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CHECKING IN FOR BETTER RETURNS

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Checking in for better returns

February 2007 (Magazine) By Jon Peterson

 There is still considerable demand from pension funds in the US for investing in hotels: the industry feels that the investment fundamentals are good and will continue to be so in the future.

Companies are still sending their employees out on more business trips; leisure travel is also strong. Meanwhile the industry still awaits the next hotel development boom. These factors have all created a healthy investment environment and the predictions are that this situation will continue for the next 12 months, barring some unforeseen catastrophe.

Most pension funds, real estate managers and consultants believe that the real investment play going forward for hotels is a value-added one, ie, to acquire an existing asset in need of some capital

improvements. Many hotels across the country have been neglected in recent years. Rob Kochis , principal with real estate investment consultancy the Townsend Group and a big supporter of hotel investments. Clients that have invested in hotel funds include Illinois State Board of Investment and the San Diego City Employees' Retirement System. "The fundamentals for hotels are still good," he says. "This is especially true for value-added transactions where you could buy an existing asset that needs some sort of capital infusion. A transaction like this will enable the investor to participate in the increased income the property will be generating in the near term."

To take advantage of the hotel market, some top real estate managers are hiring in this area. Examples of this are Principal Real Estate Investors and Clarion Partners, both of which have beefed up their hotel investment teams.

James Fitzgerald, the recently appointed managing director of hotel investments at Principal notes: "We are hopeful of closing some deals in the near term . Our focus will be on value-added deals. There is a lot of capital chasing the core transactions and we don't want to be part of that. Initially our interest is to buy assets that need a new capital infusion or re-branding. We could look at investing in new development projects in the future, in a joint venture with a development partner."

He adds: "The amount of capital we will invest in hotels will more than likely be in the few hundred million dollar range."

Principal will be seeking deals in both full-service and limited-service hotel product in urban or suburban locations in the major metropolitan markets, typically with a price-tag of $15-80m (C11.5-6om), with around 65% leverage, targeting an IRR in the mid-teens. This yield would factor in a five-year holding period.

Clarion Partners hopes to become a more active investor in hotels in the future. In 2006 it added Chuck Latham to its staff as a managing director. The real estate manager is in process of taking over a portfolio of hotels that Latham had previously managed at Sarofim Realty Advisors - $1.2bn of assets owned by the Michigan Department of Treasury. The properties involved are a combination Marriott hotels across the US.

California Public Employees Retirement System has an active and on-going hotel investment program. Overseeing this part of the pension fund's real estate portfolio is portfolio manager Randy Pottle. "We think that the hotel market does offer some interesting investment opportunities and we will continue to look at the property type going forward," he says. CalPERS has not allocated a set amount of capital to investments in hotels but will invest as it finds opportunities that it likes - most likely through commingled funds.

CalPERS' hotel investments are part of its opportunistic real estate investment program. The fund has made five investments in hotels over the past couple of years, totaling $635m. Two of the investments were commingled funds managed by RLJ Capital Partners.

Kochis sounds a note of caution about investing in core hotel deals. "The pricing on core hotel assets is very steep, he notes. "This has kept cap rates very low and we do not think this is the right kind of play for hotels now." He explains that there are many hotel markets he would be interested in - a property that is targeting the business traveler, for example. "One of these areas would be New York City, where the market is tight, he says.

james fitzgerald