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Is the M&A shopping window for hotel assets closing?

Extended Stay America’s privatization was the sector’s biggest M&A event but rising valuations and market recovery could limit further opportunistic buying.

Real estate investment giants Blackstone and Starwood Capital Group’s persistence with their roughly $6 billion takeover of Extended Stay America fructified earlier this month, resulting in the largest take-private deal within the hospitality sector since the pandemic began in March.

It was an opportunistic deal, given the pools of capital used to fund it. Blackstone’s equity will come from its $20.5 billion Blackstone Real Estate Partners IX, which closed in late 2019. Starwood will tap the Starwood Distressed Opportunity Fund XII Global, which attracted $6.5 billion in the first close in January.

As PERE has analyzed previously, there was no distress element in the deal’s pricing, which ultimately settled at $20.50 per paired share after weeks of negotiations. Moreover, the extended stay sub-segment within the hospitality sector has also been somewhat of an outlier with its standout performance during an otherwise tumultuous year for the sector.

In 2020, US hotels indeed suffered the worst year of operating performance since property services firm CBRE started tracking the space in 1938, but not all segments were equally hard-hit. Extended-stay hotels recorded a 68 percent decline in EBITDA, compared to a drop of 149 percent for convention hotels and 78.3 percent for resort hotels. CBRE noted in the report that extended-stay hotels benefited from a “base of residential guests, vacationers desiring a kitchen, and temporarily relocated medical-related demand.”

“ESA was a very smart transaction,” one US-focused hotels manager told PERE. “Especially when you look at all the cost savings one could do with such a company in a private format, given Blackstone’s historical knowledge of the portfolio and Starwood’s knowledge of the sector. Seeing how well extended stay properties fared last year, it almost presented itself as a truly recession-proof asset class.”

Notwithstanding the specifics of the transaction, however, lodging investors will look to a deal of this magnitude to understand the outlook for future M&A investment opportunities, and valuations, in the overall hospitality sector that is on a robust recovery trajectory.

Gilbert Menna, partner and co-chair of REITs and real estate M&A practice at law firm Goodwin, said he is also aware of some other offers made by private equity firms to public holders of lodging.

“It makes sense in part because lodging has been depressed,” he said. “Once the pandemic is past us, either in US or globally, you can imagine that the value increases and return on invested equity capital will be very high, especially if it can be levered with private equity capital.”

Earlier this week, for example, Condor Hospitality Trust, a hotel-focused REIT, announced it will consider strategic alternatives to “enhance shareholder value.” The firm has engaged Hodges Ward Elliot to market its 15-hotels portfolio, which includes select service, extended stay and limited-service hotels. The REIT had posted cumulative total returns of negative 52.45 percent between February 21, 2020, to June 21, 2020, according to data provided by industry organization NAREIT.

Limited opportunities

But such take-private and other M&A opportunities have been limited so far.

Sean Hehir, chief executive of investment manager Trinity Real Estate Investments, said that even before the pandemic had struck, he was expecting to see a continuation of the consolidation trend among hotel REITs. In late 2018, for example, Pebblebrook Hotel Trust completed its $5.2 billion acquisition of fellow hospitality REIT LaSalle Hotel Properties.

“I would think the opportunity to take private hospitality companies is coming to an end”

Gilbert Menna

But that did not materialize, given how the hospitality sector has started rebounding in recent months.

“While the leisure destination resorts started recovering fast around the spring break in March this year, the valuations of hotel REITs had already started rallying a few months before that. They led the curve, even though they did not have the underlying performance to support those valuations,” he explained. “The question in my mind is whether their valuations are now at a level that would make it difficult for further take-privates or mergers among REITs.”

The 13 lodging/resorts REITs that are included in the FTSE Nareit All Equity REITs index have recorded year-to-date returns of 17.37 percent as of May 28, 2021, compared to 18.08 percent for the entire index. Additionally, their funds from operations, the REIT version of earnings, is also gradually improving. FFO for lodging/resorts was negative $400 million in Q1 2021, compared to negative $521 million in Q4 2020.

“The public market has indicated to you in the past several months that lodging is back,” agreed Menna. “So, I would think the opportunity to take private hospitality companies is coming to an end.”