. What’s going on there?

Tom Engel: The third party management company business is a mere shadow of its former self. Can any of you name a management company today that’s as effective as the management company powerhouses of the ’80s and ’90s? The Continental Companies, Milt Fine’s Interstate Hotels, Roy Winegardner and John Q. Hammons? Where have they gone? I think the answer lies in the “big squeeze” phenomena. Owners have squeezed base management fees to the bone, while increasingly creating giant hurdles to manager’s incentive fees. There’s good and bad news to this. Owners have less cost. But management company execs have less incentive to go the extra mile when they’re working for less.

Butler: Will this continue or do you see change on the horizon?

Engel: It’s already beginning to change, because more and more, there’s a purer alignment of interest. Independent hotel management companies such as Steve’s company (Prism Hotels and Resorts) and Pyramid Advisors now have co-investment equity on the line in their managed hotels. The Procaccianti Group, as another example, began perfecting co-investment with investors years ago and has now taken co-investment to a new level with its recently created Hotel Fund with majority investor CalPERS. I think this purer alignment of interest will lead to the emergence of four or five powerhouse management companies in the near term.

Van: Prism intends to be the clear brand leader in third party management contracts. In fact, I predict that will happen by October 15, 2008—Prism’s 25th anniversary.

2007—Industry Forecast

Butler: Gentlemen, it’s time to gaze into your crystal balls and tell us what you see for the industry in 2007.

Baltin: The active market of 2006 will carry into 2007. We see moderating economic growth, which will allow revenues to continue to grow, albeit at a lower rate than in 2005 and 2006.

Bennett: RevPAR growth will continue for four or five more years, but the growth will lessen each year. Supply growth will continue to stay below the historical average for a few more years, but it’s coming. I think that pricing is stabilizing and will continue to stay there for the foreseeable future.

Blackham: There is pressure on expenses and we think RevPAR growth rates are slowing from year-to-date 2006 levels. Supply is increasing although still less than demand growth in many markets. With increasingly high leverage levels on loans, there could be some troubled hotels next year notwithstanding the favorable conditions.

Roth: I believe that in 2007 our deal flow at Canyon Capital will increase on all fronts. I think we will continue to see new opportunities to deploy capital in the context of restructurings as some of the massively leveraged deals of the past few years go bad and as some of the capital providers that played a role in such deals leave the business, whether it be voluntarily or involuntarily. I also think that our deal flow will increase in the new development area, in the hotel mixed-use arena.

Gilbert: In 2007, we see an uncertain economic environment, which should result in a shift to quality. With more at risk, real estate investors will more closely evaluate the fundamental value of the property. In our view, cap rate compression is not going to bail you out, if you are wrong. The quality projects in high barrier to entry markets will continue to trade at a premium, while commodity real estate will transition to more traditional valuation metrics. As RevPAR gains continue through 2007, we anticipate cap rates will increase to compensate for reduced growth prospects and the realization of risk associated with hospitality. Cap rates on hotel product in secondary markets—and those with functional challenges—will increase at a faster rate. The resort sector will continue to attract capital and will have growth in property level cash flows. Well-conceived projects with a residential component should trade at a premium.

Engel: Hotel asset management will grow in both sophistication and importance, because industry ownership will increasingly demand it. Both public and private-equity ownership will more fully subscribe to the added value of an effective hotel asset manager.

Stern: I think we can expect a continuing sellers market from an investing perspective and no dramatic changes in the cost of capital. We feel good about the prospects for full service in major domestic markets. Global investing will continue to become more prevalent among a broad array of institutions. Operating costs remain challenging. The condo hotel frenzy is likely to taper off, but hotel mixed-use will thrive.

Connolly: By the middle of 2007, the condo hotel phenomenon will have to undergo significant philosophical change if it is to survive as a financing tool. As developers try and fail in using the condo hotel as an exit strategy designed to achieve inflated prices, the concept will increasingly take on both the reputation and stink that killed timeshare in the 1970s. I also predict that the collective media effort to create a self-fulfilling “bubble” prophecy will continue.

Anderson: 2007 will be relatively uneventful, but the underlying groundwork for future stress is being laid. I see a scenario where cap rate/discount rate compression will reverse causing this element of value creation to flatten and possibly start to reverse. RevPar growth will moderate somewhat, less due to supply and demand fundamentals but rather as a result of some resistance to the high absolute dollar rate, whether it be leisure or business related traveler. New entrants across the capital stack are pushing loan to cost and real loan to values higher—which over the longer run will stress projects on the financing side. New entrants in some cases are making blatant errors in underwriting; and rating agency relaxation of underwriting criteria is contributing to the financing on a more highly leveraged basis, of more dubious borderline projects.

Van: Much to the surprise of everyone the good times will continue to roll. Recent statistics show that supply growth is SLOWING and therefore if the wheels stay on the economic wagon we will have an even better year in 2007 than predicted. However, the bad news is human nature. Although Mae West said, “Too much of a good thing… is wonderful,” most of us, including investors, believe “Too much of a good thing can’t last.” Sometime in 2008 an emotional trigger event—(remember the Russian bond default of ‘98?)—will cause a chain reaction of fear that the music is about to stop and in a self-fulfilling prophecy, it will. That irrational herd mentality coupled with the ballooning maturity defaults of CMBS hotel loans and the personal gloom of the housing downturn, will produce the next downturn. OK, so maybe it’s in ‘09 or ‘10—but get out before then!

Challenges and Opportunities

Butler: So other than overcoming the negative “self-fulfilling” prophesies, what challenges and opportunities lie ahead for the industry?

Engel: I remain skeptical, but hopeful, that brands will begin to stand for something. If the brand sponsors do get smarter and become more authentic “brand managers,” more powerful brands will emerge. And that will be for the better since most of us today are increasingly brand-oriented and brand-dependent with the hotels and resorts we own and manage.

Stern: We’ve been in an up cycle for a while now. The system is tightly wound, and there’s no law that says down cycles have been repealed. We like to have a margin of safety when we invest and this is harder to achieve when markets are so efficient and capital so plentiful. With many deals priced to perfection, many are much more exposed to problems.

Gilbert: In 2007, supply growth will continue to lag demand, resulting in overall RevPAR growth of between 8-10% per annum. A majority of this growth is priced into the asset’s valuation, therefore our goal at JER will be to focus on “value added” transactions that involve re-branding, re-flagging and/or redevelopment.

Yui: Cap rates will remain or even reduce in line with a possible cut in LIBOR, which may increase valuations. Valuations are already high, so careful due diligence will be more important than ever in terms of evaluating and preserving value.

Bennett: For us, the most important question is how to keep growing the business throughout the whole industry cycle. As we get farther into the cycle and RevPAR growth slows, we will need to be creative and look at different strategies in order to keep the business healthy and vibrant. This might include doing more international deals, mezzanine financing or sale-leasebacks. It also might benefit us to look into doing small development opportunities as a growth vehicle.

Anderson: HSH Nordbank will definitely increase its production in 2007. The main challenge is to continue with a very disciplined approach. If we lose some poorly structured mandates in 2007, we will surely get a chance to pick up distressed debt later should the markets turn. We also see the opportunity to stick to our core client relationships if markets become less liquid.

Corcoran: In 2006 we began to address capital improvements in our hotels, which include bedding, bathrooms and technology. Existing hotels will need to continue to upgrade rooms to make them competitive. This also provides an opportunity for hotel owners to increase their average daily rates.

Lomanno: We believe that ADR growth for U.S. properties will continue in 2007, at double the rate of CPI growth.

Lomanno: This will result in the first $100 ADR rate in the history of the U.S. hospitality industry.

Butler: Before we adjourn, who wants to tell us what keeps them awake at night?

Yui: At anytime, external events such as terrorist attacks, coups, natural disasters, and changes in legal systems are large concerns to us in Asia. In 2006, there was a coup in Thailand, the nuclear test in North Korea, and the real estate investment policy change in China. Those have not affected the industry so negatively to date, but these kinds of events are always of concern to us.

Roth: Our country rebounded remarkably well following the events of September 11, 2001. In fact, real estate values are up over 40% for New York real estate following September 11. New Yorkers regrouped and rebuilt quickly. Devastating and unusual as they were, the attacks were non-chemical and non-nuclear. I shudder when I think of the scenario where a dirty bomb is detonated in a major U.S. city that takes out and renders uninhabitable 10 square city blocks. What happens then? The only thing we as capital providers can do is to maintain responsible levels of geographic diversity in our portfolios.

Stern: I don’t see any meaningful cessation of capital flows into real estate in general absent some exogenous event or a compelling reason to invest in other asset classes, or both. That’s why I worry about event risk and risks from a financial system crisis.

Bennett: The largest negative impact to the industry could come with a terrorist event, but we also worry about the impacts of cost increases in labor, insurance premiums and energy.

Blackham: I worry about unnecessary expenses. The next few years will likely see “transitional” capital improvements required by some of the brands to maintain status growth with their customer base. Ultimately, they will require more widespread changes that will be required to satisfy emerging guest preferences. A portion of these investments will likely be reactionary and wasteful.

Baltin: What’s keeping me up at night is “How do we get new hotels built where the market craves it—especially 3 and 4 star full service hotels.” Secondly, I wonder, “Are cap rates too low?”

Gilbert: Spread compression concerns us. The increase in the number of conduit lenders and the acceptance and growth of the CDO product has created a market by which mezz lenders can minimize their loan risk. The CDO’s have effectively pushed spreads down 200 to 300 basis points from 2003. On the one hand this spread compression has been a favorable trend for true equity investors, however, the reliance on higher leverage at a cheaper cost increases the volatility of equity returns in comparison to the property’s economic performance. In other words the margin for error has become razor thin.

Van: I am sleeping more soundly than usual for someone in this most cyclical of industries because I have never seen the industry more balanced and with safeguards such as the transparency of CMBS loans to mitigate the next inevitable downturn.

Corcoran: Nothing much keeps me awake at night, because FelCor never borrows too much money.

Connolly: Good for you, Tom! As a born pessimist who has lived through several cycles, I am kept up at night by visions of a glass that continues to be more full when everything I know about the timing of cycles in this business tells me that it should be more empty. Then I tell myself to get over it and to continue to make hay while the sun is shining.

Butler: Thanks to all of you for participating in the 2007 Outlook Industry Roundtable. I hope you will all join me again at the end of 2007 so we can talk about the hay made in 2007, how the harvest went and what new growth you are nurturing next.

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Jim Butler is a hotel lawyer and business advisor specializing in creating solutions for hotel owners, developers and lenders. Jim leads a team of 50 members of the Global Hospitality Group® of Jeffer, Mangels, Butler & Marmaro LLP, where they have assisted clients with more than $40 billion of hotel transactions around the globe involving more than 1,250 properties. In the last five years alone, they have advised clients on more than 80 hotel-enhanced mixed-use projects, virtually all of which have included condo hotels and hotel condos. Jim can be reached at 310.201.3526 or jbutler@jmbm.com.