End of a REIT wave
l November 1997 Starwood buys ITT Sheraton for $14b (£8.65b)
l January 1998 Patriot American buys Arcadian for £92m
l March 1998 Bass buys Inter-Continental Hotels & Resorts for £1.78b
l May 1998 Blackstone buys Savoy Group for £520m
An invasion of Europe by US hotel giants is still happening by stealth and careful planning, despite having obstacles strewn in their path. Last year the pace was a gallop, as real estate investment trusts, or REITs, made best use of a tax loophole to fund an acquisition spree where money was no object. Now, thanks to the US Congress and a closing of the loophole, buying has slowed to a trot, but the pressure is still very real and the competition for properties continues apace.
In 1997 and early 1998 hotel groups in the USA were being bought at an astounding rate by REITs such as Patriot American and Starwood. It looked like every small hotel group in Europe would be swallowed up.
Starwood whipped ITT Sheraton from under the nose of fuming Hilton Hotels boss Stephen Bollenbach, having already acquired Westin. Then Patriot American bought Arcadian International and Malmaison in the UK for £92m and announced plans to open Malmaisons in capital cities across Europe. But then the REIT bubble burst.
REITs had a special tax status in the USA which allowed them to avoid paying corporate tax provided 95% or more of their taxable earnings were distributed to shareholders in the form of dividends. Normal REITs are property owners that collect rent, and their tax status prevents them from operating the businesses that are run from their properties. But the likes of Starwood and Patriot had paired-share status, which allowed them to act as landlord and operator. Effectively, they are two separate companies whose shares are traded in tandem, hence the term paired-share.
The paired-share status allows the operating company to avoid most federal taxes by passing the majority of the profits to the REIT in the form of rents or mortgage payments. The preferential tax structure meant share prices rocketed, and the likes of Patriot and Starwood were able to outflank other players by offering more money in key deals over the past two years.
It didn't take long for big guns Bill Marriott and Bollenbach to complain to the US Congress over the "unfair" tax loophole allowing their competitors to get away from them, and the law was changed last year. Whereas before the tax changes REITs had been able to raise money for acquisitions by issuing more shares, following the change in legislation their share prices slipped, leaving them with growing problems over finding cash. As the majority of their profits go to shareholders every year, profits cannot be used for acquistions. So when the tax advantage disappeared, the REITs appeared to be in difficulties.
Andries de Vaal, a director at Deloitte Consulting, says the main reason for the shooting to prominence of the REITs was "their ability to get cheap money. They could afford to pay high prices," he observes.
"The tax advantages were taken away from them and the playing field is level again. For a long while it looked like they had bought everything in the US and now they were coming to Europe," says de Vaal.
But despite the lack of cash, de Vaal believes consolidation is inevitable. "Someone will pick up the ball," he says.
With most of the main companies in the USA now part of a major player, Europe is a natural expansion target for the US chains.
Starwood appears to have recovered from the blow, changing its status to a tax-paying corporation. "Starwood has now moved on. It has been through the pain and come out the other end," says one analyst.
Cause for speculation
However, for Patriot, the period of change has not ended so neatly. It has decided to drop its REIT status and rename itself Wyndham, formerly one of its brands. Patriot creator and chief executive Paul Nussbaum has quit the leading role and Apollo Real Estate Investors has ridden to the rescue, taking a 29% stake and investing $1b (£618m). Wyndham says it will sell off several properties that do not fit in with its future plans. This has caused speculation about the future of Arcadian and Malmaison hotels. One suggestion is a management buyout, but Arcadian is saying nothing.
While Patriot may be retrenching and streamlining its portfolio, other players are still on the acquisition trail.
Blackstone, which engineered the deal to buy the Savoy Group from the Wontner family for £520m last year, is still interested in finding properties to add to its portfolio.
"Most of the transactions done a year ago were being done by Patriot and Starwood and Bass," says John Kukral, senior managing director at Blackstone and Blackstone Real Estate.
Although there is still interest in new purchases, there isn't the same large pool of capital around to do it with, he says. Each buyer is looking for the same thing: hotels in the right location with potential at the right price.
Most observers said the prices paid for the Savoy Group and Arcadian were exorbitant. With the end of the REITs' special status prices dropped 20-30%, according to Kukral, but now they are moving upwards once more.
"Prices have firmed up. There hasn't been that much for sale. Any upswing brings new sellers out of the shadows," he says.
There is also a realisation that it has to be the right hotel for the right buyer. "So much of the value is in the real estate. There's only a handful of hotels that really work, and generally those don't come on the market very often," he says.
When they do, he hopes Blackstone will be there. "In the last 12 months we have contacted every logical real-estate owner which would have fitted with the Savoy," he says.
The result of this searching should be an announcement in the summer about the addition of a new European property to Blackstone's portfolio.
Away from the REITs, the big boys of the US hotel industry, such as Marriott and Radisson, are still lining up in Europe.
Others are playing a tactical game. Choice Hotels Europe, with the master franchise from the third-biggest hotel group in the world in its pocket, is expanding in Spain and Germany without having to go down the acquisition route. Hyatt International is managing hotels and moving into new countries, for example with its first Greek property, the Hyatt Regency Thessaloniki.
Radisson SAS, the European franchise holder for Radisson Hotels Worldwide, now has 113 hotels in 34 countries. In 1998 it added hotels in 12 European countries.
Already there are three hotel groups with US connections in the UK top 10: Choice; Whitbread, with its franchise agreement with Marriott; and Bass Hotels, which has its roots in the USA and its base in Europe.
And it is not only the US giants that are circling. The reboosted Ladbroke, with Stakis incorporated and David Michels heading the hotels operation, will undoubtedly have expansion ambitions. Smaller hotel operators still have plenty of giants to worry about. As Peter Catesby, chief executive of Swallow Hotels, says cautiously: "There is still a lot to happen." n
Next week: David Michels interview
