By Steven Pearlstein
Friday, February 2, 2007

Lou Dobbs, scramble your jets!

Remember Dubai Ports World, the outfit that almost took control of the nation's biggest ports until Dobbs and his army of xenophobes rescued us?

Well, that same Dubai Ports World, through its subsidiary Istithmar Hotels, has purchased the venerable Hotel Washington, which from its location on 15th Street across from the Treasury offers the best views anywhere of the South Lawn of the White House and the second-floor residence.

I'll leave it to others to determine whether this transaction poses any threat to national security. My concern is whether this and other recent transactions are the harbingers of another bubble in U.S. asset markets, this one involving downtown hotels in major American cities.

Actually, the Hotel Washington was sold twice last year. In the spring, it was purchased by Westbrook Partners, an investment group, for about $120 million from the Texas family that had owned it since Franklin D. Roosevelt lived two doors down. But barely six months later, with hotel prices soaring, Westbrook took the opportunity to flip the property for $150 million to Dubai's royal family, which is in the midst of a $3 billion hotel buying spree in the United States that includes the Knickerbocker, Mandarin Oriental and W New York Union Square hotels in Manhattan.

The W transaction was something of a milestone in the U.S. hotel industry in that the price finally broke through $1 million per room, a standard metric for valuing hotel properties. By the old industry rule of thumb, that would require the W Union Square to charge an average room rate of $1,000 a night, which even in the frenzied Manhattan hotel market is more a hotelier's dream than a reality.

Here in Washington, where it is still a stretch for even the most deluxe hotels to get $600 as an average daily rate, purchase prices of the most prestigious properties haven't quite hit the million-dollar room mark, but they are coming close.

The $150 million price for the Hotel Washington works out to about $435,000 per room. But to turn what is now a down-at-heel property into the five-star hotel that Istithmar (that's Arabic for "investment") envisions, and deal with the demands of historic preservation fanatics and myriad local planning agencies, Istithmar will be lucky to bring this baby in below $800,000 a room. As it happens, that's the local indoor record, set last year when Strategic Hotel Capital, a private investment firm, purchased Washington's only five-star hotel, the Four Seasons in Georgetown, following a top-to-bottom renovation.

The money that's recently been poured into the deluxe hotel market locally is breathtaking. Last spring, B.F. Saul, the private investment company controlled by Frank Saul, the billionaire owner of Chevy Chase Banks, purchased the historic Hay Adams Hotel, across Lafayette Square from the White House, from Japan's equally secretive Iue family, which purchased it during the last real estate bubble, in 1989. The reported price was $100 million, or about $690,000 "per key."

A block north of the Hay Adams on 16th Street, another four-star deluxe hotel, the St. Regis, is closed for a major overhaul, as the 100-room Jefferson Hotel, two blocks further north, will be beginning in March.

In Georgetown, the Blackstone Group plans major renovations of two if its newest purchases, the Latham Hotel and the Georgetown Inn, both of which it also hopes to upgrade to the four-star category.

And it has only been a couple of years since the Sofitel and Mandarin Oriental opened their doors, and renovations were completed on the West End Hyatt and Fairmont.

You can get a pretty good debate going on whether all this investment, and the valuations on which it is based, is symptomatic of a bubble in the hotel industry.

The argument that these prices make sense comes from Michael George, chief executive of Crescent Hotels and Resorts in Fairfax; Leslie Ng, chief investment officer of Interstate Hotels & Resorts of Arlington; and industry guru Bruce Ford of Lodging Econometrics in Portsmouth, N.H. It goes like this:

In downtowns like Washington and New York, real estate is so expensive, and construction costs so high, that hotels at these prices are still 70 percent what you would have to pay to build a new one. That means that there's unlikely to be much new supply coming on at a time when demand has been so brisk that room rates have been rising at near double digits for the past two years. And there are at least two to three more good years left in the cycle.

Moreover, in a globalized hotel business, investors and travelers now demand that every chain have a presence in Washington. And because of their location, places like the Hay Adams and the Hotel Washington are one-of-a-kind properties deserving a premium price. For investors, the play is to ride this favorable cycle for another two to three years, hunker down during the next downturn, and make a killing selling out at the top of the next cycle.

The bubble argument, which was put succinctly by Paul Whetsell of CapStar Hotel Co. of Arlington (and a few others who will go nameless), goes something like this:

What you're seeing is replay of what happened in the 1980s. Back then it was Japanese investors with dollars earned through auto and electrical exports swooping in to buy up trophy properties like Rockefeller Center and Pebble Beach, pulling the rest of the market up with them until the bubble burst and they lost their shirts. This time it is Middle East investors recycling petrodollars.

Moreover, Washington is not New York: It will never attract enough visitors willing to pay $800 a room to fill up all of the hotels that are now being sold and renovated based on the prospect of commanding five-star rates. The current economic and hotel cycle is already showing signs of approaching a top, with room rates beginning to flatten and a record amount of new construction in the pipeline. When the downturn comes, and room rates fall, owners who've paid these prices will find themselves bleeding cash.

We won't know for a few years who is right. But for the moment, we might as well enjoy what is likely to be remembered as a golden era for the Washington hotel industry.

Steven Pearlstein can be reached at pearlsteins@washpost.com.