The hotel acquisition binge: foreign investors swept across Canada in late 2006, spending...

Nobody, not even the most upbeat observer, could have imagined that the record C$1.7 billion worth of single hotel asset and portfolio transactions in Canada in 2005 could be so dramatically eclipsed the following year. [??] But that's just what happened (see Figure 1). [??] And it was done not

only by vastly larger cash transactions, but ones that would also transform ownership structures and possibly management styles of hotels around the world. [??] Easily the most high-profile hotel transaction of 2006, or any recent years for that matter, riveted attention on Toronto-based Four Seasons Hotels Inc. [??] In early November, Redmond, Washington-based Microsoft[R] Corporation Founder and Chairman Bill Gates' Seattle-based Cascade Investment LLC and Saudi Prince Alwaleed bin Talal's Riyadh, Saudi Arabia-based Kingdom Hotels International each offered to buy a 45 percent stake in the super-luxury, 71-hotel global chain, thereby taking it private--for US$3.7 billion. That's cash, and included the chain's debt.

Four Seasons' founder, Isadore Sharp, would hold the other 10 percent and stay on as chairman and chief executive officer. Sharp has announced he won't entertain other offers, and in the absence of any competitive bids the deal is expected to close in early 2007.

The prince, who is photographed in both western business dress and flowing Saudi robe and head dress, has become a prominent--and one might even say exotic--figure in conservative-minded Canadian hotel circles. In May 2006, his Kingdom Hotels and Colony Capital LLC, Los Angeles, paid US$3.3 billion cash for Toronto-based Fairmont Hotels & Resorts Inc., which operates the trophy Royal York Hotel in Toronto; Chateau Laurier in Ottawa; Chateau Frontenac in Quebec City; and Banff Springs Hotel in Banff, Alberta, Canada, among more than 80 luxury hotels around the world.

The Fairmont hotels and Raffles' portfolio owned by Colony Capital will be combined, transforming them into a Toronto-based hospitality colossus with 120 hotels in 23 countries wearing the Fairmont, Raffles, Swissotel and Delta brand names.

More recently, Oxford Properties Corporation, Toronto, the real estate arm of pension-fund manager Ontario Municipal Employees Retirement Board, Toronto, bought seven of those hotels from Fairmont Raffles Holdings, including the Banff hotel and Jasper Park Lodge, also in Alberta, for an estimated US$1.5 billion.

Intrawest Corporation, Vancouver, operating 10 mountain resorts in the United States and Canada, including Blackcomb-Whistler north of Vancouver, was acquired by Fortess Investment Group LLC, New York, for US$1.8 billion.

Hilton Hotels Corporation, Beverly Hills, California, sold five of its hotels in eastern Canada for about C$243 million to Westmont Hospitality Group, Montreal.

Also worth noting, Four Seasons, New York-based Trump International Hotel & Tower and Chevy Chase, Maryland-based Ritz-Carlton Hotel Co. LLC are adding hotel/condo towers in downtown Toronto. Hong Kong-based Shangri-La Hotels and Resorts is building one in Vancouver and plans another in Toronto (see sidebar, "The Rise of Condo/Hotels").

[FIGURE 2 OMITTED]

Out of the doldrums

Talk about a change in business climate. Five years ago, the hotel industry in Canada was in trouble. Room occupancy was in the low 60 percent range, and lower, for revenue per available room (RevPAR).

Niagara Falls, Ontario, has been feverishly building hotels, with two casinos and an international honeymoon capital/tourist destination going for it. There has been a lot of renovation and refurbishment of hotel properties across the country, but not too much else.

However bad it was, it got worse after Sept. 11, 2001. Then the Severe Acute Respiratory Syndrome (SARS) outbreak in 2004 had U.S. leisure and business travel visitors staying away in droves. Mad-cow disease, and now confusion over border-crossing requirements and a perception of lengthy delays, haven't helped.

Today there is really nothing to keep them away any longer, but Americans haven't returned in any appreciable numbers. PKF Consulting Inc., a Toronto-based industry consulting firm, says the numbers of American hotel guests in Canada has sunk to a 26-year low.

Nonetheless, occupancy and RevPAR rates are reviving on the strength of more business travel from abroad and internal Canadian travel, as well as more European tourism and the first waves of what will become an international tourism phenomenon--Chinese tour groups.

Acquisition prices have gone up as well; a 2006 report by Chicago-based Jones Lang Lasalle Hotels noted the average price per "key" (room) in Canada increased from C$65,117 in 2004 to C$101,741 in 2006. Strong hotel industry fundamentals are expected to continue to keep the acquisition momentum going into 2007, the report also noted, "pushing Canada's hotel industry past the recovery phase and into the growth phase." (See Figure 2.)

The report added, "Hotels provided favorable risk-adjusted returns relative to other real estate asset classes, much of which traded at lower initial yields with less potential for upside. While hotel yields have compressed, they remain above medium-term borrowing rates--a clear attraction for investors."

Bill Gates and the Saudi prince aside, who--or what--is stirring up hotel markets in North America like that? Richard Matheson, managing director, RBC Capital Markets, Toronto, says it's coming from "the lending and buy side, private and public investors, Goldman Sachs, Lehman Brothers, CNL Hospitality, Starwood and Marathon Asset Management, for example."

Good upside, good prospects

Matheson, a speaker at the 10th annual Canadian Hotel Investment Conference in Toronto in May, said then, "There is good upside available, good prospects for future growth, and financing rates are still relatively attractive, to get fairly high leverage to improve return on equity." He also attributed the major shift that occurred in the sources of financing between 1990 and 2006 to the consolidation of companies, the disappearance of trust companies and emergence of the commercial mortgage-backed securities (CMBS) market, more global lenders and more competition.

Life companies largely dropped out of the hotel market in the early 1990s because of problem loans, but according to Matheson they are starting to come back to join conduits, banks and U.S.-based lenders interested in that asset class (see Figure 3). Matheson was a speaker at the 10th annual Canadian Hotel Investment Conference in Toronto in May.

Speaking of conduits, a fellow panelist at the conference, Paul Scholz, director, credit and origination, Canada, Merrill Lynch Real Estate Financial Group, Toronto, said more conduits serving the hotel industry in recent years has been good for borrowers because it means more lending diversity and larger loans.

The nature of the investors in Canadian hotels has changed as well. One of the slide presentations at the Toronto conference revealed much wider interest in hotel properties. It showed that 65 percent of hotel property buyers in 1997 were real estate investment trusts (REITs), compared with 7 percent in 2005. Opportunity funds that weren't even on the pie chart in 1997 accounted for 38 percent of the buying activity in 2005; real estate companies similarly turned up for the first time in 2005 for 6 percent and public companies for 4 percent.

Another chart indicated 17 percent of the buyers were from the United States in 1997, which increased to 45 percent in 2005; Canada's share dropped from 74 percent to 48 percent during the same period. The smallest number were international investors, whose share changed little over the period (see Figure 4).

Rather than buy existing hotel product, one U.S. investor decided to build it. Marathon Asset Management LLC, New York, with $7.5 billion in capital under management, is spending more than C$100 million on three hotels in Montreal, two of them near the city's international airport. GE Capital Services Inc., Stamford, Connecticut, is the lender, even though Marathon has its own proprietary capital and is itself an active lender. It also always uses local developer partners.

Jon Halpern, Marathon's managing director and senior portfolio manager, describes the Quebec market as "stabilized, with strong prospects for macro-economic growth," but more to the point says Marathon noticed "a significant amount of hotel obsolescence in the city, an average 30 years old, and whose functionality didn't match up with what consumers want today. There wasn't a lot of new product, particularly near the airport," he says.

"There is a lot of competition, but sometimes there are opportunities right under your nose. Montreal is about 300 miles away [from New York]--not 6,000 or 7,000 miles away in China or India," Halpern says, "and more firms are realizing that depth of opportunity [in Canada] to become part of the market and develop local relationships."

Brian Ricklin, senior director, asset management, Marathon Real Estate Fund, considers the Canadian market "relatively tax-efficient and a very investor-friendly place. There is more equity available as well as cheaper and more available mezzanine lending," he says. Ricklin also cites solid real estate fundamentals and "relatively few regulatory, cultural and geopolitical barriers to U.S. investment."

Still in recovery

Bill Stone, executive managing director, Toronto-based Colliers International Hotels, and co-sponsor of the hotel investment conference with Toronto-based HLT Advisory Inc., agrees there is renewed interest in the Canadian lodging industry. But he also cautions that it is for now a "recovery story" with "some room to grow."

Canadian life insurance companies and pension funds have been part of that recovery, he says, by showing more of an interest in hotel investment. Some of these players include the Caisse de depot et placement du Quebec, Montreal, Canada's largest public pension-fund manager, and Public Sector Pension Investment Board, Ottawa, a Crown corporation managing federal employer and employee contributions.

(Canadian enterprises also invest in U.S. hotel properties; it isn't all one-way. In May, for example, the Caisse and Westmont Hospitality Group, Toronto, acquired Boykin Lodging Co., Cleveland, and its 21 hotels in 13 states for US$416 million.)

While it's true that international hotel mega-deals have dominated the news recently, Lyle Hall, HLT's managing director, says that could change with individual hotel assets being sold in the next few years. And those assets could just as easily go into Canadian hands as foreign hands.

Canadian nationalists are no doubt peeved that most of the country's largest--and for that matter, smallest--hotel chains pass into the hands of U.S. and other foreign ownership. But Hall says the more important issue is "how sophisticated the owners are and what they're buying them for"--regardless of nationality.

"Companies that buy for a specific real estate play are probably in for a much shorter period than someone who is in the hospitality business for a longer period of time. The typical consumer isn't going to see a whole lot of difference in how any of these properties are operated," says Hall.

"From an investment opportunity point of view," he adds, "what we're really seeing is that Canada, despite some of the challenges we're having getting American visitors up here ... is still a pretty attractive destination. So is the economy [for lenders and investors]."

Albert Warson is a Toronto-based freelance writer specializing in real estate development-related subjects. He can be reached at awarson@sympatico.ca.

RELATED ARTICLE: The Rise of Condo/Hotels

New condominium towers are springing up in many North American cities, including conversions from dysfunctional hotels or office buildings. A more recent incarnation is surfacing--five-star condo/hotels, making a glamorous debut in Canada in Toronto and Vancouver, with local developer partners:

* The first five-star Shangri-La Hotels and Resorts project in North America is under construction in downtown Vancouver. The hotel will occupy 15 floors and condos on the upper floors of a 60-story tower, the city's tallest, opening in early 2008. The Hong Kong-based hotel/resort chain's proposal to build one of a similar height and style in downtown Toronto was recently approved.

* The Ritz-Carlton Hotel Co., LLC, Chevy Chase, Maryland, will start construction this year on a C$300 million, 53-story hotel (floors six to 20) and condominium residence in downtown Toronto, with 267 rooms and 135 condominium residences. It, too, is the first Ritz-Carlton combined hotel and condominium residence in Canada.

* Trump International Hotel & Tower, New York, will build a C$550 million, 72-story tower (265 hotel rooms, 109 condos) in downtown Toronto's financial district. Construction is expected to start this year.

These projects represent foreign investors' gift to the city of long-overdue panache to the downtown Toronto hotel landscape, and for that matter the city's larger architectural scene, along with five-star class in a city where the Four Seasons Hotel is the only one with that distinction.

And not to be outdone, Four Seasons Hotels & Resorts' owners (with significant foreign participation) have started construction on a 55-story, 265-room hotel and 125 to 150 condos on a downtown Toronto site two blocks from its flagship hotel.

RELATED ARTICLE: The Gift of Foresight

As it turned out, Toronto-based Colliers International Hotels' outlook for the Canadian hotel market in 2006 was a bit hedged, but correct, when it reported: "The financing market for hotels remained healthy throughout 2005 and, in fact, is at one of its strongest points in the past 15 years, with rising loan-to-value [LTV] ratios and increased flexibility in structuring.

"In addition to Canadian lenders, U.S. and European lenders increased their participation in the Canadian market. Although the pace of activity in 2005 may not be sustainable, we believe hotel investment will remain strong throughout 2006 [it really was] as the lodging sector continues to attract equity, and lodging fundamentals strengthen."

Figure 1 Canadian Hotel Activity

         Volume (C$ millions)

2002       $540
2003       $469
2004       $360
Q1 2005    $771
2005     $1,706
Q1 2006     $81
2006F*   $1,500-$2,000

*2006 is forecasted at C$1.5 billion to C$2 billion
SOURCE: COLLIERS INTERNATIONAL, HLT ADVISORY

Note: Table made from bar graph.

Figure 3 Canadian Fixed-Term Originators Major Players (2006)

Credit Unions -- 15%  C$2.25 billion
Pension Funds -- 17%  C$2.68 billion
Life Company -- 28%   C$4.2 billion
Bank -- 18%           C$2.7 billion
Conduit -- 22%        C$3.3 billion

Conventional Mortgage Financing--C$15 Billion Annually
Note: Fixed-term loans (excluding CMHC)
SOURCE: RBC CAPITAL MARKETS

Note: Table made from pie chart.

Figure 4 Canadian Fixed-Term Originators, 1990 versus 2006

MAJOR PLAYERS -- 1990

                                                        Trust
                                                        Companies &
Pension Funds     Banks     Conduits    Life Companies  Credit Unions

OMERS             RBC                   Great West      Canada Trust
BCIMC             CIBC                  Sun Life        Royal Trust
ICBC              TD                    Manulife        Montreal Trust
Caisse            BMO                   Met Life        Guaranty Trust
TIAA-CREF         BNS                   North American  Van City
                  CitiBank              Canada Life     Surrey Metro
                  JPMorgan              London Life     Caisse Populaire
                                        Mutual Life     First City
                                        New York Life   National Trust
                                        Prudential of   Gentra
                                          America
                                        Prudential of
                                          England
                                        Confederation
                                          Life
                                        Transamerica
                                        Standard Life
                                        Pac Life
                                        Mass Mutual

MAJOR PLAYERS -- 2006

OMERS             TD        First       Sun Life        Van City
                              National
BCIMC             RBC       Merrill     Manulife        Surrey Metro
                              Lynch
ICBC              CIBC      Column      Met Life        Caisse Populaire
Caisse            BNS       GMAC        Great West
Alberta Treasury  CitiBank  GE Canada   Desjardines
TIAA-CREF         JPMorgan  Colliers    Standard Life
                            RBC         Pac Life
                            TD          Mass Mutual

SOURCE: RBC CAPITAL MARKETS