PREI-Ashford's $400M JV Might Be Sign of Times

[IMGCAP(1)]DALLAS-A $400-million joint venture to provide mezzanine financing for the hospitality sector could be a portent of what lies ahead in 2008. Prudential Real Estate Investors has been eyeing mezz lending as a means to deploy capital since last summer–and it’s probably not the only deep-pocketed player to be doing so.

“It wasn’t so attractive before when there was so much capital out there,” says David Loeb, senior real estate research analyst and managing director for Milwaukee-based Robert W. Baird & Co. “We think this is a trend that we see other companies going into as well.”

The Parsippany, NJ-based PREI is launching its first mezzanine lending program, using Dallas-based Ashford Hospitality Trust Inc. as the quarterback for deal sourcing and capital deployment. PREI is kicking in $300 million and Ashford, $100 million, in a 75-25% split on the return, respectively. There is a two-year window to deploy the first funding round, all in the US.

“As with any successful program, it could be expanded, but we’ll have to wait and see,” James P. Walker, PREI principal, tells GlobeSt.com. “The question is whether we can deploy that $400 million in a way that achieves our return goals.”

Walker says PREI was probing ways to invest in hotels last summer when the team decided mezzanine lending was “less risky and had better return for the risk.” He says PREI’s contacts in the hospitality sector led it to Ashford.

Walker emphasizes it’s not a loan to own program. “As with any mezzanine loan, it has to be a property that, if we had to own it, we would be comfortable owning it at that cost basis,” he explains. “This is merely a program that sees a gap that developed for capitalizing or re-capitalizing hotels and tries to meet that need. We thought there was probably more opportunity and gap in hotel investments than any other sector.”

The JV’s program will fund full-service hotels and resorts in upper-upscale to luxury categories and branded select-service hotels in upscale and mid-scale segments. In the case of a portfolio, it can include a small percentage of extended stay and economy assets.

Walker says Ashford has “keyed up” a number of deals, including several portfolios. On average, he says loans will be $25 million to $50 million or up to $75 million for portfolios. The agreement specifies a 60% to 85% loan-to-value range.

The program will focus on existing hotels, but new developments aren’t being ruled out. Under the agreement, PREI’s equity stake has bought a senior position for each investment. The JV has a first right of refusal, but Ashford isn’t prevented from soloing if it wants.

Ashford has seeded the program with a $21.5-million mezz loan it funded last December for secured interests in the 487-room Westin La Paloma Resort & Spa at 3800 E. Sunrise Dr. in Tucson and 412-key Westin Hilton Head Resort at 2 Grasslawn Ave. in Hilton Head, SC. Ashford has long been a lender for the sector, but scaled back about 18 months ago due to pricing, according to a REIT spokesman. “Pricing is coming back their way. It’s the right time to be in the market,” he says.

The JV will acquire or originate first and second mortgages, stock secured loans, guarantees or preferred equity financing. According to the JV’s press release, terms are three to five years for floating rate vehicles and three to 10 years for fixed rates.

[IMGCAP(2)]Loeb says Ashford had indicated in last year’s earnings calls it was actively looking for joint venture partners. “It never said mezzanine, but this certainly fits,” the Ashford analyst says. “It’s a very attractive return for Ashford. There’s no additional leverage in the JV so there’ll be no debt in this venture.”

Loeb adds it’s essentially a way for Ashford to add assets without taking on additional debt. At one time, Ashford had a similar mezzanine lending program as did Winston Hotels Inc. in North Carolina, which was bought last year by Oak Brook, IL-based Inland American Real Estate Trust.

Loeb, referencing his 2008 hospitality outlook, says the timing is now right to launch a mezzanine lending program because CMBS financing has practically dried up for the sector. “The reality is there is very little capital available to the industry,” he explains. “Ashford is saying our doors are open.”

Loeb believes the PREI-Ashford initiative is the frontrunner for an upcoming trend in the capital markets. “It’s less risky than owning outright,” he says. “And, I would not be surprised to see more life companies and private equity doing more of this, perhaps even some public REITs.”