In Part 3 of his series, Lawrence Meyers and Monty Bennett discuss Ashford’s strategy of taking advantage of hotel cycles.

By: Lawrence Meyers

L:  Okay, last time we discussed how your management experience helps you decide the right times to buy and sell hotels for Ashford Hospitality Trust (NYSE: AHT). But how do you really know when the time is right?

M:  We get a lot of questions about that. We say, “You see the data.  Look at the demand chart. You can predict as accurately as we do.”  .It’s really not that difficult.  But, and this is the key, the problem is that other groups often do not have either the discipline or the capital to buy and sell at the right time.  So right now, when supply is outpacing demand, you want to be a seller of hotels, as upside is limited because growth has slowed.

L:  Why would others even want to buy your hotels? They see the demand-supply chart, don’t they?Are they just suckers?

M:  Well, some people find this hard to believe, but there are times when it’s good for one company to buy an asset that somebody else wants to sell for an equally good reason.  There are so many different hotel plays and every one of them can do well with an asset that others have sold. Everybody has a different reason to buy or sell a hotel.

Maybe the new company has a specialty they deal in, like boutique hotels, while the seller doesn’t have that skill set.  Maybe the buyer has another hotel in the marketplace and is overbooked, so they’re turning away demand, and they want to shift business to another property that they own. 

Maybe the seller has to put capital into a hotel, and the investors don’t want to allocate money to that sector, so the hotel gets sold. But, sometimes people just pay too much.  When we sold a lot of our assets, many of those sales went to people who had a genuine need for the asset and could add value. But as for why some companies buy when they shouldn’t — the problem with most REIT models is that people who run them understandably feel an obligation to deploy the capital they have been given.  Investors want them to deploy capital into their sector.  So they do what they’ve been charged to do, and sometimes they deploy that capital into hotels at the wrong times. What investors are really saying is, “make money”.  Until the past few years, most hotel REITS hadn’t even sold hotels.   Their strategy has always been to just buy, regardless of what part of the cycle we’re in.  Look at the history of the other hotel REITS.  None of them ever sold hotels until after 9/11, when they were forced to in order to avoid bankruptcy.  Now, the industry has matured a bit in that they are starting to realize that selling hotels isn’t such a bad idea.

L:  So how did you come to your concept of making money during the down cycle?

M:  When we talked to our investment bankers about how to grow during the down cycle, we at first thought about just buying up as many hotels as we could, and selling them as the cycle turned.  The bankers said, “You can’t go public like that. Investors want a growth story, they want a consistent dividend”.  So we thought about it.We realized that when we bought all these loans back in the early 90’s, we naturally developed a lot of lending experience.  Normally, a small amount of the hotel loans you make will go bad.  But back in 1991, we bought 150 hotel loans, and they were all bad.  So we have a lot of experience on that side. So, we thought, how can we take advantage of this? Typically, during bad times, the Fed cuts interest rates.  We could buy hotels then, lock in the long-term low interest rate.   But as good times start to peak and interest rates rise, we could sell hotels and use the capital to make loans. It can also be an ideal time to lend during not so good times as well, when there are illiquid/dislocated credit markets like there are currently.   If you are the lender and loaning at 70% of the asset, even if the asset drops 30% of its value, you’ll still get paid back on your loan.  But you’re getting an attractive interest rate on your loan, plus those returns are enhanced by some leverage.  So our investors would hopefully get a return in the low to high-teens (depending on where we are in the capital structure).   We believe this strategy offers capital appreciation and greater dividend consistency.

L:  So in the current environment, you will sell hotels and redeploy that capital in the form of loans. If you make a loan of 60-80% of a hotel’s value, if the value of the hotel drops, it wipes out the equity. But it doesn’t affect you, the lender. 

M:  The change in our position in the capital stack offers a higher likelihood of getting our payments.

L:  So who are you making these loans to?

M:  Remember, there’s $350+ billion worth of hotels in the U.S. alone. Assuming an average loan to value of 60% and the industry’s longest loan is only 10 years, and the average maturity is less than five years. You’ve got more than $50 billion worth of loans that need to be refinanced every year on average.

L:  So there’s no shortage of a need for capital.

M:  Right! So why not make those loans?  It’s not sexy, but it makes money.  Right now there is relatively low liquidity in the hospitality debt markets, which has caused rates to increase substantially, so it is a very profitable use of capital to make these loans.

Stay tuned for Part 4, where Lawrence Meyers and Monty Bennett discuss Ashford’s unique methods to profit from hotel down cycles.

Lawrence Meyers is a former writer for the Motley Fool, and is President of PDLCapital, a private equity firm (www.pdlcapital.com). He currently owns shares of Ashford Hospitality Trust. This article is only an expression of the author’s opinion, may contain inaccuracies, and is not a solicitation to buy or sell any security. All readers are advised to consult with a financial advisor prior to making any investment. The author may be contacted at pdlcapital@earthlink.net

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