Michael Palmeri
Senior Vice President, Acquisitions and Development
Loews Hotels & Resorts
New York City

Mary Beth Cutshall
SVP, Acquisitions & Business Development
Hospitality Ventures Management Group
Atlanta

Greg Friedman
Chief Executive Officer
Peachtree Hotel Group
Atlanta

Rayna Katz (MODERATOR)
East Coast Editor
ALM's Real Estate Media Group
New York City

Fred Malek
Co-Founder and Chairman
Thayer Lodging Group Inc.
Annapolis, MD

Christopher Devine
Chief Financial Officer
Pyramid Hotel Group
Boston

RAYNA KATZ: What inning are we in at this point?

FRED MALEK: The top of the fourth. In the full-service segment we've been impacted positively by the lack of supply, the return of demand and of group business. Demand is outstripping supply; that will continue in many markets for several years.

GREG FRIEDMAN: We're closer to beginning of the sixth or seventh inning; debt is about as cheap as it's going to get. I expect us to continue here over the next six or 12 months but there's not much runway left because there's a lot of new supply coming. You have maybe another 18 to 24 months.

MICHAEL PALMERI: We're in the back half of the innings. The fundamentals and the optimism you hear suggest some of those final innings might be really interesting and long.

KATZ: What are each of you working on right now?

FRIEDMAN: We're in the limited-service space. We're invested in about 28 hotel properties, primarily across the eastern half of the US. On the real estate side, we've got about 23 or 24 first mortgage notes that we own and service. We started to originate a lot of mezz and bridge loans on hotels—primarily in secondary markets and tertiary markets—and to acquire hotels in secondary and tertiary markets.

Some of the assets we recently acquired include a Sheraton Four Points in Biloxi, MS that we're going to convert, most likely to another brand; and we picked up a small Embassy Suites in Williamsburg, VA that will undergo a massive renovation. We're doing more value-add type of acquisitions.

MALEK: We have four hotels under contract, all of which have about 90% probability of closure. The biggest one is a huge hotel in South Florida. We'll do that property and go through it with co-investors—one in the Pacific Northwest, one in the Southwest, and one in the Mid-Atlantic. Then we'll be on the hunt again.

CHRISTOPHER DEVINE: We're opportunistic both on the development side and on the acquisitions side. We did a development deal in Boston right next to Fenway Park. It was a Residence Inn that opened in July 2013. We did a deal in Waikiki with Rockbridge that closed in January. Hawaii is a great market. In Waikiki, the supply of hotel rooms has been reduced; the inventory has been demolished primarily for retail, and that market is at 90% occupancy. It's seen a significant influx from Chinese travelers. There's still relatively good value there, $250 to $300 per key, although it's starting to get priced up. Some investors won't go there because you're on an island and there have been wild ups and downs. But you have to look at how big the Chinese market is. Hawaii is the number one destination from there.

MARY BETH CUTSHALL: HVMG started in 2001 with one property, and as of last week, when we opened a new Hyatt in the Perimeter area of Atlanta, we're at 42. The company has doubled in the past three years and in the past 45 days we have signed three deals. What's up for us is acquisitions; our perfect balance is 50% ownership interest and 50% third-party management. We are in some strategic relationships. One is with Gabriel Holdings Fund, for which we're starting to raise money with David Boatright and Ronnie Lott, the former NFL player.

In addition, we have created a partnership with Serendipity Labs. It's a co-shared space that is in commercial buildings and will go into hotels. It'll go after the same market as the Regus model but be targeted more toward Millennials. We're diversifying what we operate and what we do.

KATZ: Are you worried about the amount of new supply coming on line?

DEVINE: It's market-specific. There's a lot in the select-service sector.

MALEK: In the luxury segment, it isn't that much, at least in our markets. In San Francisco, all the development money is going into multifamily.

CUTSHALL: New supply will become an issue, but we aren't there yet. In Atlanta, we have a lot of multifamily projects that are coming in and, in terms of the cost per square foot, there seems to be more opportunity to generate some investment dollars in multifamily versus hotel. We're hearing that a lot of construction companies nationwide are not ramped up with skilled labor or project managers and are at maximum job capacity for 2014. There's going to be some suppression over the next couple of years for that reason.

KATZ: What are your acquisition and disposition plans over the next 12 months?

PALMERI: In a lot of the primary and secondary markets we see development as a new option, while other times we will buy. We're seeing pricing on the buy side that makes us think we either can make some compromises or we can develop exactly what we want.

MALEK: With our new association with Brookfield, we are going to see much larger hotels. Larger transactions seem to have the most promise with the greatest returns and the most leverage. At the same time, we know we're closer to the bottom innings so we'll start seeking disposal of the properties that already have achieved their equities.

DEVINE: We manage resorts and complex assets there are a tremendous opportunity. Resorts are getting their legs under them and many of these projects are complex. There are plenty of value-add opportunities on the Cap-Ex side and on improving management.

FRIEDMAN: In select-service, the sell side is very attractive. We're constantly trying to find opportunities on the buy side, but we're getting priced out. We've closed on four this year and plan to close on another five or six by year's end. Separately, we're disposing of 10 to 12 assets this year. So we're starting to shift our portfolio and we're shifting our capital from the standpoint of reinvesting in debt.

KATZ: Fred, how does the deal with Brookfield change Thayer's plans?

MALEK: Brookfield has bought our operating platform, not the funds themselves. We are now a Brookfield company. We're still operating six funds, which are mostly Brookfield money. Brookfield's resources for co-investing, as well as the money it puts into the funds, enable us to go after larger transactions without having to go out and get other co-investors.

KATZ: The CMBS market has made a strong comeback, and CMBS often backs hotel assets. What's coming due, and what's being issued?

DEVINE: $200 billion.

FRIEDMAN: And probably 10% to 15% of that was hotel paper; many of the problem assets have been worked out. There's a thought process that there will be another opportunity in 2015 and '16 or '17 with the maturity of the CMBS loans but there's not going to be a huge opportunity on the acquisitions side.

CUTSHALL: There was $367 billion issued that's coming due between 2015 and 2017. People either will refinance or divest their assets.

FRIEDMAN: There are going to be a lot of opportunities for debt financing, mezz, etc. to bridge the gap for those that don't work.

CUTSHALL: The value-add comes into play with buyers that come to the table with a creative deal thesis.

KATZ: How much of an increase do you expect in interest rates in the next year to 18 months?

FRIEDMAN: Interest rates will remain low. I expect a slow increase but they're bound to rise over the next three to five years.

PALMERI: It likely will stay low even longer than that.

CUTSHALL: The liquidity in the debt market is going to compensate for any raise in expense.

KATZ: Do you expect the healthy volume of hotel transactions to continue?

DEVINE: Anyone who bought between 2009 and 2010 is going to look to monetize in the next two years. There's plenty of money out there, including the private REITs. There will be more of those.

PALMERI: The 2009-2012 deals are going to start to trade in the next six months because a lot of people are IRR-driven. Even if their cash flows don't show it, it's too hot to hold. They might leave money on the table but they're going to recycle that capital.

KATZ: Will hotel values continue to be so strong?

MALEK: You have two things working against one another. You have increasing RevPAR, and NOI probably is going to increase at double the rate of RevPAR increases. So if you have a 6% RevPAR increase, you've got a 12% increase in your profits. To get good returns, you've got to have a value-add.

PALMERI: There are a lot of value-add stories that are created and then there's the true value-add. There's coming with a business plan and having multiple paths to improve your ADR, your occupancy, your flow-through and ultimately your profitability, and then you can take a six cap deal and exit at an eight cap. But you're seeing the rules being bent quite a bit. People are losing sight of the appropriate analysis of who their competitors are, why they're getting certain rates, why they're able to create certain flow-throughs and what they can achieve.

MALEK: The value-add story depends on the type of property you're buying and on your philosophy. Some investors do well without a lot of value-add just by buying the right stuff—and exiting—at the right time. As operators, we don't buy unless we have a very concrete plan to double the NOI within the first three or four years. That's how we get returns, which have averaged north of 20% IRR over 25 years.

KATZ: San Francisco has come up a lot. Is it still mainly the gateway cities that you're excited about or are there other markets?

CUTSHALL: We've been involved in the secondary markets for years. If you find the right assets for the right cost basis, you can definitely maximize value. It's very difficult to compete in gateway cities. Those are markets where groups are selling their assets. As a buyer, it's a challenge to make that work. Secondary markets are becoming an area of focus—Charlotte and Richmond in the Southeast. Atlanta has been undervalued from a rate perspective. Demand is growing worldwide. You have technology booms in certain secondary markets as well. That's going to continue to increase occupancy and hopefully rates.

FRIEDMAN: We're heavily invested in secondary and tertiary markets and we've been successful. It's a great place to be, especially in a down market.

CUTSHALL: It's nice to be the main property in a secondary city. There's going to be more development in urban markets than in secondary cities. The barriers to entry create less risk. It depends on your deal fee system and what your exit point is but we've done well creating value in those markets.

KATZ: Are there any markets or market types that you're avoiding?

MALEK: The Rust Belt.

DEVINE: New York has been going up for years. Miami is extremely pricey and Boston is very expensive. There are still good deals to be had in top markets though; you can get a pretty good basis there.

FRIEDMAN: We're opportunistic so we'll pretty much go in any market. But there are certain markets that don't make sense because there's no occupancy.

PALMERI: We're looking at primary and upper secondary markets, but that has a lot to do with rate penetration. Certain secondary markets won't substantiate a Loews today. Over the last year though, we've widened our canvas to pick up more secondary markets like the Charlestons, the Charlottes.

KATZ: Are there criteria other than rate in terms of what you like about a secondary market?

PALMERI: There's something to be said about being the number one or two hotel in a secondary market. Loews is known for operating larger boxes with supportive meeting space. We won't only go into these larger hotels but if we can leverage our competencies in the meetings business in a secondary market, it allows us to compete with the big brands.

MALEK: We focus more on primary markets but it is encouraging to hear about the opportunities in secondary markets so maybe Brookfield will be there.

FRIEDMAN: If you don't buy right in the secondary markets, it's the biggest lesson to this downturn. When you're looking at a secondary or tertiary market, there's a ceiling to where you can actually make a deal work. Everyone likes to talk about cap rates but over a ten-year period, there's a certain basis per key range where you need to be.

KATZ: Changing gears, as brands chase the Millennials, what impact is this having on traditional hotels and brands? What pressure is that putting on you, and management?

PALMERI: We have spent a lot of money in the last couple of years developing and renovating hotels and the focus is that Millennials are on the horizon. We—and the big brands—are focused on a much more open and social lobby. There's a communal table and free Wi-Fi.

CUTSHALL: Millennials are going to be great for the travel industry because they are more focused on having experiences than on buying things. Also, they keep us honest. They like to be critics and to keep us engaged in what we are doing for a community. But they are going to demand vibrancy, technology, creativity and innovation.

MALEK: The biggest impact is the way you market. We are using all kinds of new tools to reach them.

DEVINE: I worry about Airbnb. It's a $10 billion company: it sold more rooms than Hilton and Marriott last year. You would be shocked at the rooms you can get. If you saw what you can get in New York, you'd pick a lot of those experiences over traditional small rooms.

KATZ: It was recently announced that American Realty Capital sold its healthcare trust, and is buying Equity Inns for about $2 billion in equity. Is that a factor in the overall market?

DEVINE: ARC has done a lodging REIT and I'm sure it'll be formidable. There's a lower cost of capital in those private REITs than there is in your traditional real estate deal. So they will overpay for certain things just because they have a low cost to capital.

KATZ: Does it become a concern at some point that, in the market, it's just a case of 'he who has the greatest dollar and the lower cost of capital' keeps buying stuff up?

FRIEDMAN: That's when you exit because you're able to sell so cheap. It's a concern if you're on the buy side. If you're aggressively trying to buy real estate, buy stabilized real estate. From my understanding of American Realty, it's looking for more stabilized assets versus the value-add opportunities. Private non-traded REITs, as well as traded REITs, are looking for assets. So it's a great exit strategy for value-add players.

DEVINE: $20 billion was raised in non-traded REITs in 2013 and there will be more in the next few years.

KATZ: There's a lot of opportunity in the Eastern European markets and Turkey, are you planning to be active in those areas?

PALMERI: We aspire to grow into Europe. There are interesting opportunities there, particularly in some of the capital gateway markets. Certain markets there are tough to make sense of though.

There are a lot of non-economic players in London so for us to get into London is very difficult; the same thing goes for markets like Paris. But there are some great German markets and there are possibly some major markets in Spain and Italy.

KATZ: Jon Gray, of Blackstone, spoke this morning about India and China as markets he's watching, even as other people are shying away from them. Are they of interest to you?

MALEK: We manage hotels in those markets through Interstate Hotels Corp; we own 50% of that company. But we've had a tough enough time mastering the markets in this country so we're going to stick with our investments in the US.

KATZ: What about Latin America and the Caribbean?

DEVINE: We manage a hotel in Grand Cayman. There are some good opportunities in the Caribbean, in some markets.

KATZ: When we're sitting here next June, will we be saying about the past year?

DEVINE: We'll say we had a good year from a fundamentals perspective. We'll be talking more about mergers and acquisitions, transactions like Equity Inns and other small or medium size lodging REITs getting gobbled up.

FRIEDMAN: Barring some disaster from a global perspective or some economic meltdown, we're going to have a really good 12 months and there will be more consolidation, with companies like American Realty Capital buying bigger portfolios.

CUTSHALL: It's going to be our strongest transactional year in many years. Debt liquidity is going to spur a lot of that. With the unemployment rate going down as much as it has, and gas prices looking reasonable, travelers are going to be confident that they can take that summer vacation. In terms of corporate transient travel, companies are feeling confident. Meanwhile, group business is starting to pick up.

MALEK: We're going to say, “Gee, I wish we bought everything we could and spent all of the money that we could for this year.”