Investors say it's a good time to buy hotels. According to a recent survey, "buy" is the prevailing investment strategy for the next six months, with the proportion of buyers to sellers increasing slightly upward to almost 5:1.

Prior to the credit crunch, buyers were aggressively bidding up hotel acquisitions due to their ability to obtain low debt rates at historically high leverage levels. As debt returns to more normalized terms, sellers are likely to re-evaluate their portfolios to maximize operational revenue, while buyers will initiate a flight to quality.

The high cost of construction and land has kept the supply of rooms in check but investors' intentions to build have increased steadily over the last twelve months. The optimistic outlook for hotel operating performance over the next six, twelve and eighteen months has moderated somewhat due to uncertainties in the finance market and the U.S. economy in general.

38% of the U.S. select service hotel investors surveyed intend to buy over the next six months, while 31% of investors indicated a hold strategy - a shift from the previously dominant hold strategy indicated six months ago. The number of investors intending to sell assets (8%) remained constant from our previous survey.

With the ratio of buyers to sellers at nearly 5:1, this remains an opportunistic time for sellers. Buyers are seeing some relief in the steady pricing increases for hotels, following four years of unprecedented, record setting sales volume, while sellers will still enjoy an active bidding process among multiple buyers. Strong institutional demand for hotel acquisitions from REITs, TICs, investment funds and a growing number of international sources remains. Due to their need to deploy significant capital, these groups are targeting select service portfolio acquisitions. Sellers looking to take advantage of the current market are conducting internal valuation exercises aimed at identifying which assets in their holdings can be marketed as a portfolio transaction to attract these institutional buyer groups.

If hotel fundamentals unexpectedly decline or the debt markets experience another adjustment, it's possible that the market would see a downturn in the number of buyers, which would impact sales prices.

Between July 2003 and January 2007, demand for hotel rooms increased at a greater pace than supply1. This imbalance over the last four years contributed to the increase in investors' build strategy, which lifted from 18% to 23% in the last year. It is also reflective of the hotel market cycle nearing its peak in which construction starts to increase and ADR and occupancy rate increase moderates.

Interestingly, 36% of investors indicated that they plan to construct a new property in the next 12 months, while 48% of investors intend to acquire existing assets.

In general, the majority of lending institutions, banks, and insurance companies continue to provide loans to fund hospitality related projects, but these lenders have reverted to more The change in the hotel room development pipeline for year-to-date September 2007 compared to the same period in 2006 supports the survey's findings of owners' increased intention to build2. The number of rooms under construction has increased by 20.1%; rooms in pre-planning have increased by 70.2%; in total, the rooms in the active development pipeline has increased by 14.9%.

Overall, the current finance market is placing a greater emphasis on a flight to quality, meaning that having solid sponsorship, a well positioned property in a major market and an affiliation with a top flag is more important than ever. Overall loan leverage has reverted to a more conservative level with increased debt service coverage ratios being tested against actual versus pro-forma projections.

The construction lending market remains active due to a number of large balance sheet lenders with capacity to help fund new development. In general, the lenders with capacity to fund such transactions are quickly filling their pipeline for Q1 2008 and continue to be selective on which projects to back. Lenders report they currently prefer to fund projects in larger markets and with higher-end flags.

Survey respondents indicated that the overall value of hotels, in general, has been negatively impacted due to current finance market conditions. This impact has resulted in a slight upward adjustment for going in cap rates. In general, however, the investment market-- including both buyers and sellers--has recognized this shift and adjusted expectations accordingly with limited impact on transaction volume. Nearly two thirds of investors reported that the overall value of the hotel market has been somewhat negatively or negatively affected with only 2% of investors responding that the current credit market condition affected them positively.

In contrast to the first half of 2007, in which the flexible lending environment pushed overall cap rates downward and value of assets upward; the current market is realizing the overall value of hotels has been somewhat negatively affected by the availability and cost of arranging new financing. On the other hand, long-term holders have continued to benefit from the significant appreciation of real estate due to the healthy fundamentals which helped elevate revenues and increase property NOIs over the past several years.

Mid-market hotels remain the most popular segment for investment (39%), closely followed by upper mid-market (38%), according to survey respondents. This represents a gradual but notable change of investor preferences within select service hotel segments. Investors attracted to mid-market segments decreased from 48% last year to 39%.

On the other hand, the number of investors looking to acquire in the upper mid-market segment has increased from 32% in the December 2006 survey to 38% in the current survey. In total, 77% of investors were attracted by the higher margin levels they obtain from operating these mid-market and upper mid-market hotels. These brands tend to be less capital and labor intensive, while at the same time, are able to draw high levels of guest retention during various economic cycles.

As of year-to-date September 2007, the average RevPAR achieved for mid-market brands was $59.00. For the same period, RevPAR for upper mid-market hotels was $84.00 which is 42.3% higher than that for mid-market brands3. Increased revenue translates to a stronger bottom line for investors as both mid-market and upper mid-market hotels achieve high operating/profitability yields.

Investors' desire for extended-stay product shows a marginal but steady increase from 11% to 14% over the last year. This can be attributed to an efficient business model that includes an average 14-night stay, lower labor costs due to limited amenities and housekeeping, ultimately resulting in higher profit margins. Additionally, there is still a tremendous growth opportunity as only half of the top MSAs nationwide have extended-stay assets, and the segment comprises less than 6% to 7% of the total select service hotel room count.

The Southeastern U.S. region remains the most sought after region for select service investment, with 35% of investors expressing an intention to buy and/or develop in this region within the next six months.

The Southwest and Mid-Atlantic regions are equally popular amongst investors with 15% targeting each region respectively and another 12% of investors targeting the Midwest. California (9.6%), the Northeast (8.6%), and Northwest (4.3%) represent the remaining portion of investors' target regions.

A smaller portion of select service investors are interested in the Northeast and California. This is largely attributable to the high barriers of entry related to the cost of acquisition and development and stringent approval and development requirements in these regions, making larger investments more economically
attractive.

The median hold period for select service hotel assets remains five years. The average holding period decreased from 70 months to 61 months since the last survey. Investors' expected term to reach required rate of return decreased, which can be directly attributed to increased operating performance and the steady rise in hotel values achieved during 2006 and the first half of 2007.

While varying among asset type and by investor, the application of room revenue multipliers is still a popular method for valuing select service hotels. On average, investors are targeting room revenue multiples of 3.1x. Investors are still willing to pay a "going in" premium with confidence in the market fundamentals and their ability to improve upon historical profit levels.

Investors are targeting a 9.3% capitalization rate on average when acquiring select service assets. The lower capitalization rate reflects the targeted acquisition of premium branded properties in high barrier-to-entry markets. The median for leveraged IRR was 20.8%, an 80 basis point increase from the previous survey, which can be attributed to lower LTV requirements as well as the increased cost of debt. Investors are seeking leveraged assets with a median initial LTV of 70% of the purchase price.

Investor expectations for hotel operating performance to increase during the next six months remains positive at 57%, even though that expectation has declined from 72.1% in the June 2007 survey. Looking further into the future, the majority of investors (54%) anticipate an increase in hotel operating performance for the next 12 months. The general expectation that hotel operating performance would increase showed only a minor change - from 48% to 46% for the next 18 months. However, in the next 24 months, there is an upturn in expectations with 54% expecting an increase in performance, up from just 38.7% in June 2007.

Uncertainty with the finance market and the growth of the U.S. economy overall contributed to a slight softening of the optimistic results of the previous survey. Some investors seem to believe that the hotel market cycle is nearing its peak and, as a result, ADR and occupancy rate increases will moderate. Investors have a more optimistic outlook for the next 24 months than was expressed in June 2007, suggesting that market fundamentals will recover within two years.