ATLANTA-On July 1, 2010, Pebblebrook Hotel Trust, a Bethesda, Maryland-based REIT formed last December, purchased the InterContinental Buckhead Hotel in Atlanta for $105 million. The 422-room, AAA five-diamond hotel is located in the upscale Buckhead submarket. The hotel will continue to be managed by the InterContinental Hotels Group PLC.

The purchase was paid for by the more than $400 Million IPO that the REIT did last December. Since then, Pebblebrook has signed purchase agreements for five hotels, three of which have already been purchased, says Raymond D. Martz, chief financial officer for the company. One of them is the landmark  Sir Francis Drake Hotel in San Francisco which was bought for $90 million around June 21st and another was the Double Tree in Bethesda which Pebblebrook bought for $67 million on June 4th. A fourth hotel is under contract in the Minneapolis/St. Paul region, says Martz.

Given the combination of a global recession and a slowdown in business travel, a lot of hotels are distressed, says Martz. Plus, there were a lot of hotel transactions from 2005 through 2008, which involved high levels of leverage, which made the properties ripe for acquisition today, since many need to refinance now, but are unable to, he says. Plus, notes Martz, “because we’ve acquired hotels for all cash, some other buyers who may need financing are at a disadvantage,” he says.

The hotel in Buckhead had an occupancy rate of about 68% in 2009,” says Martz. “We bought it at discount to replacement cost, but it was not a distressed hotel,” he says.

InterContinental built the hotel between 2003 and 2005 for $115 million, says Martz.  Since then, construction costs have gone up about 5% a year, he says. Although they have gone down some with the recession, as a general rule, they are still higher than they were in 2004, says Martz. Labor costs are less than in 2003 and 2004, but building materials are more expensive now, he says.

“We believe that it is Intercontinental Hotel’s long-term strategy is to free up some of their capital and use it to grow the brand to fund new hotels,” which is why it was sold to Pebblebrook, says Martz. “Marriott and Hilton went through the same strategy,” he says.

But Guy Trusty, president of Lodging Hospitality Real Estate in Coral Gables, Florida, disagrees. “Pebblebrook is planning for the future,” he says, which means that the company hopes the hotel will pay for itself when the economy comes back. “Meanwhile, the $156 per night (the average daily rate that Pebblebrook says the InterContinental Buckhead charged in 2009) won’t pay for the $105 million purchase price at close to $250,000 per unit,” says Trusty.  To support  that price, the hotel has to raise its average daily rate to nearly $250 per night in order to break even with a 65% occupancy rate, he says.

While Martz claims that the InterContinental transaction was not a distress sale, he does say that his company is “an opportunistic investor looking for the upper hotel segment in urban locations.” With prices depressed, “this is a once in a generation opportunity for us,” he says. “We believe that we will be buying hotels at a 30% to 50% discount to replacement costs. The Sir Francis Drake, was purchased at a 50% discount to replacement costs,” says Martz, although because of zoning issues, it would be too hard to build a hotel like that again.

“Our investment goal is to deliver unleveraged rates of returns (on hotels purchases) in  the 10% to 12% range,” says Martz. Although he says that Pebblebrook doesn’t need debt to buy hotels, a number of banks, including Bank of Amerca, Wells Fargo and US Bank, will lend to the company when it needs financing.

“Pebblebrook acquires hotels, but leaves their management in place, which is an indication of the non-vulturistic (character) of the company,” says Trusty. ”A vulture would get rid of everyone and re-position the property and maybe take it down-market," he says, But Pebblebrook’s way of operating "is to be a nice guy," says Trusty.

“Operating this way shows insightful long-term thinking. You shouldn’t clean house and fire people, because that knocks the wind out the hotel which you want to re-position,” says Trusty. If there is good management in place, the hotel might not be doing well just because of the economy, “so why not keep people in place,” until the recession ends? he asks. p