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Multifamily 2013 YTD News

The apartment sector continued to lead the commercial real estate recovery in 2013. Property fundamentals continued to improve while capitalization rates continued to compress. While apartment cap rates are exhibiting historical lows, there are signs that cap rates may be reaching a floor and beginning to reverse course. Overall, the apartment markets’ performance has continued to lead the national real estate recovery.

One interesting trend to note is that Class B occupancy rates are actually higher than Class A peers. Another interesting trend is that the difference between the average Urban and Suburban cap rates compressed slightly in 2013.

Strong property fundamentals as well as the relatively strong availability of financing for multifamily assets has driven a strong demand to acquire multifamily properties.

Currently our market is described as being in the Recovery Stage characterized by decreasing vacancy rates, low new construction, moderate absorption, low to moderate employment growth and negative to low rental rate growth. This is why our market has higher cap rates than the national average as exhibited in the chart below.

Capitalization Rates Comparison
Urban Multifamily – Class A:  National = 5.76;  Our Market = 7.75
Suburban Multifamily – Class A:  National = 5.87;  Our Market = 6.75
Urban Multifamily – Class B:  National = 6.39;  Our Market = 8.0
Suburban Multifamily – Class B:  National = 6.53;  Our Market = 7.50

We have Hedge Fund Buyers, Private Investors, REIT’s and Traditional Multifamily Buyers interested in acquiring additional apartments. Many of our Buyers are “All Cash Buyers”.

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Self-Storage 2013 YTD News

Self-storage has proved to be a recession-resilient (but not recession-proof) property type considering its performance over the past five years. The most recent recession marks the first time this sector realized a pronounced decrease in operating performance. Although the recession caused performance to stumble, it generated a new demand from homeowners downsizing or losing their homes during the foreclosure crisis. During 2013, the self-storage industry has realized significant growth which has captured the attention of the nation’s investors. The Self Storage Industry exhibited materially positive absorption over the course of the year. This absorption has allowed the industry to decrease the amount of promotional discounts and concessions, further enhancing revenue potential within the sector. Occupancy increases will likely become less pronounced in the coming year and are expected to stabilize somewhat as rental rates continue to be pushed by operators. Revenue growth far outpaced occupancy growth for the industry. The amount of revenue growth should be attributed not only to occupancy growth, but also to operator’s success in increasing rental rates for existing customers and reducing discounts to attract new customers. As the industry’s track record of positive revenue growth extends, more capital has continued to flow into the asset class, making stabilized assets very attractive to investors.

Net operating incomes for the industry grew at a faster rate than revenue, indicating that operators were successful in driving top-line revenue growth while cutting expenses. A large amount of expense cuts came in the form of existing Yellow Page advertising and transitioning to online marketing. It is likely that expenses have been reduced to a point of stabilization. Expenses may actually start to increase in the coming years due to increases in property taxes stemming from higher accessed values. However, revenue increases will outpace any expense increases. Little for sale inventory over the past two years has pressured capitalization rates downward, to near record low levels. Coupled with income growth and lower overall rates, self-storage values are increasing and there is little reason to expect that the self-storage industry will reverse its recent positive momentum in 2014. We have Hedge Fund Buyers, Private Investors, REIT’s and Traditional Self Storage Buyers interested in acquiring additional self-storage space. Many of our Buyers are “All Cash Buyers”.

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Receivership Sale Ramada Plaza and Conference Center

Terry Baltes of Baltes Commercial Realty, Ltd. located in Dayton, Ohio recently concluded the sale of the Ramada Plaza and Conference Center located at I-71 Exit 116 at 4900 Sinclair Road, Columbus, Ohio. Terry Baltes was the Receiver for Hotel Investments I, LLC. The hotel was purchased by Pacific Rim Development, LLC an Indonesia Company. The 264 room hotel was purchased on December 20, 2013 for $2,640,000.00. The hotel sits on 6.865 acres, it has a restaurant and lounge, a conference center featuring 11 fully equipped meeting rooms, a 12,000 s.f. ballroom, an indoor and outdoor pool, whirlpool, fitness center and a business center. The hotel was originally constructed in 1971. The six story structure is comprised of 182,768 s.f. The new owner plans to make major improvements to the hotel.

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Self Storage Facility News

Every time we come out of a recession the Class A properties have lead the way in occupancy growth and rent growth, followed by Class B properties and then Class C properties. The last three years have been no different. Class A properties have been aggressively raising rents but are now starting to face some resistance while Class B properties have been showing stable growth. The Class C properties were the hardest hit in the Recent Great Recession as is typical in every recession. We are now at the point in the recovery cycle where Class C properties are filling up.

Class C naturally lags the other classes during the early part of the recovery. During the contraction period there is a domino effect that occurs as Class A properties lower rents to maintain occupancy. When that occurs residents are able to move up in class from a Class B to a Class A property. That occurs all the way down with Class C ultimately being hit the hardest. Class A properties are still raising rents more on an absolute dollar basis, but Class C has the best relative growth.

We have a number of well Qualified Buyers ranging from Private Investors, REIT’s, 1031 Tax Deferred Exchanges and Hedge Funds all anxious to invest in self storage facilities. Some require financing and some are paying all cash. As interest rates increase the gap will widen in seller and buyer expectations. Rates appear to be on the rise and it doesn’t look like we will see financing this cheap for another cycle, if ever. It is easier to cut a deal when financing is cheap. It can’t get much better than it is now so it is better to sell sooner than later.

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Multi-Family Properties…..

Every time we come out of a recession the Class A properties have lead the way in occupancy growth and rent growth, followed by Class B properties and then Class C properties. The last three years have been no different. Class A properties have been aggressively raising rents but are now starting to face some resistance while Class B properties have been showing stable growth. The Class C properties were the hardest hit in the Recent Great Recession as is typical in every recession. We are now at the point in the recovery cycle where Class C properties are filling up.

Class C naturally lags the other classes during the early part of the recovery. During the contraction period there is a domino effect that occurs as Class A properties lower rents to maintain occupancy. When that occurs residents are able to move up in class from a Class B to a Class A property. That occurs all the way down with Class C ultimately being hit the hardest. Class A properties are still raising rents more on an absolute dollar basis, but Class C has the best relative growth.

We have a number of well Qualified Buyers ranging from Private Investors, REIT’s, 1031 Tax Deferred Exchanges and Hedge Funds all anxious to invest in apartments. Some require financing and some are paying all cash. As interest rates increase the gap will widen in seller and buyer expectations. Rates appear to be on the rise and it doesn’t look like we will see financing this cheap for another cycle, if ever. It is easier to cut a deal when financing is cheap. It can’t get much better than it is now so it is better to sell sooner than later.

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The number of hotel transactions is up by more than 50% for the first nine months of 2013 over the comparable period last year.

The number of hotel transactions is up by more than 50% for the first nine months of 2013 over the comparable period last year. Sales transaction volume of hotels is nearing the long term annual average. According to Hotel Valuation Services (HVS) hotel values will continue to increase at an average rate of 12% for each of the next three years, this is substantially less than we have experienced the past couple of years, due to climbing out of “the Great Recession”, but still a nice increase in value. Hotel values are now reaching their 2006 peaks. There is an active market for hotels fueled by cheap financing. For existing hotels with cash flow, financing is available as cheap as 4% fixed rate 10 year money for prime assets, and only a little more expensive for non prime assets. Interest rate increases have taken a temporary pause as the result of the current Government Shutdown, but are sure to tick up slightly after Congress reaches a compromise. As interest rates rise values decrease.

Values have increased in part due to record low supply growth these past few years. That is about to end. New hotel developments in the pipeline will increase supply in the next couple of years, creating competition with older product, making it harder to continue Rev Par and profit increases in the future. Some areas already have more than their proportionate share of new development. If there are three or more new hotels coming into your market you should look at selling, as NEW ALWAYS WINS.

The only thing limiting the growth of hotel sales transaction is a lack of quality hotels that are reasonably priced. As interest rates increase the gap will widen in seller and buyer expectations. Rates appear to be on the rise and it doesn’t look like we will see financing this cheap for another cycle, if ever. It is easier to cut a deal when financing is cheap. It can’t get much better than it is now so it is better to sell sooner than later.

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“Slow and Steady” are the key words

“Slow and steady” these are the words I hear at the investment conferences and franchise shows I have attended recently. Things are certainly much better than the place we were in just four years ago. The lodging recovery is well under way and predictions are, barring any major catastrophes, we have another three to five years of continued steady growth. (See chart below)

2013 Predictions

Occupancy %:    PwC:  62.2    STR:  61.4
Occupancy Increase:    PwC:  .8%    STR:  3%
ADR:    PwC:  105.45    STR:  111.01
ADR Growth:    PwC:  4.4%    STR:  4.6%
Rev Par:    PwC:  5     STR:  68.17
Rev Par Growth:    PwC:  5.9%    STR:  4.9%
Demand:    PwC:  1.8%    STR:  2.0%
Supply Growth:    PwC:  .8%    STR:  1.4%

For Sellers it is a “Perfect Storm”. Historically low interest rates, lack of product to buy, and Buyers with lots of cash. Financing has loosened some, allowing good economic deals to be financed even new construction with experienced hoteliers. The consistent requirement from all lenders is that they want the Borrower to have hotel management experience. A hard lesson learned by the Lenders as a result of the Great Recession.

The housing market has stabilized giving consumers confidence once again. Interest rates have ticked up to 30 to 50 basis points over the last 30 days as a result of the economy gaining strength and the impending start of the winding down of stimulus from the Federal Reserve. Even with the slight uptick in interest rates that still remain historically low.

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25th Annual Hunter Conference in Atlanta, Georgia

I recently had the pleasure of attending the 25th Annual Hunter Conference in Atlanta, Georgia whose theme was “Moving Forward With Confidence”. I wanted to share with you some of my thoughts from the conference.

Leadership And Experience

This was their largest attendance ever with 30% of the attendees being first timers. There were 46 lenders. Fifty percent of the attendees plan to build a new hotel in 2013. Buyers are back and paying fair prices. Lenders are back. Interest rates are at historic lows. Interest rates are going to rise, we just don’t know when or by how much. It is a Goldilocks environment. CMBS loans are back, although not as booming as 2005 and 2006. Don’t ever bet against the U.S. our willpower and technology will lead the recovery. Pools are no longer a brand standard for Days Inn, because of the cost and liability but a fitness center is required. The new mandated pool lifts are a magnet for an accident. Due to the sequester Apple REIT is now leery of hotels located near military bases and National Parks. There are over 250 hotel brands in the United States and still more coming. Capital reserves need to be 7% to 8% instead of the old 4% rule. Brands react to customer needs. Every Brand has a redemption program. Hilton’s Home 2 Suites has 16 open, 20 under construction and 90 in planning. Despite what is happening in Washington the economy continues to improve. Every REIT is buying. Private equity is buying. Follow the oil and gas as places to buy. Now is a good time to sell the gap between Buyers and Sellers expectations has diminished. Hotel rates are coming back. Group business is coming back. The guests are requiring the amenity creep. We are at a very early stage of recovery on a scale of 1 to 10 we are at a 3 to 4 in the hotel industry.

Hotel Values

Equity return requirements used to be 20% now it is in the mid to high teens. A 30% reduction in revenue results in a 60% reduction in the net operating income. In a low barrier to entry market only about 6 to 7% of existing hotels warrant being built today based upon their net operating income. The novelty of being Green is becoming a real economic factor because of savings. Cap Rates are 9% to 10%. Lenders require prior hotel management experience. Obama Care is going to affect the value of hotels in a negative way because of the cost. It is a healthy market to buy or sell. Fixed rate financing is in the low 4’s. If your property is 10 years or older the value declines dramatically. The highest value is when your property is 3 to 6 years old. Even though there is limited supply nationwide there are certain submarkets that are overbuilt with new supply. Lot of foreign interest in investing in the United States. A one percent bump in interest rates equates to a needed 14% increase in Rev PAR. Assuming debt of 70% to value if interest rates increase by 1% the value declines by .7%. The sequester will last all year long. With the low interest rates a double digit return on cash flow is very realistic.

2013 Economy And Beyond

Every 2 months there will be another deadline in Washington due to the stop-and-go politics. GDP will be weak in 2013 as a result of the sequester. It will be better in 2014 and 2015. Demand is still growing just not at the same high rate. Transient is driving the recovery, group demand still has not come back. Supply is slowly but surely growing. Demand growth is healthy despite everything. The group outlook for the rest of 2013 has been weakening. The transient outlook for occupancy and ADR is consistent with where we were this time last year for both business and leisure. The rate of growth has dissipated. Supply growth will remain below average through 2016. Demand growth will be above average through 2015. Occupancy will be above the average level through 2016. ADR growth will be 2 times the average through 2015. Rev PAR growth will be 2.5 times the average through 2015. The fundamentals are solid. Outlined below is a summary of the outlook from Smith Travel Research and PKF Consulting.

OUTLOOK
Supply:   2013 – STR:  1.0%    PKF:  .8%    2014 – STR:  1.5%    PKF:  1.7%
Demand:   2013 – STR:  1.8%    PKF:  1.8%     2014 – STR:  2.8%    PKF:  3.9%
Occupancy:   2013 – STR:  8%    PKF:  .6%    2014 – STR:  1.3%    PKF:  1.4%
ADR:   2013 – STR:  4.9%    PKF:  5.0%    2014 – STR:  4.6%    PKF: 6.2%
Rev PAR:   2013 – STR:  5.7%    PKF:  6.1%    2014 – STR: 6.0%    PKF:  8.4%

Financing

This will be a 9 to 10 year recovery cycle. We are somewhere between years 3 and 4. Financing is coming back, delinquencies are down, CMB lenders have become more aggressive and there are more. Hedge Funds are lending. New construction loans still harder to secure than acquisition loans. Community Banks are the best source for new construction lending. They will lend at a 60 to 65% loan to value. The rate is prime plus. The amount of the plus depends upon the quality of the deal. The operator, brand and metrics of the local market determines who gets the loan. Lenders prefer the Branded properties. Non-branded properties are much harder to finance. Banks are willing to work with good operators that are over-leveraged instead of foreclosing. Lenders are being very disciplined. “Debt yield” is the new hot word, Net Operating Income divided by loan value. Lenders like owner/operators better than third party management. Recourse is difficult to enforce from the lenders perspective. Permanent long term rates are in the 4% range, 20-25 year amortization with a full balloon payment in 10 years.

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How the New “Fiscal Cliff Bill” affects your hotel ownership

How the New “Fiscal Cliff Bill” affects your hotel ownership:

Capital Gains & Dividends: For individuals who earn $400,000.00 or more and married couples who earn $450,000.00 or more the tax rate will increase to 20%. In addition there is a 3.8% tax from the 2010 health-care-law (Obama Health Care). The 15% tax rate remains the same for everyone else except for those earning $200,000.00 single, or $250,000.00 married who will have to pay the extra 3.8% Obama Health Care Tax.

Income Tax: For an individual who earns $400,000.00 or more and a married couple who earns $450,000.00 or more the top tax rate increases from 35% to 39.6%.

Payroll Taxes: Payroll taxes will rise with the expiration of a temporary 2% tax cut adopted two years ago, resulting in less take home pay.

Estate Taxes: The estate tax exclusion remains at $5 million per individual and $10.0 million for married couples, and is adjusted for inflation. According to unofficial estimates the adjusted amount for 2013 should be $5,220,000.00 for individuals and $10,440,000.00 for married couples. Estate and gift tax rates increase from 35% to 40% above the exclusion amount. Good news if you are a resident of the State of Ohio, effective January 1, 2013 Ohio has abolished its 7% estate tax.

Annual Gifts: The annual gift exclusion amount per individual increases to $14,000.00 from 2012’s $13,000.00.

The fighting in Washington will continue as the ugliest battle is still yet to come, in the first quarter, the raising of the debt ceiling. Obama wants to boost it with no strings attached. The GOP wants to trim a dollar of federal spending for every dollar in higher debt that’s authorized. The ceiling will be raised, lest the U.S. default and scare off investors. But don’t be surprised if the action isn’t in time to avoid a credit downgrade.

Economic growth is expected to be modest in 2013, with Gross Domestic Product (GDP) anticipated to rise by 2.9%, but the supply of hotel guestrooms is expected to increase only 0.7% over the next year, much lower than the 1.7% to 3.1% annual increases seen from 2007 to 2009. As a result, there will be continued upward pressure on hotel market values as performance fundamentals remain relatively strong and hotels continue to be good investments in an uncertain economic environment. Positive factors affecting hotel values include rising consumer spending (2.3% growth anticipated in 2013), increasing home values (5.6% growth anticipated), and limited, if any upward pressure on oil prices. Offsetting the positive factors is the expected continued high unemployment rate, though the expected rate of 7% to 8% would be lower than in recent years. Hotel values are expected to register a healthy 8.7% growth rate in 2013 following an 11.8% increase in 2012. Luxury hotels are anticipated to continue to show strong value increases with an 8.9% gain in 2013 which, at $28,773 per guestroom represents the highest increase in value per room of all hotel types. Economy hotels are expected to record the greatest value percentage increase at 10.8%. Overall the Hospitality Industry is outperforming the national economy. But it will be a modest growth. Not the recovery we had all hoped for. 

To keep you informed of the value of hotel rooms we have listed the average 2012 capitalization rate for class A hotels:

Central Business District:   Our Market:  9.50   National:  8.58   Difference:  .92
Suburban:   Our Market:  9.56   National:  8.95   Difference:  .61
Airport:   Our Market:  9.50   National:  9.03   Difference:  .47
Average:   Our Market:  9.52   National:  8.85   Difference:  .67

As you can see the capitalization rate in our market was higher than the National average in all three categories resulting in a slightly lower sales price.

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5th Annual Midwest Lodging Investors Summit

I recently had the opportunity to attend the 5th Annual Midwest Lodging Investors Summit in Chicago and I wanted to share with you the thoughts from the various speakers.

A Five Year Retrospective
Occupancy is up. Business travel is back, and thankfully leisure never left. Group Business is starting to come back, Rev Par is up 6.8%. Natural gas, because of fracking will make us energy independent. PIP’s are back and stronger than ever. Five years ago the recession was just starting, the worst lodging downturn since 1973-1974. Recovery has been slower than anticipated. Cycles are no longer here, what you see is what you get. Generation Y is leading Generation X. The new thing is multi-generations. Grandparents, parents, children and grand children now vacation and travel together. The cost cutting that we made is here to stay. It will never be cheaper to buy than today for the next decade. Room rates will meet a new high. Profit margins will increase because of the reduced labor costs. Change breeds opportunity for success. Success is the ability to go from one failure to another with enthusiasm.

A View From The Top
We currently have the highest demand ever. Depth of each downturn gets deeper and more often.  Record demand but ADR is not up. Now is the time to take the risk and raise rate or else you will miss the opportunity. The years 2007 & 2008 were the bubble numbers. Second half of 2012 is tepid. Urban select service is the most profitable right now. Focus, upper mid-scale & mid-scale is where the action is. New sells, old smells. Good beginning for 2012. Economy segment is finally getting some traction. Transient demand is strong but not rate. Group ADR is still depressed.

Market Report Segment Tracks
If you can find the financing, now is a great time to build urban or suburban but not interstate. Lifestyle centers are a good place to build a hotel. The guests like being able to walk to the restaurants and shops. Interstate travelers are impulse buyers. Colleges are great room demand generators. For every new freshman there were 4 applicants who visited the college with their parents.

Sixty-five percent of the loans that came due last year and year to date 2012 have not been paid off. Black Monday, when stocks lost 50% of their value happened in 1978. The Savings and Loan crisis happened in 1988. The Resolution Trust Era (RTC) was in 1993-1994. The great recession was in 2008-2009. The year 2007 was the pinnacle year, it will be several years until we return to the 2007 level, maybe 6 to 9 years. We have had the big increase in Rev Par, the next few years will only bring a modest gain of 3% annually. Nobody really knows whats going to happen with this economy. These are very uncertain times. Get your staff rejuvenated and enthusiastic. Get off the OTA’s. National hotel occupancy rate today is 60% it will grow to 63% in two years. Rate growth will have a cumulative gain of 4% over the next two years and then flatten out.

Transaction Temperature
Transactions are back. Supply is still muted and will be for the next several years. Underwriting is still very stringent and painful, although there is plenty of debt capital available at very attractive rates.

PIP’s are a major factor now
PIP’s are forcing a lot of sales. There is still a big difference between ask and bid price, but the gap is narrowing. First half of last year was better than the second half. This year will be the same as things wind down. There are 3 tiers, REIT’s buying the upper tier in major markets. The middle tier $5.0M to $10.0M is the most difficult to finance. The lower tier has all cash buyers and SBA financing. Europe is still a major concern. We have a lack of real job growth. There is a flight to quality. Still a lot of uncertainty.

Who’s Got Money
Interest rates have only one direction to go and that is up. The Marcellus Shale Region located in Ohio, Pennsylvania & West Virginia is the largest known deposit of oil. Hotel values are a function of the National and Local Economy. CMB lending has come back. They along with Life Insurance Companies are making loans of 65% to value, 20 year amortization, 10 year balloon interest rates around 5.0%. The Small Business Administration Lenders (SBA) are making 80% loans to value. Local and Regional Banks are lending at 75% loan to value. Lenders are looking for a 1.4 to 1.5 debt coverage ratio. There is $1.7 Trillion of debt coming due in the next 5 years of which only half will be paid off. Extend and pretend has worked because values have increased over the last 2 years. Equity investors are looking for a 20% return. Construction financing is at 65% of cost primarily for select service product such as Courtyards, Hampton Inn & Suites, Hilton Garden Inns, Homewood Suites, Holiday Inn Expresses, Residence Inns and SpringHill Suites. The new norm for the unemployment rate is 8%. With the low supply growth, the lodging space is out-pacing the economy. The single family housing market is stabilizing. Don’t borrow more than 65%, otherwise you run a huge risk of not being able to refinance the debt when it comes due. Your attitude will determine your altitude.

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