MeriStar Hospitality chief executive Paul Whetsall felt the chill last year when Wall Street, faced with a global financial crisis, turned its back on hotel real estate investment trusts. Fears abounded that the hospitality industry's four-year run of record profits and revenue, which had been spurred by strong consumer demand, would abruptly end.
Lower stock prices would mean it would be harder for Whetsall's company -- MeriStar Hospitality in the District -- to continue buying hotels. MeriStar Hospitality operates as a "paper-clipped" REIT, along with MeriStar Hotels & Resorts. But the two companies operate separately, with MeriStar Hospitality owning the properties while MeriStar Hotels manages them.
The much-feared severe downturn in travel never happened, but the stocks of hotel REITs have been stuck in the doldrums. Early this year, MeriStar reached a deal with a private equity partnership run by Robert M. Bass to invest $400 million. The joint venture with Oak Hill Capital Partners will allow MeriStar Hospitality to buy up to 15 hotels over the next year.
"We needed to get access to the capital markets," Whetsall said. "We all know the public capital markets aren't friendly to every industry all the time. It's a pretty creative way to stay active in the business."
Hotel REITs have had to become far more creative in finding ways to fuel growth. Several large hotel REITs, including MeriStar and Patriot American Hospitality Inc., have recently inked deals to raise millions from private investors, including pension and opportunity funds and wealthy individuals.
Investors have been fleeing hotel REITs in droves, fearing that the hospitality industry has reached its peak. Industry experts say demand will soften this year and remain flat through 2000.
PricewaterhouseCoopers predicts that the U.S. hotel occupancy rate will decline to 63.5 percent in 1999 -- down nearly a percentage point from 64.4 percent two years ago. That would translate into $2.1 billion less in profits for the hospitality industry. Bjorn Hansen, who heads Pricewaterhouse's hospitality group, is also predicting that growth in average daily rate for hotel rooms will slow through 2001.
The average daily rate is predicted to increase only 3.3 percent in 1999 -- a pace that is about half of its gain of 6.1 percent in 1997, which was a record year for the hospitality industry. As the environment becomes more competitive, hotels will begin discounting rooms or finding other ways to raise fees, industry experts say.
With lower earnings anticipated, the amount that investors receive in dividends can also be expected to decline. Even worse, lower stock prices have made it more difficult and expensive for hotel companies to raise money.
"Hotels are still an attractive investment," said Robert A. LaFleur,a REIT analyst at Bear Sterns. "They're not getting that respect on Wall Street. You can buy hotels cheaper on Wall Street than Main Street."
The hotel REITs have been swept into the arms of the most unlikely of partners -- vulture capital funds -- the equivalent of borrowing money at higher rates from a loan shark. The hotel REITs are choosing to call their new arrangements opportunity funds.
The marriage between REITs and opportunity funds comes with a high price tag. The REITs will continue to be able to buy up properties as a means to fuel growth. But the opportunity players are demanding hefty double-digit returns in exchange for their cash.
MeriStar's Whetsall said it is vital for his company to have a pool of money from which it can draw to buy properties because the industry's slowing pace of acquisitions has made hotel prices more attractive. "The lack of liquidity means values [on properties] come down, and the private sector recognizes the opportunity," he said.
MeriStar's venture with Oak Hill will be funded with a combination of common and preferred equity and debt. Oak Hill will contribute 90 percent of the equity to the partnership, which will be called MeriStar Investment Partners. The remainder will come from MeriStar.
MeriStar Investment Partners' strategy is to continue buying upscale hotels in strong markets where a large gap still exists between a property's purchase price and replacement costs. It is also a segment that analysts predict will weather a downturn better than mid-priced and economy hotels, a segment which is experiencing some overbuilding.
The partnership has already purchased three full-service hotels and one resort -- the Radisson Resort & Spa Scottsdale in Arizona, the Hilton Minneapolis/St. Paul Airport, the Radisson Mission Valley-San Diego and the Holiday Inn Iowa City. The Holiday Inn will be reflagged with an upscale brand after extensive renovation.
Wall Street has rewarded Meri-Star Hospitality's stock since it created its hotel partnership. Since the deal was announced in January, the stock price has risen nearly 5 percent to $21.87.
Hotel REITs also are turning to pension funds as a source of capital. Over the past several years, pension funds have taken advantage of the record sale prices for hotels and sold their interests. As prices have dropped, some are getting back into the game in hopes that the value of properties will increase again.
A year ago, Lowe Enterprises Inc., a Los Angeles real estate company, purchased Washington's ANA Hotel and a sister hotel in San Francisco for a pension fund. The purchase was an all-cash transaction valued by industry sources at $270 million.
Although the company bought the hotels at 80 percent of replacement costs, Ronald Silva, who manages the San Francisco office of Lowe Enterprises, said the investors are expecting a high return. Silva noted that pension funds in general expect returns of up to 10 percent annually on their investment. He said they sometimes expect those returns to occur within a short period of time, as little as 10 years.
"You have to have a dramatic turnaround to make returns, quite frankly," Silva said. He noted that the two ANA hotels are being repositioned to be stronger players in the full-service, luxury market. The company is investing $12 million to renovate the 415-room hotel at 24th and M streets NW, which was renamed the Washington Monarch.
Some opportunity funds are taking the chance to invest in public companies that have struggled financially after the mergers and acquisition boom of the 1990s. With its stock price languishing, Patriot American Hospitality found itself having difficulty operating after it bought the Wyndham hotel brand. Patriot American and Wyndham International Inc. operate as a "paired-share" REIT.
"Paired-share" REITs can own and manage businesses other than real estate but pay little or no federal income taxes as long as 95 percent of their earnings is distributed to shareholders as dividends. Patriot American is one of five firms that had an exemption to continue to operate as a "paired-shared" REIT after Congress prohibited use of the instrument in the mid-1980s, but Congress recently took action to ban that loophole.
In March, Patriot American signed an agreement with a group of opportunity funds for a $1 billion investment. Among the investors are Thomas H. Lee Co., Apollo Partners Inc. and Beacon Capital Partners Inc.
The investment group initially will own 29 percent of the company, based on some options in the agreement. More important, Patriot American will be able to reduce its debt and settle other equity obligations.
Sometimes, Wall Street isn't impressed with the deals. Patriot American's stock has declined about 3.2 percent over the past year and closed Friday at $5.06 1/4.
CAPTION: REIT Retreat (This graphic was not available)