The Real Estate Update
By Michael Dowd (TMF Yorick)

Boston's Meridien Hotel Sold for $300,000 a Room!
What Does That Mean for Hotel Stocks?

Boston, MA (May 30, 1997) -- Yorick's Bar & Grill is a quiet neighborhood place. There are yellowing photographs on the wall of long-dead pols who spent post-election eves with Yorick's grandfather. Some were celebrating their victories, some drowning their sorrows, some already planning their comebacks.

By contrast, the Meridien Bar in Boston's Le Meridien Hotel is one of the most elegant pieces of interior architecture in a city that prides itself on great taste and nice rooms. The best public rooms in the Meridien are in a renovated building that was the former home of the Boston Federal Reserve Bank. It features a magnificent ceiling, and two huge N.C. Wyeth paintings left by The Fed when it departed. One shows Alexander Hamilton, deep in worries about financing the American Revolution, the other shows President Lincoln and his Treasury Secretary Salmon P. Chase worrying about how to fund the Civil War. (1)

There's another difference too. Yorick is staying put tending the bar at his ancestral watering hole, while the Meridien bar (and the hotel that goes with it) has just been sold for an astonishing $96,000,000.

Earlier this month a mild-mannered man who looks a lot like Clark Kent walked into Yorick's Bar and Grill to ask about the just-announced sale of the Meridien. Signaling for his usual, Perrier and soda with a splash of water and a cocktail onion, he quizzed the bartender:

"OK, so did you advise the buyers or the sellers on the rumored Meridien Hotel transaction? At $100 million (+/-), that's apparently just north of $300,000 per room. Excellent from the would-be sellers' perspectives. And, who knows, perhaps not bad from the rumored potential buyers' viewpoint either (Hong Kong's Lo family) -- it is a superb hotel in a great location. But $300,000 per room in Beantown? Hmmm? What do you think about that price vis-a-vis the long-term productivity of any four-star hotel in Boston?"

Yorick got into the hospitality business by tending bar. Give lousy service, you get lousy tips. He swished a clean linen bar rag officiously over the lacquered mahogany before setting down the frosty, slightly effervescent glass.

"First a few comments. For starters, we didn't advise anyone who finally bid. One of our favorite hoteliers did ask us to look at it. Then when we inquired earlier this year, the good folk at Beacon told us they already believed they'd get $300,000 a room. We thought that was an extraordinary price for a hotel that in 1995 achieved 75% occupancy at an average daily rate of $194 or so.

"There's a rough rule of thumb in the hotel business. It says you need an average daily rate (ADR) of $1.00 and a stabilized occupancy approaching 70% to support a value of each $1,000 per room. A 70% occupied hotel with an ADR of $75 is usually thought to be worth $75,000 a room. A better property with an ADR of $100 is thought likely to be worth more like $100,000. At near that price you can generally forecast making a current return on your total investment of around 10%. You can also hope, if room revenues increase faster than operating expenses, to do better than that as years go by. But the Meridien had a reported ADR in 1996 of $210, so that suggested a price closer to $200,000 a room than $300,000.

"We tried to think of other ways our client might make a profit on a higher cost per room but we honestly couldn't. You might pay quite a bit more than $100,000 a room for a $100 a night hotel if you were also acquiring extra land on which you thought you could expand to build more rooms. Last year Richard Rainwater paid over $300,000 a room for the Canyon Ranch resort outside Tucson, but if you factor in double occupancy, the ADR there was more in the $500 a night range. The Canyon Ranch Resort runs closer to 80% occupied, and there is a chance to develop a whole string of similar luxury spas around the world built into that $300,000/room price. The Meridien does not come with those extra goodies.

"You might pay a lot more than $1,000 per $1.00 of ADR if you were buying a world class trophy. The Sultan of Brunei is reportedly into The Beverly Hills Hotel for an all-in cost of well over $1,000,000 a room, but the swimming pool is equipped with scantily clad hot and cold running starlets. The Polo Lounge is the premiere deal-making spot of all moviedom. You can pay a lot for luxury hotels in other places too. We talked to the folks at Nikko when they were putting around $550,000 a room into the Essex House on the wrong end of Manhattan's Central Park South. We figured they'd never get it back out and they probably won't. Another Japanese investor sunk over $1,000,000 a room into building New York's Four Seasons and became really scantily clad. He lost his shirt. But owning the Meridien, nice as it is, doesn't give you the eclat of owning The Beverly Hills Hotel. Besides, our client isn't chasing starlets, he wants to make money.

"You might even pay extra if you believed the hotel was badly managed and you thought a new management or franchise would markedly improve operations. A new buyer had the option of removing the Meridien folk, but in fact the successful purchaser is keeping Meridien as both owner and manager, so we don't see how there's any big play there.

"It fills the zoning envelope, so there's no place to expand it an inch. There are no amenities we can think of that would greatly enhance its marketability, although I do wish they'd bring back Fancy's.

"Fancy's was the world's best luxury lingerie and gift store. It adorned the lobby when the Meridien opened in 1981. It was run by a really stylish and smart lady shopkeeper named Max. One time not long after the opening my friend Suzy-Q was in from LA staying at the Meridien and I wanted to buy her a present so... but I digress... where was I? Oh, yes the Meridien Hotel...

"Anyway, the present owners have already done an incredible job of improving the neighborhood. They knocked down an old ugly city parking garage you wouldn't have gone into at night without an armed guard. They replaced it with a lovely urban park, and constructed one of the city's best office buildings. They even built two clean, modern garages where you can leave your BMW secure in the belief it will be there when you get back. It's become a great location, but it's not going to get much better now.

"The entire Post Office Square complex the Meridien anchors was originally developed by BEACON PROPERTIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BCN)") else Response.Write("(NYSE: BCN)") end if %> principals the Levanthals and Sidmans. They and their partner, GE Investments, were sellers. If anyone in the world could think of an entrepreneurial way to help the hotel's bottom line, we thought Beacon was the most likely. And they have the local clout with politicians to get it done. Heck, I even read Alan Sidman got to sleep in the Lincoln bedroom. (Mr. Levanthal's been such a big Democratic contributor that he asked for a Mint on his pillow the night he stayed over and I hear they put the deed to another Federal Reserve building instead. But never mind.)

"So anyway we advised our client -- a noted hotelier with experience in first class Boston properties -- to take a pass. We were later asked to look at the same hotel by two other first class, entrepreneurial operators. We'd already taken sides, but they independently came to the same conclusion.

"In the end, the hotel was not bought by an experienced, bottom-line-driven, local hotel operator like Roger Saunders (formerly The Boston Park Plaza), Sigi Brauer (formerly the Ritz-Carlton) or Alain Tremain (formerly the Copley Plaza). Nor was it bought by one of the high-flying hotel REITs like PATRIOT AMERICAN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PAH)") else Response.Write("(NYSE: PAH)") end if %>. There was no rumor it was being hotly pursued by STARWOOD LODGING <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HOT)") else Response.Write("(NYSE: HOT)") end if %>, though Starwood had recently bought the Park Plaza Hotel from Roger Saunders, acquiring a large $100 ADR property for about $100,000 a room. There was also no rumor of a serious bid by FELCOR <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FCH)") else Response.Write("(NYSE: FCH)") end if %>, which has just picked up five hotels from IT&T at about a 10% cap rate. Richard Rainwater's aggressive CRESCENT REAL ESTATE EQUITIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CEI)") else Response.Write("(NYSE: CEI)") end if %> was nowhere to be seen.

"Beacon itself did not appear to be intrigued by paying extra money (which it has in buckets) to buy out General Electric Investments' part interest. (Beacon principals owned the rest.) In a recent sale of the most comparable property, Arthur Winn elected to sell only half the ownership of the nearby Bostonian Hotel to a Far Eastern investor, but for whatever reason, Beacon's principals decided that at $300,000 a room they would be sellers of 100% of one of the family jewels. Beacon's landmark development had triggered the movement of the center of Boston's financial community off State Street for the first time since the 1600s. Beacon still holds on tightly to the attached 764,000 SF One Post Office Square office building and garage. Beacon still owns the nearby Boston Harbor Hotel. But even Beacon did not appear to be actively interested in hanging on to the Meridien when they were offered $96,000,000 for its 326 rooms. At $294,487 a room, to be precise, they were sellers.

"The winning bidder paying that extraordinary price was, as you note, Hong Kong's Dr. Lo Kai-shiu, through Romona, California-based Pacific Eagle Holding Ltd., in turn an affiliate of Hong Kong-based Great Eagle Holdings, a real estate development and investment company. What values did Hong Kong's Dr. Kai-shiu see that Boston's Roger Saunders and Sigi Brauer could not see -- or could not use --or were not willing to pay for?

"Well, my welcome customer, let's agree that $300,000 a room is an extraordinary price to pay for a fine but slightly off-location and at best four-star hotel. The Boston Meridien is right smack the financial district, but because the Meridien is not a tourist draw as well, it's not in one of Boston's two prime hotel locations. By contrast, Beacon Properties is keeping the Boston Harbor Hotel, which is nearby but right on the harbor. It's near the financial district for business travelers who dominate the weekday, top-end hotel market in Boston. At the same time, it has harbor views for tourists. The other key location that attracts both high-ticket businessmen and luxury tourists is the Boston Public Gardens, where The Ritz-Carlton and the Four Seasons overlook Boston's famous swan boats.

"Let's take a look at a few basic statistics and see what they tell us... First, please note that the Boston hotel market is booked tighter than the Lincoln bedroom during a DNC fund-raiser. Smith Travel Research says that at an overall occupancy of 69.3% in 1995 Beantown was the 10th tightest market in the U.S. Ranked by ADR, Boston was the third tightest market at $101.73. Combine the two to get revenue per available room (REVPAR) and Boston was again fourth at $70.50. But Boston's REVPAR growth, at 9.4% in 1995, was second only to Honolulu's startling 15.0% increase.

           PRIMARY LOCATION           SECONDARY LOCATION
           HOTELS                     HOTELS 
           Four     Boston   Ritz     Bostonian Meridian
           Seasons  Harbor   Carlton  Hotel     Hotel
Location     A+       A+        A+      B++       B++

1995
ADR ($)      N/A        221      217      191      194
Occ (%)      N/A         72.5     78.6     77.7     75
REVPAR ($)   N/A     58,482   52,255   54,168   53,108

1996
ADR ($)         260     234      223      206      210
Occ (%)          80      80       80       75       72
REVPAR ($)   75,920  68,328   65,116   56,394   55,188

% Increase
ADR ($)      N/A       +5.8%    +2.76%  +6.0%    +7.9%
Occ (%)      N/A       +7.5%    +1.4%   +1.4%    (2.5%)
REVPAR (%)   N/A      +16.8%    +4.60%  +4.1%    +3.9%

Souce: Equity Research Collaborative

"While the Meriden's REVPAR growth is healthy, it is not extraordinary. The total average REVPAR growth for all hotels in the U.S. was 7.7% in 1996. But we and others expect that to decline to the 5%+ range in 1997 and 1998. We note that most of the new supply coming on line is for limited service hotels, so we'd expect the luxury category to do better than average for a while. Still, even in costly Boston, new star full service hotels are beginning to pencil out as REVPAR rises and soon that will dampen rent increases.

"Those REVPAR numbers in bold type on that chart up there are serious numbers. About 70% of a hotel's room revenue hits the bottom line. The other 30% goes for maids, linens and such. If the Four Seasons really gets $20,000 a room more annual REVPAR than the Meriden, then $14,000 or so gets down to net operating income (NOI). If a hotel sells for a conservative 10 times NOI, then a hotel like the Four Seasons is worth $140,000 a room more than the Meridien. If you think a five-star hotel usually justifies a higher multiple than a four-star hotel (and most of us do), then the difference is even greater.

"So from all this we'd draw some conclusions: First, top class Boston hotels are just about full. It is very hard to keep a hotel running much above 80% occupancy on a consistent basis. If a top quality hotel is full on September 10, but empty on Good Friday, then there isn't much that marketing or aggressive pricing, or group and convention sales can do to fill that Good Friday drought. So if there's the slightest weakness in citywide luxury hotel demand -- hot summer weekends for example -- the lead dogs among the luxury hotels get it all and the other guys suffer. You can take it from me, the Four Seasons and the Ritz and the Boston Harbor hotels will always have higher occupancies than the less-well located Bostonian and Meridien.

"Second, management matters. We think the Ritz-Carlton has started off being mismanaged during the HOST MARRIOTT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HMT)") else Response.Write("(NYSE: HMT)") end if %> takeover. The bar's frequently been filthy, the classic dining room totally disorganized, the steaks provided by Marriott's central purchasing have been far below five-star standards, and the service company Marriott brought in to run its garage sometimes couldn't find the customers' Cadillacs and BMWs for an hour. It's also true that the Boston Ritz, which recently celebrated its 75th birthday, has too many old-fashioned small rooms without good views. It does not have the pool and elaborate health spa that is typical of a modern full-service property. In that regard, it is unlike the much more modern Four Seasons just across the Public Gardens. Still, the business/tourist location and the Ritz name can pack 'em in. The Meriden, nice as it is, has neither the location nor the tradition.

"Third, 80% occupancy is effectively close to being 100% full. These best Boston hotels will pretty much have to depend on increasing rates to get more revenue per occupied room (REVPAR). This will not be easy when the AVERAGE reported rate (including groups and clergymen who come in the off-season at reduced rates) is already in the $230 range.

"Fourth, the three best located hotels were able to increase rate AND occupancy simultaneously. At exactly the same time, the less-ideally located Bostonian and the Meridien hotels did succeed in raising their rates, but they paid a price of lower occupancy to do it. The Meridien kicked rates up 8%, but it gave back almost half that in lost occupancy.

"So pardon me for rambling on so," Yorick said to the Clark Kent look-alike who was by now half asleep. "But if I recall your question was: What do you think about that price vis-a-vis the long-term productivity of any four-star hotel in Boston?

"I think it's proof that the best hotels are being priced very fully when they are sold. There's no place left on the Boston Garden where I see a truly luxury hotel getting built, though maybe you can still get one in on the harbor. It will be hard to find any buildable location for a new luxury property to compete with the five-star Four Seasons, and the 4+ star Ritz in both the business and tourist markets.

"The Meridien can't easily correct for that by cutting rates. As the lower-tier good hotels push rates up, they will displace demand to other pretty attractive hotel categories. For a well-off summer weekend visitor with kids, the Doubletree in Cambridge is a lot more accessible than the Meridien or the Bostonian. He doesn't want his kids in a luxury dining room every evening. He probably doesn't want them in the bar at all. He wants easy access, large rooms and a pool. Maybe the Ritz doesn't have to worry too much about that, but the second-tier four-star hotels like the Meridien certainly do.

"I further think that at something near $225 a room ADR, other hotels like the Meridien and the Bostonian will pencil out as justifying new construction. There's an all-suite hotel being considered at Logan airport. Fidelity's John Drew is going ahead with one near the main convention facility. Beacon is considering one near City Hall. These will compete fairly directly for the lower-end four-star business. As a result, I don't believe the Meridien or the Bostonian has quite the upside in room rates that the top class hotels do.

"I wonder whether, if the market had not been looking a bit askance at the price of some recent Beacon office acquisitions, Beacon might not have been a bidder itself. Still, even if that's so, this is another indication that the buyers in the REIT market are micro-inspecting REIT acquisitions. I suspect increased scrutiny of acquisitions will start taking some of the optimism out of higher-flying REIT pricing. Both stock analysts and REIT acquisitions staffs will be doing a lot of pencil sharpening this year. If REIT analysts can also learn to factor the "credit quality" of portfolios into their decision making, then this will be a good thing. If many of the new young REIT analysts continue to believe that development is less risky than buying existing properties, or that it's only worth an extra 50 basis points in risk, then I am pretty sure we'll get another snappy correction in about two years -- maybe less.

"I note that hotel REITs, with all the power of the strongest REVPAR increases in anyone's memory, are the hottest performing REIT sector, up 5.4% YTD at this writing while all REITS were down 2.8%. Non-REIT hotel stocks are up even more, though part of that may be due to that little spat between Bollenbach and HILTON <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HIL)") else Response.Write("(NYSE: HIL)") end if %> vs. Araskog and ITT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ITT)") else Response.Write("(NYSE: ITT)") end if %>. (2)

"But while I think four star REVPAR numbers are going to continue to grow like gangbusters this year, the real lesson from the Meridien sale is that the years of REITs -- or anyone -- buying good properties cheap is gone for this cycle. It's not yet time to pay the piper. There's been no overbuilding yet. But it's surely now a time in every good hotel market nationwide when you have to to pay up to buy good hotels at all. I would think that tightening of the acquisition market will be noticed by the stock markets, and it will be ratcheted fully into stock pricing within two quarters, maybe less.

"I wonder if the hard-headed investors who put Far-Eastern money into the Bostonian and the Meridien would have paid these prices if there were not so much pressure to get money out of Hong Kong.

"Speaking of paying up, Mr. Lan Res, it's closing time now. I'd like to offer you one more on the house and ask you to settle up. Don't rush, but Yorick's is shutting the bar until tomorrow. Thanks for coming by."

Respectfully,

Michael Dowd ([email protected])

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