Stamford, CT RockBridge Capital LLC Davidson Hotel Co Crescent Hotels & Resorts Carlyle Group

In Dallas, a local firm, Aimbridge Hospitality, has teamed up with New York City-based GoldenTree InSite Partners and JF Capital Advisors. The trio plan to acquire $500 million of value-added hotel assets over the next two years. Although there are no hard numbers tracking such deals, industry players agree that the number of JVs formed to acquire hotels is increasing.

Deborah Friedland, director of hospitality consulting services for the Schonbraun McCann Group in New York City and Roseland, NJ, says the number of JVs coming across her desk is definitely rising. "In 2007, my practice has had a much busier quarter than Q1 2006. Another difference is that these have all been JV deals," she says.

The attraction for such JVs is clear. Hotels are still considered a lucrative asset class, despite rumblings the market cycle may be peaking. "There are more non traditional investors entering now than before," she says. These equity investors, because they lack the industry-specific knowledge, need to partner with an operating company that knows the industry, knows how to reposition a property if necessary, and more fundamentally, can source a good deal. "It can be a nice marriage," she adds.

Particularly in this environment--where assets are priced to perfection as the saying goes--industry expertise is crucial, says Jere Lucey, executive vice president, capital markets at Jones Lang LaSalle. "It is why you are seeing more JVs. Financial partners realize it is not just about passively owning and operating assets. It is about owning an asset where value can be created through a repositioning or taking advantage of compression in an improving market."

Lucey tells of one client that improved NOI by 90.3% from the prior year through aggressive yield management. Simplified examples of such strategies range from using the Internet to selling surplus rooms at the last minute--but at very high prices to business travelers that absolutely have to have a room in a city on a certain night--to increasing rates during conventions, he says. Tighter management of food and other services in the hotel is another example.

The upshot of this growing demand for hotel expertise is that threshold returns in JV structures are falling to favor the operators, says Mark Gordon, a principal with Sonnenblick Goldman in New York. A typical partnership between an equity partner and operating partner would be a waterfall structure in which the equity investor would get a pari passu return alongside the operating partner up until a certain threshold return level. After that, the returns are adjusted based on a perceived risk of the investment in favor of the operator.

"An operating partner's knowledge becomes part of the asset and it needs to be rewarded for its expertise," Gordon says. "There are a limited number of investors that have that level of knowledge and experience."

Over the past 24 months, threshold return levels have been dropping by several hundred basis points, he reports. Now the typical threshold return for a stable asset is in the 10% to 12% range. For a transitional asset, it is 12% to 15%.

Gordon predicts those numbers will continue to drop as the fundamentals in this asset category are expected to remain strong for the near future. "It is hard to generalize because each deal is unique--more so for hotels than other asset classes--but I think there is room for threshold returns to fall another 150 basis points."

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