In Part 6 of his series, Lawrence Meyers and Monty Bennett discuss Ashford’s REIT structure and how to read their balance sheet.

By: Lawrence Meyers

L:  Let’s talk about hotel REITs and how they work, and specifically, how Ashford Hospitality Trust (NYSE: AHT) works.

M:  REITS are not allowed to operate their own hotels.  They can own them, but must have someone else operate them.  So they have to get third party managers.  The problem is that a brand manager may not be best for the property you have.  So you need an independent manager.  In Ashford’s case, almost 40% of our properties are managed by Remington Lodging & Hospitality, nearly 40% by Marriott, and the rest by other managers such as Hyatt and Hilton.

L:  Remington is an affiliate of Ashford, and it’s owned by you and your father. I think a lot of investors might be concerned about a conflict of interest.  Can you ease their concerns?

M: Sure, the financial arrangement is documented on our website and in our SEC filings. Still, some investors don’t like that. They say, “Hey, you can have Ashford go buy assets just so you can manage them, using someone else’s money as a public company, and then you benefit by getting the management fees”.  Comparing my father’s and my ownership in the REIT, we are extraordinarily aligned with the interests of our fellow shareholders, much more so than the management of most other REITs.  The potential management fees don’t even compare.  Our independent Board of Directors have a great deal to say about the management selection – which is why in addition to Remington we have six other management companies operating AHT’s assets

Furthermore, who would you rather have manage the hotels?  A company like Marriott (NYSE: MAR) which is very well qualified, but has many, many other hotels to worry about?  Or would you rather have Remington, with 403 hotels, where I care dearly about how well that property performs?  Economically, the REIT gets far more value from Remington. The challenge of any owner with a manager is to have that manager’s interest aligned with the owner’s.  Remington is as aligned as you can be. 

L:  What about your management fees being negotiated at arm’s length?

M:  They were negotiated with our investment bankers at our I.P.O. They came up with what they thought was a fair market value for Remington’s services, and so did we. Then we negotiated, and settled on what we all believe is a fair number, comparing it to similar deals other REITs have done along the way.  The ultimate affirmation was going public and having all our shareholders invest, fully aware of the details of the arrangement. 

L:  Let’s talk about how to read your balance sheet.

David Kimichik, the Chief Financial Officer, joins the conversation.

L: Let’s look at the balance sheets you just released along with your first quarter earnings. So this would compare the first quarter of this year with the year end balance sheet for 2007.    Let’s go through them and highlight the important parts for investors.

D:  Investment in hotel properties is the book value of our purchased hotels.  Book value is gross value less asset depreciation.  There is a schedule for each of these investments in our 10-K. In our case, there’s been little depreciation since we are a relatively new company.  So the direct hotel investments book value we have is pretty reflective as to the hotels’ initial costs.

Cash and equivalents is our free cash.  Investors should make sure we have liquidity and $94 million is a lot.  Restricted cash is held in escrow for property taxes, insurance, and so on. 

What’s important is to separate what is property specific and what is macro-REIT specific.  Inventories, pre-paid expenses are all property specifics.  In liabilities, it’s accrued expenses and accounts payable.  An accrued expense might be a utility bill or a vacation.  You must book an expense in the period it was incurred whether or not you pay it.

Assets held for sale are hotels which, after we have purchased, have reviewed strategic alternatives and elected to sell.

Notes receivables is our mezzanine loan business — that’s principal outstanding on those notes.  From the perspective of an institutional investor, you want to look at our investments in hotel properties, the notes receivables, and the cash we have.   On the liability side, you look at mortgages payable.  Our weighted average interest expense is 5.05%, an incredibly low historical number.  We are trying to find ways to reduce that even further.

L:  Shouldn’t the retail investor add back the depreciation to find the true value of a hotel’s assets?

D: Even more than that.  That’s a given. A lot of the analysts will value us from a NAV angle, price per key ratio, or multiples on the EBITDA cash flow. 

M:  Loan to value is relevant, but even more important is what they pay on their debt.  So we look at EBITDA over interest expense ratio.  Our cost of debt is so low, that’s a world of difference compared to some others.  Look at those coverage ratios to look at the ability of a company to pay interest expense.

L:  Dividends that get paid out come out after debt service has been paid, yes?

M:  Yes.

D: From an investor’s perspective, the easiest thing is to look at all of the shares in the REIT, and you see where we calculate our per share numbers, it includes all of this.

Not only are we the highest paying dividend hotel REIT, but it’s also more than covered by our operating results.

M:  At the end of the year, we will probably set our dividend for 2009 and not revisit it every quarter.

L: Thanks for taking the time to sit down with me.

M: My pleasure. 

Stay tuned for Part 7, where Lawrence Meyers analyzes Ashford’s Second Quarter Earnings and comments on his impressions of his CEO interview.

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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