March 1, 2010 - View From The Top - Industry leaders offer opinions on trends, issues and opportunities, as well as forecasts for the months ahead.

By HOTELS

There remains trepidation and a wide range of opinions about the state of hotel industry affairs. Some of the more optimistic industry leaders say the industry is in recovery mode-even in the luxury segment-and opportunities to drive rate are finally right around the corner. Still others continue to point to a potential bubble in China, weak real estate prices and the continued threat of terrorism as hindrances to the onset of any profound rebound in hospitality sectors.

To keep the dialogue fresh, HOTELS' Investment Outlook sent questions to top hotel executives in Europe, where finance issues have recently become more acute. On the following pages, read what Orient-Express Hotels CEO Paul White, Jumeirah Group Executive Chairman Gerald Lawless, Avington Financial Chairman David Mongeau and Meridia Capital Chairman and CEO Javier Faus had to say in late January about subjects ranging from M&A and managing costs to the evolving needs of their guests.

HIO: Do you now see this moment in time as the right moment to dive in and buy assets?

WHITE: There are some interesting opportunities around, but we remain cautious on the general market outlook, so you won't see us diving in as such-more dipping our toes into the water.

The hotels we recently acquired in Sicily represented an excellent opportunity to expand our Italian portfolio into an increasingly popular part of the country, in an excellent financial deal. Hotels like Grand Hotel Timeo and its sister hotel, Villa Sant'Andrea, don't come onto the market often. It is a perfect fit with our investment criteria-the iconic status of the Grand Hotel Timeo; the location of the properties not only in Sicily, one of Italy's fast growing tourist destinations, but in Taormina itself; financial upside; and barriers to entry for new competitors.

These two great properties traded well below their potential and at RevPAR, some 70% below our existing Italian assets. The share offering helped us to finance the cash element of the deal but also gave us additional funds for general corporate purposes, including the long-awaited renovations at Hotel Ritz Madrid.

FAUS: Yes, we believe now is a good time to buy hotels. We are not property traders, and over time we focus on adding value to our hotels through very thorough asset management. But we are in a cyclical industry, and not trying to play the cycle would be foolish for us. Trading performance has always come back, and it will be no different this time.

Now, the issue is: How low should we buy? This is extremely difficult to answer. Our rule is to keep buying prime assets in gateway cities in Latin America and Europe at a 35% to 40% discount over replacement value. Even with such discounts, yields might look low if we take trailing 12-month figures. However, given that we focus on long-term appreciation, that we still have access to reasonable debt financing and that we are not a public company, we are moderately optimistic about delivering the returns that our shareholders expect.

HIO: Is there money available to develop hotels? If so, where and with whom can you source debt and equity?

LAWLESS: Our pipeline of new developments has continued to expand in spite of the recession. Including the 11 hotels we are operating today, we have more than 40 management agreements in place, and we expect to reach our target of 60 hotels either under agreement, in development or in operation in 2012.

Funding appears to be available for well thought-out quality developments and, as a hotel management company, we have had particularly positive results from China and high-end tourism destinations such as the Maldives. We also receive many inquiries from investors, owners and developers in the Caribbean and in South America.

WHITE: As you saw from our recent offering, which was more than four times oversubscribed and priced at no discount, there is an appetite for the right deals. Potential investors have to like the story and see the potential return. We have done well in the public markets in the last couple of years. Private equity appears quite quiet at the moment, and sovereign wealth possibly has too many suitors in the current climate.

FAUS: Financing development deals is an extremely complicated task these days; that does not mean impossible, though. In our Paris property [announced W project], we managed to secure financing with three Spanish financial institutions that were comforted by the fact that the asset is well located, in a key European capital city, with a top hotel brand, an excellent retailer and with a quality sponsor.

Over the last six months we have also seen quite a few examples of the public markets injecting capital into the sector-Hyatt's IPO, for instance-as well as several new industry-specific equity funds being created to invest in hotels. The dynamics of sovereign wealth funds have also changed over the last two to three years. These are increasingly professional/institutional and much more selective. They scrutinize deals more thoroughly, which we view as a very good thing. Although money in the sector is obviously not as readily available as before, it is there for quality projects.

WHITE: We see limited interest in greenfield development projects at this time. Debt providers and institutional equity currently focus on existing properties with repositioning or conversion opportunities.

HIO: Do hotel companies need to reinvent their business models to secure their pipelines? If so, how? How much damage has been done to pipelines?

MONGEAU: Almost by definition, a development pipeline-and any individual hotel's development-is in a constant state of flux until formal opening.

The financial crisis has amplified these risks and perhaps done as much damage to the management companies' credibility as to their pipeline. Hopefully, this will cause everyone to be more circumspect about when they announce a "new hotel development."

In other industries, such as oil and gas, accepted standards such as 'proven and probable' impose a discipline on these types of announcements. For hotel developments, availability of financing is a fundamental condition-always has been and always will be. If everyone was a bit more mindful of this, the aggressive pipeline statements might be put in perspective.

WHITE: Reinvent is probably too strong, as at the end of the day, the hotel business is a relatively stable business model. The balance of power between owner and operators continues to move, and it is our view this trend will continue, with owners' demands becoming more specific as they have a greater understanding of the industry.

FAUS: Rather than how much damage has been done to pipelines, perhaps the question should be how much damage have pipelines done to the industry. Easy financing and brands eager to expand led to a spur of development deals worldwide that was heading in the wrong direction. I mentioned before that owners should deploy more equity and accept more modest returns. By the same token, operators should learn to live with lower pipeline figures and with a more balanced sharing of risks. It is easy to say, but difficult to implement-especially for public companies scrutinized on a quarterly basis.

HIO: What are you doing to best manage costs and grow revenue?

WHITE: There are always opportunities to reduce costs; the secret is ensuring that they do not impact negatively on the customer experience and maintaining the savings once the initial crisis has passed. Our team has excelled in the art of managing costs, but the challenge now is to build revenue. We are pretty creative about offers to entice our guests to travel or return, but it is never enough. Like everyone else, we need to get better.

FAUS: Owners need to be more conservative on their financing, deploy more equity and expect lower returns in an industry that continues to be long-term. Brands need to understand that risks should be better shared with owners. And banks will force some changes in management contracts and in owner-operator relationships.

Brands have been good at cutting costs aggressively at a corporate level. What is interesting to see is that they can do the same now with 30% to 40% fewer staff. The goal for brands is to transfer those same efficiencies to the hotels' back office. Without affecting service or brand standards, hotels can be run more efficiently.

Being more specific, several actions can be taken: Make sure that you have the best GM (a poor GM is a bad business regardless of the brand); protect your existing customer base as much as you look for new business; if your cash flow allows you, keep investing in marketing and in regular capital expenditure-in essence, be prepared for when the cycle turns and challenge your operator with best practices from other brands. In this cycle, we have managed to understand pretty well with which operators we wish to keep doing deals when the climate changes and which operators for which we have had enough.

LAWLESS: Our commitment to quality is essential with regard to maintaining our loyal customer base. We have insisted on maintaining our employee-to-guest ratio in the guest service areas. The areas in which we have introduced initiatives to manage our costs include the introduction of energy conservation measures, which is particularly important in Dubai, and the intelligent recycling of water. For example, we continue to source innovative solutions on both fronts with engineering and energy companies and have a number of pilot schemes in place to operate in a way that is both environmentally and economically smart.

MONGEAU: Avingstone's business model is to have our asset managers work cooperatively with brand managers and, hopefully, allow everyone to benefit from our investors' previous experiences with multiple brands, particularly with repositioning F&B operations as an aid to drive RevPAR enhancements.

HIO: Have market conditions put an end to brand proliferation?

WHITE: It may have put an end to the sort of new brand launches which have not been fully thought through. Guests know what they like and what they are willing to pay for. Generally, that is about the kind of experience they want from their hotel, and while there will always be gaps in the market for innovation to fill, I think the marketplace got a bit crowded for a while and customers couldn't see a tangible difference in some cases.

FAUS: A break, rather than an end, perhaps. The market was growing so rapidly that it was difficult to keep up with the large number of new brands invading the market. Guests had virtually no time to digest and differentiate the numerous new names in every segment of the hotel marketplace. In difficult times like these, we at Meridia have decided to bet and invest in existing strong brands, rather than in new ones. Globalization, the Internet and the online travel agents will also favor the strongest players.

MONGEAU: Not market conditions, in and of themselves, but when taken in conjunction with increasing customer 'brand fatigue,' perhaps we will see hotel companies return to a focus on core brands and strengths.

HIO: How is product adapting at the luxury level given the "new frugalness" of consumers?

MONGEAU: We are always careful to distinguish between 'false economies' and 'true value,' especially at the luxury level where we are focused. Elimination of frivolous amenities and services is obvious and should never have been allowed to creep in.

Today, for corporate executives on increasingly compressed travel and meeting schedules, true value lies in the enhanced efficiency that they obtain from a properly run, conveniently located luxury hotel, with concierge, business centers, 24-hour roomservice and other important services. They don't view this as 'luxury,' but rather as essential to their business performance as their BlackBerry is.

Similarly, for the luxury leisure traveler, if the pressures of business and the economy mean that they can vacation less, they want to ensure they have the best leisure experience possible when they do. Rarely is this a question of frugalness; it is almost always about the quality of the experience.

LAWLESS: Demand for luxury will continue, but we recognize that the needs of the market are evolving. Especially in the leisure sector, guests are looking to enhance their overall well-being and life skills when on vacation. One of the ways we are responding to this new need is to offer opportunities to connect with the local culture. For example, we offer guests Arabic cooking classes at the facilities of the Emirates Academy of Hospitality Management; insights into crafts, arts and other cultural activities in the local community; and we engage them directly in some of our corporate social responsibility programs. This allows them to enjoy luxury, but without the guilt.

WHITE: It is no longer about wealth or bling. Now it is about how our guests live their lives. It is about authenticity, elegance and understatement and attentive personal service. It is all about knowing your guests and understanding what they want.

FAUS: Don't be wrong. Regardless of what you call frugalness, luxury guests still demand a perfect product at the room level. In our view, what are not needed anymore are those lavish and overly expensive public and restaurant areas. Great personalized service is much more relevant than chandeliers, and that is where a good or bad GM/brand can make a huge difference.

HIO: What are you doing to best position yourself for a pending upturn?

MONGEAU: We are making sure that we factor in extra capital expenditure, to be deployed immediately, in any acquisition we are reviewing so that we can ensure that the hotel will be in the best possible physical condition as the cycle upturns.

WHITE: We have been working to position ourselves for the upturn for a good 18 months now. Initially it was about cutting costs, paying down debt by raising funds, disposing of non-core assets and selling developed real estate. The last two still apply, and you will see us continue to make progress in those areas, but now we are back to a strong focus on revenue generation.

FAUS: We are still in a buying mood but, as stated earlier, we will only consider prime urban assets with an important discount over replacement value. On our existing portfolio, we keep investing in all properties. Our four hotels in Latin America have either been partially redone or will go through some type of redo over the next 12 months. We are adding new F&B concepts, creating buzz in the hotels' lobbies, etc. They will all be ready to fight for business when the cycle turns. We have always been of the opinion that money should be on the field. But that as far as operators understand that, they need to be extremely efficient at the back of the house and with matters that do not affect brand specs and service.

LAWLESS: Jumeirah is very active in the development field, and we are continuing to build our development teams in Asia and the Americas. All the feedback from the market tells us that the Jumeirah brand is in high demand as a luxury hoteloperator, having established our credibility through the management of our hotels in London, New York and Dubai. We also look forward to the imminent opening of Jumeirah Frankfurt in October 2010 and Jumeirah Messilah Beach in Kuwait, as well as Jumeirah Hantang Xintiandi in Shanghai later this year.

HIO: Talk about some recent surprises in development and performance.

MONGEAU: On the development side: the sudden lack of interest in Caribbean resort developments/residential. On the performance side: the strength of the London and Paris markets.

WHITE: I prefer not to have surprises. The recovery in demand from the U.S. in the second half of 2009 was a highlight, as was the purchase of our properties in Sicily. We have also been delighted to be able to sell non-core assets at 20-times EBITDA.

FAUS: The Crowne Plaza in Santiago has been a fantastic experience for us. It is an old hotel, which is not located in the heart of the new Santiago. However, thanks to a full redo last year and to extremely focused management, it has outperformed the market the last three years. In a very challenging environment, NOI in 2009 closed higher than in 2007.

As a negative surprise, we are facing a rather painful development process in Paris. Honestly, we never thought that the city would be so challenging. The project is extremely demanding, very slow and time-consuming. It requires a lot at every level. We are putting a great deal of effort into it to ensure it becomes a true success. Having said that, I can only add that looking forward, it is a major deal that we are all very excited about. Now we understand that once you have a prime hotel and retail asset up and running in the center of Paris, you have a jewel for life.

HIO: When will real estate hit bottom?

FAUS: We believe 2010 will see the bottom of the cycle.

LAWLESS: I believe that the real estate sector has already bottomed out, and I expect activity in hotel transactions to start turning around by the end of 2010.

MONGEAU: It varies by market segment and jurisdiction. Some say that London's luxury hotel real estate merely stopped increasing for a brief period.

WHITE: Pass me your crystal ball.

HIO: What is your forecast for 2010 and beyond?

FAUS: Within our portfolio we are expecting a better 2010. That is because Brazil is up-Chile, too, thanks to higher commodity prices and the new elections-and Mexico saw the very worst in 2009 because of the swine flu and the huge impact of the U.S. recession. Overall, we believe that the industry will not recover until 2011 and that we will not see 2008 RevPAR levels until 2013-2014, depending on the markets.

We expect the luxury segment to recover more strongly than others. It is more volatile and, therefore, it is reasonable to assume that, after having suffered more severely, it will show a stronger comeback. Luxury will also benefit in this coming decade from reduced supply. These days, with financing restrictions and without the support of branded real estate ancillary in the hotel project, it is extremely complicated to develop luxury hotels.

MONGEAU: From our due diligence investigations on targeted properties and anecdotal comments from Avington's advisory clients, RevPAR appears to have stabilized in most of our target markets, with some showing nominal occupancy gains but no major rate increases.