Interest hot for Canadian hotel properties

Tuesday, May 20th, 2014


Regina’s Hotel Saskatchewan may not have the chateau-style architecture of its sister hotels built across Canada by Canadian Pacific Railway in the late 19th and early 20th centuries, such as the Banff Springs Hotel and the Château Frontenac in Quebec City.

Yet the elegant, 10-storey iconic landmark on Victoria Avenue, completed in 1927, has remained like so many of Canada’s old CPR hotels – a premier destination.

It’s storied reputation played a central part in a Winnipeg-based real estate investment firm’s decision to purchase the 224-guestroom hotel last month for $32.8-million from the U.S.-based chain Radisson Hotels Corp.

“When anybody thinks of Regina and where to stay, it’s always Hotel Saskatchewan,” says Gino Romagnoli, executive vice-president of Temple Hotels Inc., which purchased the hotel. “The price was right. The market was good. All things considered, it was a great deal for us.”

A publicly traded company, Temple has been aggressively snapping up hotels across the country since purchasing its first asset in 2006, the 179-guestroom Temple Gardens Mineral Spa Resort in Moose Jaw, building a portfolio of 27 properties across Canada.

Yet Temple isn’t alone in its interest in Canadian hotels as a potentially profitable investment. Last year was the best year in half a decade for Canada’s hotel real estate sector, a recent report by Colliers International Hotels found.

Transactions in 2013 were double the average of about $1-billion annually for the previous five years with more than 115 hotels changing owners, worth $2.02-billion in total.

“We’re in a pretty strong up-cycle,” says Robin McLuskie, vice-president at Colliers International Hotels. “Last year was third-highest year on record.”

The highest activity on record was in 2006 and 2007 when the volume of deals was worth $2.91-billion and $4.5-billion, respectively.

Yet Ms. McLuskie says last year’s sales are a more promising indicator of the sector’s health than those in 2006 and 2007 when markets were peaking.

“Those two years had two major REITs that went public that dominated the market, so we see 2013 as a much more active year in comparison.”

Like 2006 and 2007, institutional buyers led the way in 2013, accounting for 42 per cent of the volume.

Yet Ms. McLuskie says a host of ideal conditions has attracted a greater diversity of buyers. “There is just a lot of money chasing deals.”

What’s drawing investors such as U.S.-based Starwood Capital Group, which purchased five Westin Hotels in Canada in a $765-million deal with Middle Eastern partners, are a combination of favourable borrowing conditions – low interest rates and creditors willing to lend – and growing revenue per available room (RevPAR).

The Colliers report found RevPAR – a measure of a hotel’s profitability – grew 3.8 per cent in 2013, higher than the 10-year average of 2.9 per cent.

Growth in the West was the strongest at 5.4 per cent, with eight markets experiencing double-digit growth led by northwest Calgary at 18.4 per cent growth over the previous year.

The upward trend is expected to continue in 2014 with RevPAR forecast to grow by 4.1 per cent, the report states.

A large draw for investors is the attractive yields. Capitalization rates for hotels involved in the transactions last year averaged about 8.4 per cent. Although rates have experienced compression since 2008-09 down from about 10 to 12 per cent, the yield is still higher than other commercial real estate sectors. A late 2013 report by Avison Young shows capitalization rates for other sectors at less than 6.5 per cent on average, and they’re compressing, too.

While capitalization rates have compressed in the hotel sector over the past few years, Mr. Romagnoli says Temple is still able to find high-yielding investments such as the Hotel Saskatchewan, which had an 11.5-per-cent capitalization rate at the time of purchase. Unlike most other provinces, no hotels changed hands in Saskatchewan in 2013, according to the Colliers report. Often overlooked by investors, Temple sees Saskatchewan as fertile ground for good deals.

“We typically go in with a 10-per-cent cap rate, so the Hotel Saskatchewan is definitely better than average,” Mr. Romagnoli says, adding Temple will invest about $6-million over three years to upgrade guestrooms, the dining room, lounge, meeting space and lobby.

“The Hotel Saskatchewan has good bones so it’s really cosmetic-type renovations.”

Mr. Romagnoli says assets requiring larger injections of capital are less attractive because additional costs eat into the investments’ higher yields, which compensate investors for the higher risks associated with this sector of real estate.

Yet the high yields relative to other sectors are traditionally a function of the risk involved in hotel ownership.

“Hotels are viewed as essentially having to find a new tenant 365 days a year as opposed to commercial property where you’ve got five- or 10-year leases,” he says, adding they are also more sensitive to the economy than other sectors because business travel and vacations are often the first casualties of a downturn.

Additional risks aside, real estate investors, who traditionally have not invested in hotels, now find the sector attractive, Ms. McLuskie says.

“Because the yields on other real estate classes are so low and competitive, they’re seeing opportunities in hotels, which have higher cap rates.”

Among them is Morguard Corp., a Toronto-based, diversified real estate firm, which purchased five hotels, all Marriott properties in the Greater Toronto Area, in 2013 for $70.5-million.

“Our attraction to hotels was price and value,” says Rai Sahi, chairman and chief executive officer of Morguard, adding hotels are a new asset class for the company.

“We have experience with furnished suites at several of our apartments in our residential portfolio and see this as a natural extension to create synergies.”

Until its purchase last year, Morguard owned one other hotel property purchased in 2012. Valued at roughly $100-million, its hotel portfolio makes up a small portion of its $15.1-billion in assets. Like other investors, Morguard will continue seeking opportunities in the sector, Mr. Sahi says.

Because of continuing interest, Colliers forecasts 2014 will be another strong year for hotels, estimating the volume of transactions between $1.25-billion and $1.75-billion. “It won’t be a frenzy – more of a balanced market where we expect to see good activity,” Ms. McLuskie says.

While increased interest will compress capitalization rates further, good for existing owners but not for buyers, Mr. Romagnoli says the sector is not yet as competitive as other real estate markets.

“We’re not encountering a heck of a lot of competition to be honest,” he says.

“It’s also why the cap rates are high – a factor of supply and demand – because if there was more competition for product, we’d see price compression.”

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