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LaSalle Hotel Properties Inc. (NYSE:LHO)

Q3 2008 Earnings Call

October 23, 2008 9:00 am ET

Executives

 

Jon Bortz - Chairman, Chief Executive Officer

Hans Weger - Chief Finical Officer

 

Analysts

 

Chris Woronka - Deutsche Bank

Bill Crow - Raymond James

Will Truelove - UBS

Jeff Donnelly - Wachovia

Dennis Forst - Keybanc

Mike Salinsky - RBC Capital Markets

Presentation

Operator

Good day and welcome to the LaSalle Hotel Properties third quarter 2008 conference call. This call is being recorded. (Operator Instructions) At this time, I would like to turn the call over to Mr. Jon Bortz, Chairman and Chief Executive Officer; please go ahead sir.

Jon Bortz

Thank you, Operator. Good morning everyone and welcome to the second quarter earnings call and webcast for LaSalle Hotel Properties. Here with me today is Hans Weger, our Chief Financial Officer.

As we do each quarter, in addition to providing the financial results of our third quarter, Hans and I will discuss the company’s activities in the quarter and the year, the performance of our assets and the trends affecting them, the status of our ongoing reinvestment program and our outlook for the remainder of 2008 and some early views on 2009 on both a macro basis for the lodging industry and for LaSalle Hotel Properties; Hans.

Hans Weger

Thanks Jon. Good morning. Before we begin, I’d first like to make the following remarks. Any statements that we make today about future results and performance or plans and objectives are forward-looking statements. Actual results may differ as a result of factors, risks and uncertainties over which the company may have no control.

Factors that may cause actual results to differ materially are discussed in the company’s 10-K for 2007, quarterly reports and its other reports filed with the SEC. The company disclaims any obligation or undertaking to update or revise any forward-looking statements. Our SEC reports as well as our press releases are available at our website www.lasallehotels.com. Our most recent 8-K and yesterday’s press release includes reconciliations of non-GAAP measures such as funds from operations to the most comparable GAAP measures.

Third quarter funds from operations or FFO was $39.9 million as compared to $43.7 million in the prior year. FFO per diluted share was $0.99 compared to $1.09 in the third quarter of 2007. FFO for the third quarter of 2008 was reduced by $4.3 million related to the final settlement of all litigation with Meridian. Excluding the settlement expense, FFO for the third quarter 2008 would have been $44.2 million or $1.09 per diluted share, a 1% increase from the last year.

EBITDA for the third quarter was $60 million as compared to $65.5 million in the prior year period. EBITDA for the third quarter 2008 was reduced by the $4.3 million expense related to the settlement of the Meridian litigation. Excluding the settlement expense, EBITDA for the third quarter 2008 would have been $64.3 million.

RevPAR for the total portfolio decreased by one-tenth of a percent in the third quarter. The RevPAR decrease was a result of a 1% decline in ADR offset by an occupancy increase of 0.8%. Our hotel portfolio generated $66.9 million of EBITDA in the third quarter of 2008 versus $66 million in the prior year. Hotel revenues grew 1.6% versus the prior year period while expenses were held to an increase of 1.7%.

For the nine months ended September 30 2008, FFO increased to $97.1 million from $93.6 million or $2.41 per diluted share from $2.33 per diluted share for the prior year period. FFO for the nine months ended 2008 included the negative impact from the $4.3 million settlement expense related to the Meridian litigation. While FFO for 2007 includes the negative impact from the $3.9 million non-cash write-off of the initial issuance cost of the Series-A preferred shares due to their redemption in March of 2007.

Excluding these two events, FFO for the first nine months would have been $101.4 million for 2008 versus $97.5 million for 2007 or $2.52 per share in 2008 as compared to $2.42 per share in 2007.

EBITDA for the nine months ended September 30, 2008 decreased to $155 million from $189.3 million for the prior year period. EBITDA for 2008 includes a negative impact from the $4.3 million settlement expense related to the Meridian litigation. EBITDA for 2007 includes a $30.4 million gain on the sale of the LaGuardia Marriott. Excluding these two events, EBITDA would have been $159.3 million in 2008 versus $158.9 million in 2007.

RevPAR increased 1.6% for the nine months ended September 30, 2008 to $153.26 versus the prior year period. The RevPAR increase was attributable to an ADR growth of 1.1% to $201.95 and an increase in occupancy of 0.5% to 75.9%. For the nine months ended September 30, 2008, the company’s hotels generated $168 million of EBITDA compared with $165.7 million for the same period last year, a 1.4% improvement. Hotel revenues grew 2.1% versus the prior year period while hotel expenses increased 2.4%.

As of September 30, 2008, our trailing 12 month corporate EBITDA as defined in our senior unsecured credit facility to interest cover ratio was 4.2 times and our total debt to trailing 12 month corporate EBITDA equaled 4.5 times. On October 1, 2008 the company repaid the maturing loans secured by the San Diego Paradise Point Resort with cash and borrowings from its line of credit. This reduced the company’s total outstanding debt to approximately $961 million.

In addition, on October 3 we exercised the option to extend for one year the $20 million loan secured by Gild Hall. We have two options which would allow us to extend this loan until December 2011. 18 of our hotel properties, which generated approximately 45% of our EBITDA, are unencumbered by debt, providing significant opportunity for additional capital liquidity, if needed.

Through December 10 2010, the company has $82 million of non-extendible debt maturities. The non-extendable debt is comprised of $38 million maturing in July 2009 secured by the Western City Center Dallas and The Sheraton Bloomington Hotel, Minneapolis South. $31 million maturing in September 2009 secured by Hilton Alexandria Old Town and $13 million maturing in July 2010 secured by Le Montrose Suite Hotel.

If we are faced with an unfavorable credit market as these loans mature, we have capacity on our senior unsecured lines to extinguish these obligations. Currently, the company has $225 million available under a senior unsecured credit facility and $8 million available under its LHL credit facility.

Before I turn the call over to Jon, I would like to discuss the company’s balance sheet and liquidity, and the steps that we are taking to enhance them. The events over the last 18 months related to the bursting of the housing bubble and the dramatic rise in gasoline and food costs and other costs in general led to a significant consumer led economic slowdown earlier this year.

While the impact was initially contained to select industries, this downturn led unexpectedly to global capital market crisis. With debt markets completely freezing up, a total loss of confidence in our financial system and the equity market crashing, all leading to a global public intervention on an unprecedented scale.

We believe the impact of these very significant shocks, as well as the necessary de-levering of the global economy, will likely result in a significant recession in the US and many other countries around the world. While no one can accurately predict the depth or length of this downturn, we believe it is likely to be both more severe and longer than typical recessions.

As an economically sensitive industry and one that generally lags economic changes by three to six months, we are operating the company and are working with the operators to run the hotel, assuming the lodging sector is in for a very challenging 18 to 24 months.

Consequently, we believe that it is prudent to plan for a deep recession while hoping that the economy will balance more quickly and that being, in addition to our efforts over the last year we are taking several steps to enhance our already solid balance sheet and liquidity of the company.

First, due to the excellent current condition of our portfolio and the recent renovations, redevelopment and repositioning of a large portion of the portfolio, we are in a position to be able to limit capital investments in 2009 at our properties to those related to life safety, critical capital maintenance and a few necessary minor projects that are currently under way.

Additionally, we are no longer fast tracking development in preconstruction activities at the former IBM building in Chicago and now anticipate construction to commence in early 2010 with an opening in 2011. As a result, we expect capital investments in 2009 to range between $10 million and $20 million for the portfolio with an additional $5 million related to the redevelopment of the former IBM building.

Second, we continue to work smartly and aggressively with our operators to lower cost. We have been very successful since we have commenced these efforts in the fall of 2007, but as we anticipate further declines in occupancies next year, significant additional reductions in cost are necessary and will be achieved. The experience we and the operators gained in 2001 and 2002 have been and continue to be of great value in our efforts.

Third and finally, we announced yesterday that we have reduced our regular common dividend to $0.085 a month versus $0.175 a month beginning with the dividend to be paid on November 15.

The Board’s decision, with management’s recommendation, was made on this sluggish operating environment that has transpired since the fourth quarter 2007 compounded by the rapid deterioration in the economy in the past two months, the current negative economic outlook for the next 18 to 24 months, the desire to match the dividend more closely to future cash flows and to bolster the company’s balance sheet and liquidity, as well as position the company to take advantage of likely investment opportunities to come after the economy and the operating environment improve. This reduction will provide an additional $100 million in liquidity over the next 26 months.

As you know, our dividend policy and balance sheet strategy were structured with the objective of maintaining and growing the dividend even in economic downturn by building a healthy level of cash flow coverage in the dividend during the good times and then utilizing that coverage to absorb a cyclical drop in cash flow and borrowing if necessary at the bottom of the cycle for a short period of time, due to this downturn coming on top of the decline operating environment of the last nine months and I believe that this recession is likely to be both more severe and more extended than a typical recession.

Combined with the lack of liquidity in the capital markets, we did not believe it was prudent to hold on to this policy and strategies that were not designed for this unusual period in our country’s history. By taking these steps, we expect to further strengthen our balance sheet, provide additional liquidity, position the company for challenging times ahead and allow us to take advantage of future investment opportunities after the economy and the operating environment improved.

I would now like to turn the call over to Jon to discuss the recently completed quarter as well as our outlook for the remainder of 2008; Jon.

Jon Bortz

Thanks, Hans. In the third quarter, the economy continued to weaken under the weight of the housing recession, growing unemployment, financially strapped consumer and fear and panic that have resulted from the freezing of global debt market and collapse of global equity markets.

Starting in June, industry wide RevPAR turned negative and continued to weaken as the quarter progressed with the exception of a minor positive respite in July. Industry wide demand fell further into negative territory in the third quarter, declining 1% as compared to last year. Industry wide demand weakened as the quarter progressed, up 0.6% in July, down 0.7% in August and declining a more material 3.1% in September.

Leisure travel weakened further during the quarter reflecting the growing economic difficulties and significant drop in wealth being experienced by consumers. Business travel was the bigger story in the quarter, particularly towards the end of the quarter as business demand, both group and transient, weakened materially and while our portfolio went into the month with a large group pace advantage over 2007, slower short-term bookings and greater attrition reduced both our rate and room night advantages by the end of the quarter.

Group bookings for the fourth quarter also slowed, turning a significant positive pace advantage for Q4 2008 into a current pace shortfall. As for tangent, while our pace going into the quarter was only slightly negative, transient bookings in the quarter led to an ultimate decline in both room nights and ADR.

All customer types exhibited growing price sensitivity leading to less full price business and more discount business. We pursue this business generally through our third-party opaque distributors allowing us to maintain rate integrity. All of these negative trends have continued and accelerated into the fourth quarter.

While US hotels, particularly those in gateway cities, continue to benefit from strong growth in international travel, unfortunately the numbers have not been large enough to make up for declines in domestic demand and as the dollar has strengthened and foreign economies have weakened, we believe international travel is likely to be substantially less robust going forward.

On a RevPAR basis, our portfolio outperformed the industry in the quarter benefiting from our redeveloped and repositioned properties as well as our other more stabilized hotels. Both occupancy and rate came in at the middle of our outlook with a combination delivering a minor RevPAR decline of 0.1%.

On a monthly basis, our portfolio as a whole, RevPAR declined 2.6% in July, 1.1% in August and rose 3.3% in September. Our group business was strong, particularly in September, despite slower in the quarter for the quarter bookings and an increase in attrition with group room nights up 4.3% from last year and group ADR up 2.9%.

This was due to a strategy shift we adopted last summer to increase group room nights overall at our properties aided by the strategic addition of sales people at our group oriented properties last year. This group strength also led to a 6.9% increase in food and beverage revenues portfolio wide.

RevPAR at our urban hotels rose 2.6% in Q3 driven by a 1.9% increase in occupancy to 80.3% and a 0.6% increase in ADR. RevPAR at our convention hotels fell slightly by 0.4% with a 0.8% decline in occupancy to 81.5% and a 0.4% increase in ADR to $200.28.

RevPAR at our resort properties declined by 3.8% with ADR falling 5.3% to $233.64 while occupancies rose 1.6% to 84.5%. Our independent properties outperformed our branded properties with RevPAR growth of 0.9% versus a RevPAR decline of 1.1% at our branded properties.

Individual property performance was led by the Alexis in Seattle and Gild Hall in New York City, both benefiting from the recent redevelopments. RevPAR at the Alexis rebounded 36% in the quarter and Gild Hall RevPAR climbed 27.5%. The Indianapolis Marriott had a great group quarter and that drove a 14.1% increase in its RevPAR. The Hotel Viking in Newport also benefited from its recent repositioning as evidenced by its 8% increase in RevPAR.

West LA continued to be our strongest overall market outside of Seattle which was heavily skewed due to the performance of the Alexis. RevPAR at our four properties in West L.A. rose 3% with ADR up 5% while occupancy declined 2% to a still strong 84.6%.

Our weakest market overall was San Diego. Our occupancies were up in the quarter by 0.4% to a very strong 88.8%, yet full rated transient customers, especially leisure, were price sensitive. So while demand for San Diego was there, it took the third party discount channels to attract them. Not surprisingly, demand for our hot price suite was also off significantly replaced by upgraded regular guest room customers.

As for our other major markets, our properties in Washington, D.C. were up 0.7% in RevPAR. Our hotels in Boston had a 1.3% decline and RevPAR at our Chicago hotels weakened 1.1%. RevPAR at our stabilized and non-stabilized properties performed about equally in the quarter with RevPAR at redeveloped and recently built hotels down 0.1% and RevPAR at our stabilized properties down 0.2%. While most of our redeveloped properties outperformed the portfolio, their performance in total was negatively affected by weak group bookings at Lansdowne and price sensitive leisure customers at San Diego Paradise Point Resort.

Portfolio wide hotel non-room revenues for the quarter increased 5.2% led by a 6.9% increase in food and beverage revenues due primarily to increased group business. Total revenues portfolio wide increased 1.6% in the quarter.

On the cost side, expenses were well controlled in the quarter given the almost 1% increase in occupancy and the 6.9% increase in lower margin food and beverage revenues. Total hotel expenses portfolio wide grew 1.7% as compared to Q3 last year. As a result, EBITDA at the property level increased 1.4% with our portfolio wide EBITDA margin declining just seven basis points.

Departmental expenses rose by 5.3% driven by increases in wages and benefits, higher room expenses due to repositioning and certain pre-opening costs and food and beverage expenses that grew along with increased food and beverage volume. Undistributed expenses increased 0.3% with a 13.4% decline in franchise fees due to the conversion of two previously branded hotels to independence.

Energy and other utilities declined 0.5%, benefiting from the significant energy saving capital investments we’ve made over the last two years as well as our best practices efforts. Fixed expenses declined 12.1% due primarily to a 13.7% decline in property taxes, resulting mostly from a successful appeal in Western Michigan Avenue and a lower tax rate in Chicago than what we had expected. We are hopeful of further success on reducing taxes in the future as we’ve appealed the assessments of most of our other non-California properties.

Previous initiatives and insurance also continue to generate savings including a 33% reduction in general liability expense and a 24.5% reduction in property and casualty insurance costs. Year-to-date, RevPAR portfolio wide is up 1.6% with ADR increasing 1.1% to $201.95 and occupancy up 0.5% to 75.9% despite early year displacement from renovations. Through the first nine months, our independent hotels outperformed our branded properties with RevPAR up 2.5% versus an increase of 0.8% at our branded properties.

Geographically, our strongest markets year-to-date include west L.A. with RevPAR increasing 7%, in Boston with RevPAR growing 3.2%. Our two Seattle properties were up 24.5% due to the ramp-up from the renovations last year. Chicago RevPAR is up 0.8% year-to-date, San Diego is down 2.3% and Washington, D.C. is down 0.1%.

Our best performing properties through the first three quarters were led by a number of our repositioned hotels and resorts including the Alexis with RevPAR climbing 44.7%, the Viking up 14.1%, Hotel Sax up 9.8% and Lansdowne increasing 8%.

Turning to our capital initiatives, we invested $17.1 million in the third quarter in the portfolio with the bulk of the dollars primarily related to paying for redevelopment projects previously completed and the build out of several restaurants. Total capital investments to date totaled $69.1 million, excluding the 330 North Wabash redevelopment.

As for the former IBM building, as Hans mentioned, we have gone from fast tracking the project to a much slower development approach with significant construction not expected to begin until 2010 and then the completion in 2011. We will modify our model room, complete construction drawings and find a restaurant tenant or operator between now and construction commencement.

As discussed last quarter, our extensive program of redevelopments and repositioning was essentially completed earlier this year, except for new restaurants at Liaison Capitol Hill, Gild Hall and Donovan House. The [Libber] team, the Todd English restaurant at Gild Hall and Art and Soul, the Art Smith restaurant at Liaison both opened successfully in September as planned.

Our Donovan House restaurant is under construction and continues to be targeted for opening by the inauguration. For 2008, we continue to project total capital investments of $80 million to $90 million for the year, excluding the Chicago redevelopment where we expect a total of $6 million this year excluding the acquisition costs for our portion of the building.

Now let me turn to our outlook for what is left of 2008 and some comments about 2009. We thought forecasting was hard three months ago; now it’s even more challenging. Since our last report to you, economic conditions have worsened substantially and it seems clear that the US is now or shortly will be in a recession. The downturn has broadened from a few industries and companies to most industries and companies.

Given the economic decline to date and expectations for further significant declines in economic activity over at least the next few quarters, we can expect and are planning for industry wide demand to decline for at least the next few quarters. The four economic indicators that we utilize to forecast lodging demand, employment growth, corporate profits, consumer confidence and airline implements, all continue to worsen. As a result, we expect lodging demand to decline and put additional pressure on occupancies in the fourth quarter and in 2009.

Unfortunately, the economic visibility we currently have is all negative. So there are no signs of an economic recovery anytime in the near future. We are projecting that industry wide demand for rooms will decline between 1% and 2% for 2008 despite it being down only 0.6% through the first nine months. With an expected 2.5% increase in supply, we are forecasting industry wide occupancy in 2008 to decline by 3.5% to 4.5%.

ADR should increase 2% to 3% for the year, resulting in industry RevPAR declining between 1% and 2% as compared to 2007. We caution that the speed at which the economy and lodging industry are weakening is rapid and it makes for extremely difficult forecasting at this time. For our portfolio we now expect RevPAR to be flat to down 1% in 2008.

For the fourth quarter, with the rapid and shocking decline in the markets, we are currently forecasting that portfolio RevPAR will range between a 6% decline and an 8% decline as compared to last year’s fourth quarter. For 2009, it’s not unrealistic to think that demand could decline a further 2% to 3% next year with greater severity in the first half. With industry supply expected to increase 3% or so next year, which is the peak for this cycle, occupancies can see a 5% to 6% decline.

Consumers and businesses can be expected to increasingly seek out discounts, putting pressure on ADR through a change of mix. This is likely to be offset to some extent by increases in group rates and to a lesser extent corporate rate. For our portfolio, given the expected ramp-up of our redeveloped and repositioned properties, we should be able to outperform though as we’ve discussed previously; it becomes more challenging to gain penetration in difficult times.

As for our group pace for 2009, we continue to pace well ahead of the same time last year for 2008 though our pace advantage has declined substantially from three months ago. As of the end of September, we had approximately 50% of our targeted group rooms for the year on the books. We are up 2% in room nights and 2.9% in ADR as compared to the same time last year for 2008. Three months ago however, group pace was up 4.9% in room nights and 4.5% in ADR. So it’s clear that group bookings have slowed as businesses have become much more cautious.

Facing a challenging and uncertain economic environment, we’ve worked very closely with our operators since late last year to implement extensive cost reduction programs as well as revenue enhancements at all of our properties. As trends have weakened, we’ve initiated even more stringent cost saving measures throughout our portfolio. Given the worsening economic environment, we are already working with our operators to make significant future reductions in costs and implement additional revenue enhancement programs in anticipation of meaningful expected occupancy declines in 2009.

Due to the success of our aggressive asset management efforts, we now believe that total expenses on a comparable basis throughout the portfolio can be limited to 1.5% increase for 2008, which is half of our 3% forecast just three months ago. As a result, we expect that our EBITDA margins for the year will be limited to a decline of between 50 and 100 basis points. They are down just 22 basis points year-to-date.

Based upon these assumptions we are currently forecasting EBITDA for the year in a range of $199.8 million to $201.8 million and FFO per diluted share in a range of $3.02 to $3.07. EBITDA and FFO both exclude the $4.3 million Meridian litigation settlement.

To conclude, the remainder of 2008 and all of 2009 will certainly be challenging with an economy likely in recession and further weakening to go and a lack of clarity as to the depth and breadth of its decline. Nevertheless, this year we completed the last of our major redevelopments and repositioning with significant upside to come over the next three to four years.

We are in solid financial condition and with the steps outlined earlier by Hans, we should continue to maintain our strong balance sheet and liquidity to meet our needs. We are aggressively working with our operators to reduce operating costs and our team is well prepared to deal with the challenging economic environment to come.

As we look further out into the future and as a result of the rapid decline over the last year in new construction starts and with construction financing all but gone, we expect the next up-cycle, whenever it begins, will feature a strong recovery in demand and little to no new supply for an extended number of years.

That completes our remarks. Operator, Hans and I would now be happy to answer any questions that the audience may have.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question from Chris Woronka - Deutsche Bank.

Chris Woronka - Deutsche Bank

As you look out to 2009 you mentioned you made a conscious decision to group-up a little bit this year. Do you see that continuing? How would the potentially higher occupancy or less occupancy decline, but lower rates impact, your thoughts on margins?

Jon Bortz

Yes Chris. Our approach right now is to aggressively pursue group. I think at this point in time we are certainly not alone in that pursuit and I think it’s going to be a challenging year. However I think our approach with the additional sale people that we’ve added, I think gives us an advantage.

It should allow us to put group in the past with strong transient would have taken transient which means our mix is going to change a little bit. Hopefully that comes with more food and beverage. Although I think we can expect that there will be certainly cutbacks in that per person spend that typically happens in a downturn. So hopefully we’ll get some offset by the additional group that we have.

From a margin perspective, certainly additional food and beverage outside of the occupancy decline will put a little bit more pressure on the margin, but it will add to the bottom line EBITDA.

So when we look at next year on an operating cost basis in a down five or down six kind of environment on an occupancy basis, we are looking at expenses hopefully that are going to be down at a minimum 2%, which of course will involve significant cuts at the properties. I think what we are trying to do is describe our margins in terms of revenues and expenses as opposed to margins because the margins are purely a mathematical result.

Chris Woronka - Deutsche Bank

And then any early indications on how much the inauguration might help your Washington portfolio? Is there any way to quantify the magnitude? Is it 100 bips on full year RevPAR or something like that or could it be more?

Jon Bortz

No, it’s nowhere near that. If we look historically at the last inauguration, I think RevPAR in January was up about 40%, a little over 40%. January would be a relatively less than pro rata revenue month typically in D.C., and D.C. represents about 20% of our portfolio EBITDA.

So it will help our properties in D.C. It will help our RevPAR for the year in D.C. by a point perhaps or two compared to what it might otherwise be, but it’s going to be a challenging environment in D.C. with a very weak convention calendar offset to some extent by what we expect to be a pretty active congressional year.

Operator

Your next question comes from Bill Crow - Raymond James.

Bill Crow - Raymond James

Hans, a couple questions for you to start with. The CapEx spend in ‘09 you mentioned $10 million to $20 million plus $5 million for the IBM building. That’s exclusive of recurring maintenance CapEx I assume and that should be running at $25 million?

Hans Weger

No, the $10 million to $20 million is all CapEx and then the $5 million for the IBM building. So we would expect all CapEx maintenance, life safety, anything that we need to do would be between $15 million and $25 million next year, including the IBM work.

Bill Crow - Raymond James

And then Hans the compensation agreements that were put in place earlier this year with the CEO transition, how is that going to impact the G&A line in ‘09? Does that vary based on stock price at all? How much can you control G&A after those agreements were put in place?

Hans Weger

With those agreements, the stock price does not impact the expense that the company would recognize on the G&A line and in addition to what was incurred this year, it would be at approximately $1.3 million to $1.5 million increase in G&A related to those agreements.

Bill Crow - Raymond James

Okay. So this year plus some inflation number plus the agreements is kind of the number for next year. Jon, can you just talk about how this environment compares or contrasts to what you saw post 9/11 or even heading into 2001 when things were deteriorating?

Jon Bortz

I think the period that we’ve seen through probably this year; probably what we’ll see through September and October will probably be pretty similar to what we saw through the first eight months of 2001 and I think what we’ve begun to see at our properties in the last six weeks is a rapid deterioration in call volumes, business activity, group business, an increase in cancellations, even from healthy companies and a significant increase in attrition and so in some ways it’s not dissimilar to what we saw after 9/11.

How deep this sort of initial drop goes is very hard to measure at this point and to predict. So there are some fairly significant parallels. Hopefully it won’t be as near as bad, as what we saw then. That was certainly very unprecedented and certainly typical recessions or probably more like what we would have seen for this year by the end of the year.

So what we are trying to prepare for is kind of that worse case scenario; although I’ll tell you we are not prepared for a depression and I don’t think we are going to have one. I think it’s still low likelihood, I’m not trying to scare anybody, but we are prepared for a severe recession and that is evidenced by the moves that we made and announced yesterday.

Bill Crow - Raymond James

And then Jon finally, help us a little with how you look at valuation here, because stocks $10, $11 it doesn’t seem like cap rates mean much today. No transactions out there to compare the public and private markets and you’re not buying stock for I think obvious reasons, but how do you value of the company here?

Jon Bortz

Well, we generally don’t talk about value and the view of it. I’m not sure the stock markets actually reflect value at this point with so many of the forced redemption in sales that are going on in the market throughout the market, certainly not just in our sector.

When we get down into these recessionary periods, typically the markets move to more of a price per key kind of valuation where the cash flow at the trough is far less relevant as opposed to the future earning power of the properties and so as we begin to see some light in terms of the recovery and people begin predicting growth in revenues again and a recovery in the economy, you begin to see a pretty rapid decline in cap rates and a fairly rapid increase in values even despite a challenging and a re-priced financing markets.

So when you look at price per pound, you have to start looking at replacement cost in addition to the future earning power of the properties and when we look at replacement cost for our portfolio today, given the fact that the bulk of our properties are in major urban markets and resort markets, we are looking at replacement costs today in the $425,000 to $450,000 per key and at yesterday’s close for our stock, you’re looking at a value of about $205,000 per key.

So that tells you that there’s a huge gap between new supply and the recovery that will take place in the operating cash flows and the earning power of these assets will be achieved in the next recovery and I’d say it’s interesting. A month or two ago we would have been forecasting a U-shaped recovery, but maybe we’ll be down further but maybe ultimately when the recovery comes, it’s going to come pretty rapidly because it will come from a pretty low level.

Operator

Your next question comes from Will Truelove – UBS.

Will Truelove – UBS

A couple of questions; to the opaque websites, what kind of margins hit do you take when selling through opaque versus say the non-opaque website?

Jon Bortz

Pretty substantial. When you look at the opaque sites, Hotwire, Priceline, and others like those, those are priced for your property to be selected within its little local neighborhood based upon the request of the customer and the blind request of the customer. So those I’d say for our portfolio can range anywhere from $50 a night for some of the lower rated properties to as much as $120, $130, $140 a night for some of the better located properties and clearly when demand is strong, mid week at our properties, those channels are not open. So we are not selling at those levels.

Will Truelove – UBS

William Shatner is a very tough negotiator.

Jon Bortz

That he is

Will Truelove – UBS

The second question is when you look at your portfolio, which is I know you have a lot of what we call independent hotels versus you have a few what I’ll call big national brands say for example Western and whatnot. Do you see a differential in usage of opaque in your independent hotels versus say the more national brands?

Jon Bortz

Yes. I would say in general the third party sites are probably used a little bit more liberally by the independent properties because we don’t have the burden of the brand cost, the loyalty programs, the 10% off the top and I think that’s how we it helps our independent properties achieve better overall RevPARs and in fact better margins at the end of the day.

Operator

Your next question comes from Jeff Donnelly – Wachovia.

Jeff Donnelly – Wachovia

Jon, if I can try to go back to some of the questions on margins. I think it’s inevitably what I think a lot of people are trying to drill down, the absolute margin or margin change for ‘09 and 2010. I’m curious what ability you think, I guess I will call it the typical full service urban hotel has to trim expenses over the next year or two from this point, particularly given that it sounds like you are laying out a scenario for RevPAR at least for next year that’s going to decline maybe something worse than the 5% dip I think most embracing these days.

Jon Bortz

I think we have almost unlimited ability to cut Jeff, and I think that’s what we learned after 9/11. What we found was there had previously been a belief that a lot of the costs at a hotel were fixed and I think what we learned was that’s not the case, that most of the costs were variable.

So, what does that mean? It means in tough times with less occupancy, we are going to right size both our labor force and our management staff. It’s going to mean that the people that are left at the properties are going to have to work harder and longer hours. It means that ultimately some of the customer conveniences are going to be impacted. It might take another minute to check in. It might take a couple more rings for somebody to answer the phone. It may be that the restaurant hours are shortened, that room service hours are shortened.

So we believe that there are a tremendous number of things that we will still do at the properties to reduce cost. I think we are going to see a little different attitude about wage increases next year. Some of the branded properties are talking about wage freezes and so I think there is a recognition that we are not in a normal period of time and that we need to do things that we don’t like to do, but that we are going to have to do and I think there’s a willingness to do that as there was after 9/11.

Jeff Donnelly – Wachovia

9/11 largely was the surprise nature of it. We saw margins decline in some hotels, at least in certain quarters, 600, 700, 800 basis points on an EBITDA basis. Do you think because this is foreseen but it’s been coming at us somewhat steadily, would you be surprised if margin deterioration is constrained only 100, 200, 300 basis points even under some of those severe RevPAR decreases?

Jon Bortz

Well, that would surprise me. I think that’s a very difficult level to achieve when you are talking about a severe decline in revenues, but I think in a down six RevPAR environment with expenses down 2% or 2.5%, you are looking at 450 basis points of decline; that’s kind of how the math works.

It’s possible we can achieve better increases in expenses. We start with the fact that we have a run rate advantage. We’ve been cutting expenses all year. We’re going to get the benefit of that next year. We’ve been able to reduce our natural gas cost which makes up about 25% of our energy. We hope electricity costs will come down since natural gas has come down.

We think property taxes are going to come down. So, we think there are lots of areas where maybe we’ll get a little bit of wind at our back and allow us to perhaps trim those expenses more, but I think it’s going to be challenging.

Jeff Donnelly – Wachovia

And then just a question concerning your revised dividend policy; can you talk about how that was determined? Was that somewhat arbitrary or give us some insight into maybe what the EBITDA or RevPAR guidance you’re forecasting? I guess what I’m angling at is did you anticipate that there might even be a need to pay a special dividend next year even if current conditions persist?

Jon Bortz

I think if you take my comments about ‘09, which we talked about perhaps a 5% to 6% drop in occupancy and flat or potentially declining ADR that should give you an idea of the numbers behind the evaluation we did in coming up with the dividend. We looked at that. We looked at a worse scenario to test our model and we really wanted to reduce the dividend to a level that had significant coverage in that highly stressed environment. We really didn’t want to reduce the dividend more than once. If we have depression, all bets are off, but that’s not what we are planning for.

So we planed for a severe downturn. It allows us to effectively de-lever or avoid levering up further by retaining that capital, reducing our capital expenditures and investments, deferring the Chicago project and I think we looked at our debt to EBITDA ratio which has been important to us and a desire to maintain a low level of that or certainly a relatively low level debt to EBITDA ratio.

Then ultimately as the economy recovers, it will give us the same ability we had last time after 9/11, which was to be one of the first out there to take advantage of opportunities that come about and we think this time there will be some significant distressed opportunities down the road; not in the near term, not something we would be pursuing at this point in time, but as we begin to see a more positive outlook and less risk in the environment, that’s when we begin to take advantage of those opportunities, markets willing.

Hans Weger

And Jeff, I think it’s important to reiterate that this is a proactive move. Our balance sheet right now is very strong. We don’t have a lot of maturities coming up; our debt to EBITDA ratio is only 4.5 times right now. We have coverage of the current dividends and the new dividend has even that much more coverage. So in our mind this is a proactive step to maintain our strong balance sheet, liquidity and flexibility and continue to be a leading performer in our industry.

Jeff Donnelly – Wachovia

Just one last question; actually probably for you Hans or maybe it’s somewhat a two-part question. Can you talk a little bit about; and I know it keeps changing, the lending market for hotels today? I guess on one side people say it’s completely shut but on the other hand you do continue to see deals get done. Can you maybe I guess highlight the underwriting parameters you are seeing on loan-to-value coverage ratios and how the hotels are being valued by lenders?

The second part and this is somewhat of a hypothetical question but it helps us understand, if you had to for instance recast your balance sheet today and seek mortgage debt for your assets, are there assets that you guys hold today that you expect would be difficult to obtain leverage on just because of where they are located or the types of hotels or where they are in their ramping process?

Hans Weger

To answer the first part of the question, we did go out into the market and evaluate what the opportunity was with Paradise Point and what we found was there were lenders out there for our high quality assets with cash in the major markets which is where our portfolio is primarily located with those assets.

What we found was that on the variable rate side you’re looking at debt in that 50% to 60% level. Prefer that 50% to 55% and you are looking at LIBOR all in cost with up front fees and spreads probably between 300 and 350 for that. So there is a market out there, but I think its limited somewhat to high quality assets, high quality markets, high quality sponsorship and cash is there. So as far as it relates directly to our assets, we don’t believe there will be issues.

If we needed to tap into the capital markets to place debt on our hotels, we think they meet that criterion. The way that we run our company is we have a very good relationship with lenders. They are supportive of both us and our company. We have high quality assets and we are primarily in the eight major markets that we focused on over the years. So we don’t think it would be an issue if we decided to go that route, but what we have is the flexibility because of our move in January to increase our line of credit from $300 million to $450 million with pricing at LIBOR plus 70, 80 basis points, that our cost of capital is significantly cheaper than the current marketplace.

So the thought with Paradise Point was take advantage of the flexibility that we have and as the debt markets calm down and become more competitive as more people begin to lend, we would come back out and look at putting debt back on the hotels.

Jon Bortz

And Jeff, we mentioned in our talk; there are 18 hotels that are unencumbered; represents 45% EBITDA and they can all be used, they can all be financed. A lot of them are smaller properties which actually benefit in the market because you’d be looking for relatively small mortgages on those properties and I think we have a reputation in the market of being a superb owner, somebody who invests in their hotels, keeps them competitive and keeps the operations efficient. So I think we’ll continue to see opportunities in the market, whatever that market is over the next 18, 24, 36 months.

Jeff Donnelly – Wachovia

One last question, Jon; I’m curious have any lenders approached you guys with hotels that they might have foreclosed on that they’re looking to unload?

Operator

(Operator Instructions) Your next question comes from Dennis Forst - Keybanc.

Dennis Forst - Keybanc

I wanted to ask about the IBM project. You paid $46 for the opportunity and how much are you planning to spend over the next I guess now next two to three years to complete it?

Jon Bortz

The total project costs in addition to what we have in it about $110 million

Dennis Forst - Keybanc

 $100 plus the $46.

Jon Bortz

Yes, plus what we have in right now is I think closer to $55 to $60.

Dennis Forst - Keybanc

Okay, so $170 and how many rooms would that give you?

Jon Bortz

335 rooms.

Dennis Forst - Keybanc

So that’s somewhere right around $500,000 a room.

Jon Bortz

Correct and that does not take into account the ability to monetize historic tax credits which we’re estimating to be between $15 million and $20 million.

Dennis Forst - Keybanc

On a different subject, it seems as if your occupancies have been a lot stronger than the national occupancies. We’ve been seeing occupancies going down nationally for I think over a year now offset by better ADRs, but up until the third quarter you were getting higher occupancy and higher ADRs. Why do you think your occupancies have held in so well and why are they going to move in the other direction so dramatically over the next year?

Jon Bortz

Dennis, I think on a relative basis clearly our properties are in markets that have much higher occupancies than the industry. The bulk of our markets D.C., Boston, Chicago, San Diego, L.A., are markets that even on a trailing 12 basis are running anywhere from 73% occupancy levels all the way up to --?

Dennis Forst - Keybanc

But they always run at a higher occupancy.

Jon Bortz

Right and why have we held up better? Well, first of all, a lot of these markets have held up well because demand has actually continued to grow in those markets this year, but at our properties, it’s a combination of a couple of things on a relative basis. One is the condition of our properties, the fact that many of them have been repositioned and redeveloped and fully renovated.

Part of it is the group-up strategy which adds occupancy and/or does replace transient; therefore, not impacted as much by declining transient business and I think part of it is a willingness to participate in the third-party channels where necessary for additional occupancy, customers who are only buying through those channels.

Dennis Forst - Keybanc

And lastly, reading the Q it lays out what the Donovan did in revenues and costs and the like and clearly the Donovan goes through your income statement. My understanding is it’s not in the RevPAR numbers?

Jon Bortz

That’s right, because there wasn’t any last year.

Dennis Forst - Keybanc

So when will we anniversary that and start including Donovan?

Jon Bortz

It will anniversary in the second quarter of next year.

Dennis Forst - Keybanc

So we’ll include about the second quarter of ‘09. So the first quarter of ‘09 will be excluded and we’ll be able to on a year-over-year use the first quarter of ‘08 as a base.

Jon Bortz

Correct

Dennis Forst - Keybanc

And the Donovan, again looking at the queue, looks like it's not contributing yet. When should it start contributing?

Jon Bortz

It should start contributing next year and that will come from the ramp-up, the ability to attract corporate accounts primarily due to the opening of the restaurant which will occur in January of next year.

Dennis Forst - Keybanc

Have you been generally satisfied with how the Donovan has done in a start-up mode?

Jon Bortz

I think we’ve been satisfied by the reception to the product. I think we’ve been very disappointed and probably over estimated the performance of the property or to put it another way under statement estimated the impact from not having the restaurant open.

Operator

Your final question comes from Mike Salinsky - RBC Capital Markets.

Mike Salinsky - RBC Capital Markets

Jon, you were one of the first ones to go out and make hotel acquisitions in the past upturn. I know there’s a really bleak scenario, but when would you expect to begin looking at opportunities either on balance sheet or within the fund and kind of as a corollary to that, can you talk about how much of the stress you expect to see in the lodging sector over the next several years relative to the past downturn?

Jon Bortz

As was the case last time, we need to be in a position where we feel comfortable from a risk perspective. In other words, we’ve minimized the uncertainty about the economy and therefore we can now begin to under write the timing of the recovery in the lodging business.

So, I think we have to get to the point where we see some reasonably clear signs that things are either getting better or it’s clear that they are going to get better and then we can evaluate this is where we are, this is what our balance sheet looks like and this is where the capital markets are in terms of available capital. So I think those things need to come into play.

I haven’t the faintest idea when that’s going to be, and that’s as frank as we can be. If somebody can tell us what the economy is going to do, then we can figure out what will happen with the lodging business, but it’s really hard to know right now. So that’s kind of our view for new opportunities and I think that’s similar to the last go around. I think we made our first new acquisition in the spring of ‘03 and I’d say that we started looking probably in late ‘02 and we began to see a turn-up in RevPAR in the second half of ‘02.

Mike Salinsky - RBC Capital Markets

With regards to the distressed assets?

Jon Bortz

Yes. I’m afraid to say in one regard I think there is going to be a lot of distress. I think assets that were purchased under the assumption that you needed significant growth and cash flow to cover dividend, to cover mortgage payments and interest payments.

I think there were a lot of investments made with shorter term three or four-year debt and I think with the combination of the downturn and the operating environment from the economy and the crash of a debt capital markets and the fact that hotels are clearly viewed as riskier and I’d say when you look at sort of the de-levering movement, hotels are going to have to de-lever more than other product types because of the uncertainty of the cash flow.

We think there will be a lot more opportunity this go-around than the last go-around and the reason is not the operating environments, but the fact that in the last go-around people remembered that the early ‘90s and you didn’t see that over levering that took place where this time people look back at the early ‘90s or looked back at the early part of the century after 9/11 and said “wow there wasn’t any distress, things worked out well. We can lend a lot more” or whatever rational was used. So, we have much higher loan-to-value loans out there and I think there will be a lot of distress in that area.

Mike Salinsky - RBC Capital Markets

Second question for Hans. You talked about running different scenario analysis worst case scenario, best case scenario; I just wonder if there was any assumed asset sale in those scenario analyses.

Hans Weger

When we did the analysis, that weren’t any asset sales considered there. However, as we stated before as we look at our portfolio, if the opportunity comes to sell an asset on a basis that makes sense, we would do it.

Mike Salinsky - RBC Capital Markets

Okay. Finally John you touched upon the Washington, D.C. market for next year. To my understanding, Chicago is supposed to have a better convention calendar than the last year or actually the move this year and Boston is supposed to be more evenly space. How are group bookings shaping up in those markets and kind of what’s your feeling in those two markets?

Jon Bortz

Well, we’re running ahead in our two properties in Chicago on a group space basis versus last year at the same time. The issue hasn’t been the bookings as much from the conventions and even the in-house group; it’s been who’s shown up and how many people have shown up or not.

So next year on paper, it looks like a great year in Chicago, from a convention perspective, but we’ve seen this year that that doesn’t necessarily translate into actually great levels of demand, because companies have cut back on exhibiting, they’ve cut back on participating, they’ve cut the number of people attending those conventions and they’ve shortened the time that they are going to those conventions and all of those things have had a negative impact when you look at on paper bookings versus what’s actualized.

Mike Salinsky - RBC Capital Markets

Okay and for Boston?

Jon Bortz

Boston, I think our bookings in Boston are relatively flat and if you want to wait one second, we’ll check real quick, but Boston seems to be pretty even. It was pretty even this year compared to last year, next year. Right now it’s down two conventions but that’s the same place we were a year ago for this year, and they booked two conventions in the marketplace.

So when we look at really our big dog in that market, which is Copley, we are up about 5% in group bookings in room nights versus last year and we are up $20 in rate right now.

Operator

(Operator Instructions) It appears we have no further questions at this time.

Jon Bortz

Thank you operator and we thank all of you for participating in the call. We appreciate your support and we look forward to communicating to you our year-end results and a full outlook for 2009 early next year.

Operator

This concludes the conference. You may disconnect at any time. Thank you. Have a great day.

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Source: LaSalle Hotel Properties Inc Q3 2008 Earnings Call Transcript
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