Under Priced Hotels Comprise Chunk of Market

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. October 14, 2008

NEW YORK, NY, October 18, 2006. Despite the avalanche of equity capital chasing hotel deals around the country, there is significant pricing inefficiencies across the lodging sector according to Hotel Investment Strategies, LLC, a lodging investment advisory firm based in New York.

"While we believe the hotel sector as an asset class is priced correctly today, compared with other real estate asset classes, we find the hotel sector to be much more inefficient in an asset pricing sense compared with all the other real estate asset classes," said Ross Woods, Principal of Hotel Investment Strategies.

Based on an equilibrium hotel pricing model developed by Hotel Investment Strategies, the firm has found that about 28% of full-service hotel markets are currently underpriced on a risk-adjusted basis and are likely to generate excess risk-adjusted returns over the next five years.

"About 23% of markets are fairly priced and are expected to generate returns commensurate with their risk which leaves 49% of markets which are overpriced on a risk-adjusted basis," said Mr. Woods.

"From an asset pricing perspective, the lodging industry is much more inefficient than previously thought and explains in large part why some investors have been able to consistently outperform the market and provide superior risk-adjusted returns." "If the market were efficient, abnormal returns would be infrequent."

"While hotel investors appear confident in forecasting the relative amount of risk in the hotel sector as a whole relative to other real estate asset classes, they appear unable to fine-tune their perceptions of relative risk to the level of specific hotel types and locations in any sort of way that is reliable or stable over time." "As a consequence they do not require significantly or persistently different going-in IRRs across different hotel types and locations," said Mr. Woods.

"It seems the reason hotel investors have not appropriately priced the hotel sector across markets is that they have consistently underestimated its risk in many markets and overestimated the risk in other markets." This artefact has flowed through to underwriting assumptions, most notable, in required rates of returns. "This is borne out in survey after survey, where investors only ever require a 300 to 400 basis point spread in the going-in IRR between the riskiest and least riskiest hotel markets in the country."

Mr. Woods said that most hotel investors believe, implicitly, if not explicitly, that they are getting a higher expected return without assuming greater risk. The consequences of overconfidence can be to take excessive risks or to pass up attractive opportunities. Investors are more likely to underestimate the risks rather than the opportunities because of another habit of mind that lead them astray - eternal optimism.

"Investors who derive the most realistic risk profile for a hotel will have the highest probability of achieving abnormal returns." "Forecasting ability will therefore separate the investors who achieve superior risk-adjusted returns from those who don't," said Mr. Woods.

Hotel Investment Strategies finds that most superior performance is attributable to an investor's decision to overweight outperforming hotel markets relative to the market portfolio and consistently acquire underpriced assets in these markets.