The Washington Investing column in the Nov. 21 Business section imprecisely described real estate investment trusts. They must return 90 percent of taxable income as dividends. They also must follow standard accounting rules in reporting earnings, although they usually emphasize other measurements, such as funds from operations. (Published 11/24/05).
What do you call a company that's the biggest in its business, valued by Wall Street at more than $16 billion?
The poor relation.
That's long been the status of Host Marriott Corp., the Bethesda real estate investment trust that invests exclusively in hotels.
Even though Host Marriott's revenue totaled $2.65 billion for the year through Sept. 9, it has never been as well known or as well understood as its corporate sibling, Marriott International Inc., which is the world's biggest operator of hotels, with revenue of $7.91 billion so far this year.
That underappreciated status could change with completion of a deal announced last week. Host Marriott will pay $4 billion for 38 hotels with almost 19,000 rooms from Starwood Hotels and Resorts Worldwide Inc., owner of Westin, Sheraton and other brands.
To make certain everyone gets the message that Host Marriott is no longer the poor relation of Marriott International, the company is changing its name to Host Hotels and Resorts.
The name change is more than symbolic. After purchasing a batch of Sheraton and Westin hotels, the company will not be as dependent on Marriott brand names, which generate 70 percent of its revenue. That will drop to a little more than 50 percent after the Starwood transaction. And the Marriott brand is likely to account for less than half of Host's future business because the company plans to sell some of its existing properties.
Diversifying brands is a plus for Host as far as Wall Street is concerned, especially considering that the company is hooking up with Starwood, whose Sheraton, Westin and W hotels are viewed as hotter brands than Marriott.
Some will no doubt find Freudian symbolism in the effort of Host to escape from the shadow of Marriott.
The real estate company's chairman is Richard E. Marriott, 66, the younger brother of J.W. "Bill" Marriott Jr., 73, chairman and chief executive of Marriott International.
Freudian, schmeudian. Bill and Richard Marriott are both so successful, they don't have to worry about sibling rivalry. Both are private, low-profile people, not given to self-aggrandizement.
The bifurcation of the family business into a hotel-operating company and a hotel-owning company was not the result of family differences but of federal tax laws and accounting rules.
As every homeowner knows, there are tax advantages involved in real estate. Like homeowners, hotel investors get to write off their mortgage interest and taxes. Unlike homeowners, they also get to write off depreciation on the properties, deducting a portion of the purchase price every year on the theory that hotels wear out and their value declines over time.
After the accountants work their magic, a building that puts millions of dollars in its owners' pockets every year may show little or no reportable profit. No profit means no taxes, which is fine if you're a landlord whose equity in a property grows more valuable by the year. Investors, however, are cautious about putting their money into companies that don't report steadily growing earnings.
The solution, adopted more than two decades ago by Marriott and later by almost everybody in the lodging business, was to separate the ownership of the buildings from the operation of the hotels, restaurants and banquet halls.
Starwood, for example, is set up as an operating company and a real estate investment trust (REIT), though the two entities trade as a single security.
Host Marriott was spun off from Marriott International in 1993. Members of the Marriott family own about 7 percent of Host and 13.6 percent of Marriott International, according to Securities and Exchange Commission filings.
By doing business as a REIT, hotel-owning companies such as Host get to play by a different set of accounting rules. As long as most of their earnings are paid to shareholders as dividends, they don't have to pay federal taxes. Investors grade REITs not on reported profits but on measurements such as funds from operations and earnings before interest, taxes, depreciation and amortization. Both will improve significantly for Host after the Starwood deal, say analysts who have run the numbers on the transaction.
As a landlord, Host is a radically different kind of business than Marriott International. Running the world's biggest hotel chain requires more than 130,000 people, including about 13,000 at the headquarters in Bethesda. Host has only about 200 people on the payroll, nearly all of them here, and does not expect to increase its workforce significantly after the Starwood deal is done.
The differences between the businesses also call for contrasting management styles. Bill Marriott is the quintessential hotelier, who tours the properties constantly, lifting toilet seats and looking under beds to demonstrate that service is Job One. Richard Marriott, on the other hand, is known for delegating details to Host's highly regarded management team, led by President Christopher J. Nassetta.
Nassetta was ebullient about the Starwood deal, on which he had been working for months. The hotels Host is buying "represent one of the highest-quality lodging portfolios available" and they were bought "at a very attractive price," he said in an interview.
Analysts regard it as a good deal for both sides, a tricky balance in hotel real estate deals. The $4 billion purchase price comes to $213,000 per room, which Calyon Securities called "especially good value in this market."
Starwood gets to cut its corporate debt from roughly $3 billion to about $1.5 billion, according to Deutsche Bank, which helped broker the deal.
But Starwood's hotel operating revenue will not shrink because the company will continue to manage the properties, which will keep their brand names.
One person who doesn't like the deal is Starwood founder and former chief executive Barry S. Sternlicht.
"It was a bad thing for shareholders," Sternlicht told Bloomberg News on Friday after it was disclosed that he sold some of his Starwood stock since the deal was announced.
Sternlicht complained that Starwood might have gotten as much as $1 billion more if it had auctioned off the properties instead of negotiating privately with Host.
"No comment," Nassetta said in a phone interview Friday.
If anything, Sternlicht's dissent verified Nassetta's claim that Host got "a very attractive price."
The transaction will vault Host into the top tier of the real estate game, making it the largest hotel REIT and the sixth-largest publicly traded REIT.
Ambitious as the purchase may be, Nassetta said it "is not a change in the strategy of the company. This is execution of a strategy articulated over many years.
"It is a large transaction, but we are making an acquisition that is adding value to our company on a per-share basis."
Wall Street seemed to buy that. Host stock inched up every day after the deal was announced, from $16.65 a share at closing Monday to $17.46 after Friday's trading.
Jerry Knight's e-mail address is email@example.com.
Host Marriott's purchase of 38 hotels from Starwood for $4 billion, which has Wall Street analysts praising Host, includes two W hotels.