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Hospitality Properties Trust (NYSE:HPT)

Q2 2010 Earnings Call Transcript

August 9, 2010 1:00 pm ET

Executives

Tim Bonang – VP, IR

John Murray – President and COO

Mark Kleifges – CFO and Treasurer

Analysts

Andrew Wittmann – R.W. Baird

Jeffrey Donnelly – Wells Fargo

Michael Salinsky – RBC Capital Markets

Fred Taylor – MJX Asset Management

Smedes Rose – KBW

Operator

Good day and welcome to the Hospitality Properties Trust second quarter 2010 earnings results conference call. This call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Vice President of Investor Relations, Mr. Tim Bonang. Please go ahead.

Tim Bonang

Thank you and good afternoon. Joining me on today's call are John Murray, President and Mark Kleifges, CFO. John and Mark will make a short presentation, which will be followed by a question-and-answer session. I would also note that the recording and retransmission of today's conference call is strictly prohibited without prior written consent of HPT.

Before we begin today's call, I would like to read our Safe Harbor statement. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and federal securities laws. These forward-looking statements are based on HPT's present beliefs and expectations as of today, August 9th, 2010. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call, other than through filings with the Securities and Exchange Commission or SEC. In addition, this call may contain non-GAAP numbers including Funds from operations or FFO. A reconciliation of FFO to net income, as well as components to calculate AFFO, CAD, FAD are available in our supplemental package found in the investor relations section of the company's website.

Actual results may differ materially from those projected in any forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Forms 10-Q and 10-K, filed with the SEC and in our supplemental operating and financial data package found on our website at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

And now I would like to turn the call over to John Murray.

John Murray

Thank you, Tim. Good afternoon and welcome to our second quarter 2010 earnings call. Today, HPT reported second quarter FFO per share of $0.81. FFO this quarter excludes two non-cash charges totaling $0.18 per share, related to early extinguishment of debt and asset impairment at three of four hotels HPT has decided to sell.

Focusing first on HPT's hotel investments, second quarter RevPAR increased 4.1% across our 289 hotels, driven by a 6.8 percentage point increase in average occupancy to 72.9%, but partially offset by a 5.6% decline in average daily rate to $90.50.

RevPAR increased in all regions, except the west central regions, compared with the 2009 second quarter. RevPAR at our Spring Hill Suites, Country Inn and Suites and Hyatt Place Hotels gained 11.4%, 10.1% and 9.5% respectively this quarter, demonstrating the appeal of all-suite select service hotels.

HPT's hotels are primarily in suburban locations and are diversified across all segments except economy with a concentration in the upscale and mid-priced without F&B segments of the industry. The average RevPAR increase of our mid-scale without F&B hotels was 4.3%, slightly above that segment's average. However, in the upscale segment, our hotels didn't perform as well as the industry this quarter.

Among HPT's upscale branded hotels, only Hyatt Place and Spring Hill Suites exceeded the industry average RevPAR growth this quarter. HPT's upscale RevPAR growth versus the segment as a whole reflects that our upscale hotels are primarily select service suburban assets. In the early part of this recovery, urban and full service upscale hotels have achieved stronger improvement.

Nonetheless, we are optimistic that occupancy, rate and RevPAR trends for our hotels are moving in the right direction and indications of our, that these positive trends will continue.

Growing and maintaining rate remains a challenge. Although occupancy was up, in fact it was at or above 80% in four of our portfolios this quarter, ADR declined in every portfolio versus the second quarter of last year. Our managers continued to struggle with balancing guest mix, competitive pressures and the legacy impact of previously negotiated rates. This latter point may take until 2011 to overcome.

We have seen consistent RevPAR improvement each month, but more needs to be done to manage rates. Our asset management team continues to emphasize this in our meetings and conversations at the hotel level, as well as with our managers, regional and national revenue management teams.

The economy appears to be slowly recovering and year-over-year RevPAR comparisons continue to improve faster than we had projected at the start of the year. Indeed, we didn't expect positive quarter-over-quarter RevPAR for our hotels until the second half of this year but achieved that in the second quarter.

Updated projections by our managers generally indicate slightly positive RevPAR for 2010, but there is uncertainty. Although the situation is improving, booking windows remain short and it is difficult for our operators to accurately project monthly revenue until that month. Importantly, there is a renewed sense of optimism, as a result of the significant jump in demand that started in March and continues today.

The outlook for flow-through of projected increases in revenue to hotel level cash flow is less encouraging. Incremental cost savings are difficult for our operators to achieve, especially when demand is so hard to predict accurately. There is growing cost pressure in the area of wages and benefits and as occupancy is improving largely without average daily rate increases, this too has and will continue to cause margin pressure.

Accordingly, GOP margins in the second quarter were 38% down 2.1% versus last year and full year between hotel net operating income is expected to decline versus 2009, even if the improving forecasts prove accurate. Despite this, our hotels are participating in the recovery and will gradually return to past levels of cash flow because of their attractive locations, high quality and recognized brands.

Although, only one of our hotel portfolios achieved one times coverage of our minimum rents and returns this quarter, we were paid our full contractual returns and rents under each hotel agreement, except from two Marriott portfolios. We continue to be paid less than the required periodic minimum return and rent amounts required under the Marriott Number Three and Number Four agreements and have drawn on the related security deposits for the deficient amounts.

In early July, IHG notified us that they believe four hotels met or soon would meet criteria outlined in our agreement to be classified as non-economic hotels. Two of these so called non-economic hotels are in the IHG Number Three portfolio and two in the IHG Number Four portfolio.

Based on our analysis and the opinions of respected hotel brokerage firms, we believe the carrying value of these hotels exceeds the net realizable value for three of the four hotels and have taken a non-cash impairment charge of $16.4 million or $0.13 per share to reflect this.

The hotels will be marketed beginning this quarter and sales are expected by the first half of 2011. The minimum returns due to HPT from IHG will be reduced as the hotels are sold and the expected benefit will be better performing portfolios going forward with improved coverage of our returns.

Based on our projections and the forecasts prepared by our operators, we expect less than one times coverage of our hotel rents and returns in 2010. Our hotel portfolio security deposits and guarantees were not designed to last indefinitely during the lodging downturn as deep or prolonged as the one we have been enduring.

If economic growth does not pick up pace and if increased lodging demand does not continue or result in meaningful ADR growth, some of our security features may be exhausted. However, we believe the existing guarantees and deposits will be sufficient to offset minimum return and rent shortfalls in 2010 for all of our agreements including the Marriott Number Three and Number Four agreements.

It remains difficult to confidently predict 2011 and beyond given the fragile nature of the economic recovery, it's too early to breathe a sigh of relief. Unemployment is very high. Consumer confidence is anemic. The housing market remains weak and the pace of improvement in manufacturing is moderating.

Turning to our TravelCenter investments, this morning TA reported second quarter 2010 financial performance which reflects continued, albeit gradual improvement in the U.S. economy, which enabled further improvement in fuel volume trends.

Fuel volumes this quarter were up 7.1% quarter-over-quarter, across HPT's 185 TravelCenters, increasing for the third consecutive quarter. A mid-signs that worldwide economic growth rates might be moderating, fuel prices generally declined during the quarter, which is generally favorable for TA's pricing strategies.

As a result, per gallon diesel margins have increased almost 20% over the 2009 second quarter. Non-fuel revenues and gross margin also grew this quarter by 6.3% and 7.7%, respectively. Together, these factors led to 30% growth in property level cash flow versus second quarter 2009.

At June 30, TA's primary sources of liquidity its $170 million of cash on hand and the ability to defer up to $5 million of rent per month through December 2010. We remain hopeful that TA's working capital issues have been successfully addressed and that TA is heading down the road to recovery.

However, while TA has demonstrated the ability to pay us rent at the reduced amount, quarter-to-quarter results remain volatile, particularly as a result of large swings in cents per gallon fuel margins. Also, despite the 7.1% quarter-over-quarter increase in fuel volumes at our TravelCenters in the second quarter, volumes remain 18.9% below second quarter 2007 levels.

TA's ability to pass the full contractual rent beginning in 2011 remains dependent on continued economic recovery. Furthermore, as TA noted in their 10-Q they filed earlier today, it is not clear they will have the capacity to fully repay the deferred amounts due on July 1, 2011 as previously agreed. And they plan to engage us in discussions about that before year end. No such discussions have taken place to date.

HPT is one of the most well capitalized hotel REITs and we have maintained our investment grade credit rating throughout this difficult economic environment. The availability of attractive hotel investment opportunities has been disappointing, but is picking up during 2010.

However, debt at servicers and the willingness of lenders to extend and or modify troubled loans has affected the market. We believe this has caused a supply demand imbalance, such that the hotels which are trading today are trading at overly aggressive prices given their performance. We intend to remain a disciplined investor.

We are ready for growth opportunities. We ended the quarter with $712 million of availability under our revolver, $6.4 billion of unencumbered property and no significant term debt maturities until 2012. This remains a challenging economic environment and we intend to continue to aggressively asset manage our real estate investments, maintain our strong capital base and liquidity and grow our real estate portfolio.

I will now turn the presentation over to Mark.

Mark Kleifges

Thanks, John. Hotel portfolio revenues increased $11 million or 4% versus the 2009 second quarter and this represents the first quarter with year-over-year revenue growth, since the 2008 third quarter. Hotel profit margins declined again this quarter with hotel level cash flow available to pay our minimum rents and returns down $2.5 million or 3.5% quarter-over-quarter.

As a percentage of revenue, hotel level cash flow available to pay our minimum rents and returns declined 1.8 percentage points versus the 2009 second quarter to 23.7%. This decline in flow-through was due primarily to rising wage and benefit costs resulting from both higher occupancy and wage rate increases, an increase in repair and maintenance expenses associated with previously deferred projects and step-ups in the FF&E reserve percentages for certain of our hotel portfolios in 2010.

Although, hotel level cash flow declined again this quarter, the trend has improved significantly from the 2010 first quarter, when cash flow was down 19.6% quarter-over-quarter. In fact, four of our hotel portfolios had quarter-over-quarter growth in cash flow in the second quarter.

2010 second quarter rolling 12 month coverage of our minimum returns and rents was below one times for all of our hotel agreements and while we expect this trend to continue throughout 2010, we believe our available credit support is adequate to cover the expected current year shortfalls.

Information regarding security deposit and guarantee balances at the end of the second quarter for all of our agreements is included in note 12 of our Form 10-Q, which we filed earlier today.

Turning to our TravelCenter portfolio, performance was very strong this quarter with cash flow available to pay rent up $20.6 million or 30.2% over the 2009 second quarter. Fuel volumes increased 7.1% and non-fuel revenues increased 6.3% quarter-over-quarter.

Per gallon fuel margin was $0.025 higher in the second quarter of 2010 than last year and non-fuel gross margin percentage increased by 70 basis points. Slight level operating expenses increased 5.4% compared to the prior year.

Property level rent coverage for the 12 months ended June 30 was 1.14 times for our TA Centers and 0.97 times for our Petro Centers. Both of these coverage amounts have been calculated based on contractual cash rents and exclude the impact of the rent deferral agreement.

Earlier today, TA reported second quarter 2010 corporate level EBITDAR of $75.8 million and TA's EBITDAR coverage of contractual rent at the corporate level for the second quarter was 1.23 times. Adjusting rent for the deferral agreement, coverage of cash rent was 1.63 times for the second quarter, which is typically one of the two strongest quarters of the year for TA's business. Year-to-date, coverage of contractual rent was 0.89 times, and coverage of cash rent was 1.18 times.

Turning to HPT's operating results for the second quarter, this morning, we reported FFO of $100 million or $0.81 per share. FFO this quarter excludes a $6.7 million or $0.05 per share loss on early extinguishment of debt and a $16.4 million or $0.13 per share asset impairment charge related to our decision to sell four hotels. EBITDA was $143.1 million in the second quarter and our EBITDA to total fixed charges coverage ratio for the quarter remained strong at 3.4 times.

On May 25th, HPT paid a cash dividend on our common shares of $0.45 per share. Our FFO payout ratio was 56% for the 2010 second quarter.

On July 15th, we announced a regular quarterly dividend for the third quarter of $0.45 per share, which is payable on or about August 24th. With respect to our balance sheet and liquidity, at quarter end we had cash and cash equivalents of $45.3 million, which included $41.5 million of cash escrowed for future improvements to our hotels. And we had only $38 million of outstanding borrowings on our $750 million revolving credit facility.

Turning to our financing and investing activities, during the second quarter, we repurchased $185.7 million face value of our 3.8% convertible senior notes and as a result, we recognized a loss on debt extinguishment of approximately $6.7 million. We used our existing cash balances and borrowings under our revolver to fund the repurchases.

In July, our $50 million of outstanding 9.125% senior notes matured and we redeemed these notes using borrowings under our revolving credit facility. Our next term debt maturity is in 2012.

As discussed on last quarter's call, 2010 capital spending for most of our hotel portfolios will be limited to amounts available in the FF&E reserves. However, we are performing renovations this year at 27 Courtyards included in our Marriott Number One portfolio and 11 Residence Inns in our Marriott Number Two portfolio. As a result, we expect to make capital funding in excess of FF&E reserves for these two portfolios of approximately $103 million in 2010.

We have funded approximately $17 million of this commitment through the second quarter and expect to fund an additional $38 million and $48 million in the third and fourth quarters respectively. In addition, under our lease with TA, we are committed to fund an additional $3.6 million of capital improvements to our TravelCenters.

In closing, we are encouraged by the recent signs of increased demand at our hotels and TravelCenters and believe HPT is well-positioned to both manage through the remainder of this difficult period and take advantage of attractive growth opportunities. Operator, we're ready to take questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We'll go first to Andrew Wittmann with RW Baird.

Andrew Wittmann – R.W. Baird

I just had a question on, starting with I guess TA. The Flying J and Pilot merger is now complete and I know it's still pretty early to see what that means, but just with your initial discussions or ongoing discussions with the folks at TA. Can you just talk about what you feel like the impact of that merger? I guess it's going to be about 570 locations when they're combined, how that impacts their business?

John Murray

I think it's too early to tell on what that impact will be. Obviously, that acquisition closing for Pilot makes them the 800-pound gorilla in the segment and just remains to be seen how they do business going forward. I don't think there's really any way to answer the question.

Andrew Wittmann – R.W. Baird

It does sound like they tried to pull out a lot of competitive changes to their model but I guess only time will tell. Just, again, on TA, I guess in their conference call, they mentioned that they're optimistic that by the end of the year they hope to have a resolution with you guys. Is that something you disagree with, that it's potential that we might get to a resolution for a long-term solution there this year?

John Murray

Well, I definitely agree that they hope there will be a resolution. I think it will be a positive for both sides if the ongoing relationship and their ability to make full payments is clarified. And we haven't had any discussions about that as of yet, but I think the current situation, as defined as it is, creates uncertainty and every time there's uncertainty in the public markets, that has – creates an overhang for the shares. So I think it will be good for both sides to resolve the relationship going forward.

Andrew Wittmann – R.W. Baird

Okay. But it sounds like they hope to engage you formally starting very shortly. Is that true?

John Murray

I believe that's their intent.

Mark Kleifges

Andrew, that's really required, given that the deferral agreement – their ability to defer rent ends at the end of this year. So I think that really will force both parties to the table to discuss the agreement.

Andrew Wittmann – R.W. Baird

Okay. Then just a couple here on the balance sheet. Looks like you announced the closing of the tender offer, something like $139 million, $140 million and then announced here at the quarter a little bit more. So you're doing more open market purchases there is the implication. And then the question is, are you continuing to buy in the open market as much exchangeable notes as you can at par? Is that the strategy we should look for going forward?

Mark Kleifges

Yes. Well, subsequent to the completion of the tender offer, we had a couple of reverse inquiries into us with people willing to sell at an amount slightly below par and we took advantage of those. But we're not actively out in the market looking to redeem additional notes. We're just being opportunistic when situations present themselves.

Andrew Wittmann – R.W. Baird

Okay. That makes sense. On the other side of that, just in terms of – I'm sure, Mark, you're continuing to monitor the unsecured market. What are your thoughts about where pricing would be today and your appetite to maybe pay down some of the line or do another bond offering to fund the capital structures today?

Mark Kleifges

Well, as of today, unfortunately, we don't have a whole loss of uses today for capital. I agree; the markets are extremely attractive. I saw something earlier today where our 2018 senior notes were trading at a yield of about 577. I'm not saying we could issue 10 year paper there today; it would be obviously higher than that. But it is attractive; we only have as of today about $48 million out on the revolver. So just don't have a lot of uses for capital at this stage, absent our ability to be successful in the acquisition front.

Andrew Wittmann – R.W. Baird

Okay. Good. I'll chime back in if I have any more.

John Murray

Thanks.

Operator

(Operator Instructions) We'll go next to Jeffrey Donnelly with Wells Fargo.

Jeffrey Donnelly – Wells Fargo

Good afternoon, guys.

John Murray

Hi, Jeff.

Jeffrey Donnelly – Wells Fargo

Just because, you used the term non-economic with IHG. I guess how does that process work? Are we at the beginning of a stream of hotels that could be ruled non-economic or was that more of a one-off event?

John Murray

Well, there's a provisions in each of our agreements with IHG and I think in some of our other agreements as well but it varies probably between agreements. With IHG, the hotels need to have less than one-times coverage of our returns for three straight years and I don't think that – I don't think this is the beginning of something larger.

I think these are four properties, actually three properties that clearly meet the test and one property that may get there, but happens to be adjacent to one of the other properties. So it just makes sense they that they would be considered for sale together. But I think that this is probably the extent of the sales that are driven by this particular definition and most of our agreements, because we are portfolio fanatics, there's limits of how many hotels in any given portfolio can be considered non-economic, regardless of what the actual test is. So it's possible over the next year or two that you'll see more pruning take place. But I think in terms of non-economic hotels, this is – I think this is probably it.

Jeffrey Donnelly – Wells Fargo

I like the portfolio fanatic term. I'm not sure, Mark, if you're able to do this. Had you – are you, may be quantity for us, if you had sold those non-economic hotels, maybe what your lease coverage would have been on those IHG lease without them? I'm trying to figure out how impactful they would have been.

Mark Kleifges

We really can't do that until we know the sales price, Jeff. Because the way the contract works is the minimum return under the agreement will go down by a percentage of the sales proceeds. So until we know what we sell the hotels for, we can't do that math.

Jeffrey Donnelly – Wells Fargo

Okay. And the write-down does not trigger that at all?

Mark Kleifges

No.

Jeffrey Donnelly – Wells Fargo

Okay. I guess or maybe – I'm not sure if you can go more broadly with that is. Are there a small handful of assets in each one of your pools, not just IHG but some of the other ones as well that to the extent that you did effectuate a sale you could see a material change in your lease coverage rates? I guess I'm wondering if there's a small number of assets that represent the greatest amount of call it underperformance?

John Murray

I don't think I would say that. Whenever you have a portfolio, there's obviously in any given quarter, there's those that are at the top and those that are at the bottom. But what we find is and the reason why it's a three year test in our agreements is what we find is the assets that may have a tough year this year have a great year next year or vice versa.

There's usually – well, there's often regional or industry or natural disaster type reasons why particular hotels or particular regions are negatively impacted in any one year. But it's not usual that that continues for a prolonged period. So we don't sort of have a list of properties that we would love to get rid of. They're all pretty steady performers.

Jeffrey Donnelly – Wells Fargo

And just one last question, on the Intercon lease, I know there was about a $36 million or $37 million security deposit if you will but there's also a limited corporate guarantee. Can you just remind us I guess how that functions and is there a dollar amount that's limited to and I guess what that stands at today?

Mark Kleifges

It is $125 million the corporate guarantee is capped at $125 million. The outstanding or the remaining balance on that guarantee at the end of the second quarter was $37.7 million and that guarantee covers all four of the Intercon portfolios. In addition, there's an almost $37 million security deposit, that security deposit relates to all of the Intercon portfolios, excluding the number two portfolio.

Jeffrey Donnelly – Wells Fargo

Great. Thank you, guys.

Mark Kleifges

Yes.

Operator

Our next question is from Michael Salinsky, RBC Capital Markets.

Michael Salinsky – RBC Capital Markets

Good morning, guys.

John Murray

Hey, Mike.

Michael Salinsky – RBC Capital Markets

Couple quick questions. First, to start on the acquisition pipeline, you mentioned opportunities were still not quite where you wanted. I mean, how far off are we talking at this point? Also, are you seeing any more portfolio opportunities? I think in the past you talked specifically about one-off acquisitions being more attractive, just be interested to get a sense of pricing as well.

John Murray

That's always a tough question to answer because for all the deals that are sort of that are being marketed out there, not only do you, does your confidentiality limit you to not repeating the confidential information but in most cases it even prohibits you from identifying, which transactions you're talking about.

So we have submitted offers on an additional portfolio this quarter that we haven't talked about previously. I think, we were in the top tier of in terms of the amount offered but the terms that we wanted were not acceptable to the seller. So, I think the second round is probably going right now and we're not part of that.

We're not willing to part with hundreds of millions of dollars and have it be possible that the hotel manager could be making a management fee, when we're not earning a reasonable return for our shareholders and so that's a part of our strategy that we're just not willing to change at this point. And so, that's why we were not successful in that transaction, even though I think our purchase price offer was fairly competitive.

There are a number of transactions that are being announced that we just wouldn't be competitive on, I think, that there have been a couple of recent transactions announced which at least through the rumor mill that the implication is that they're trading at somewhere between 2% and 4% cap rates on recent performance and expected upcoming performance and there's a limit to how much growth we're willing to factor into our models in pricing transactions today, so.

Michael Salinsky – RBC Capital Markets

I'm just curious because with your debt you were talking about 5.5% pricing in the unsecured market right now. I'm just curious as to, I mean, what kind of IRRs are you targeting right now or what kind of cap rates? Can you give us that kind of sense, I mean, I understand the confidentiality, but can you kind of give a sense as to how you're kind of looking at it?

John Murray

I think the best way to describe it is that we like to have returns in the range of 8% cash yields going in.

Michael Salinsky – RBC Capital Markets

Okay. That's helpful. Second of all, a question for Mark there. Obviously, you went through in detail the 2010 CapEx spend but as you start to look at budgets here and planning out for the next couple years, any sense as to if that's a recurring amount, as you look ahead to 2011, will there be additional amounts you're going to have to spend?

Mark Kleifges

Yeah. We're starting to, just starting to take a look at next year and I think there's a good chance that we will be funding amounts in excess of the FF&E reserves next year. I know for a fact that there are certain hotels in the Marriott Number One agreement, certain of our Courtyard hotels that we plan on renovating next year that are not in the current year plan.

So, I think you will see that amount for at least, a similar amount, probably, for next year, although we'll probably provide a little more color on that on the third and fourth quarter calls.

Michael Salinsky – RBC Capital Markets

That's all from me, guys. Thanks.

Mark Kleifges

Thanks.

Operator

And next we'll go to Fred Taylor with MJX Asset Management.

Fred Taylor – MJX Asset Management

Actually mine were about the convertible buy-in and possible bond issuance, so mine's been answered. Thank you.

John Murray

Great. Thank you.

Operator

And we'll go next to Andrew Wittmann with R W. Baird.

Andrew Wittmann – R.W. Baird

Yeah. Just kind of follow-up on, I guess, cost controls and margins. I think, John, in your comments, you mentioned that even if we're on this continued glide path of improvement for the rest of this year you still expect same store NOIs to be down. I guess the question is where do we have to be with RevPAR for the back half of the year to see kind of year-over-year NOI same store expansion?

John Murray

I'm not sure if I have a good answer for that question. I think where our projections are today, it's roughly, for the full year we're expecting about somewhere between 1% and 3% RevPAR growth and I think our projections are roughly 2010 over 2009 for a decline in margins of about 150 basis points.

So we would have to see RevPAR gains continue and be higher than the forecast average that I just mentioned and I think, what would be more important is that right now all of our RevPAR gains are coming from, they're all occupancy driven. We're still seeing ADR declines. If we get to a point where we're seeing ADR increase then I think we'll be well on the way to very strong RevPAR and margin growth so that's really the key.

I think the fact that we have four portfolios this quarter that are about 80% occupancy, should be getting to the point where our operators should be able to push rate more. But there's some contracts that are lingering that need to be worked out, some mix issues that need to be resolved.

Andrew Wittmann – R W. Baird

It does seem like, I mean, the brand – some of your brand companies, IHG, Marriott, Hyatt, have been on the record that they are starting to push rates. Do you think that's applying more to their kind of full service or upper upscale brands then to some of the mid-scale stuff that own or are you starting to sense that your operators are moving rates or close to moving rates in your brands?

John Murray

Well, I think, that it's clearly easier in the large urban hotels and the luxury segments, both of which have RevPAR increases well into the teens this past quarter. Those are segments that had been beaten down probably harder than the upscale and mid-priced category and so their recovery is stronger.

But I think in terms of our managers' conviction to wanting to push rate, I think they're trying to push it everywhere. They're just initially finding more success in the luxury and urban full service hotels and it's a little bit more challenging in the suburban business hotels. But it will come. It's just a question of whether it comes next quarter or whether it comes early in 2011.

Andrew Wittmann – R W. Baird

Okay. That makes a lot of sense. Thank you.

Operator

And we'll go to Smedes Rose with KBW.

Smedes Rose – KBW

Thanks. I just wanted to make sure on something. You're refunding a security deposit in the fourth quarter as well, is that right? Can you just remind us how much that is?

Mark Kleifges

It is roughly a $17 million security deposit on the Marriott 2 portfolio for the 18 Residence Inns and at the end, that lease expires at the end of this year and Host Marriott has indicated that they're not planning to renew. So assuming there's no default between now and then, we will refund that deposit to Host.

Smedes Rose – KBW

Okay. So your non-escrowed cash balance at a little less than $4 million at the end of the second quarter, should we just assume all these are drawn on the credit line, the incremental capital expenditures and the security deposit?

Mark Kleifges

Yeah. Well, for the most part. I mean, there will be some free cash flow generated by the business. We're not at 100% payout ratio.

Smedes Rose – KBW

Yeah. No. I meant beyond the cash flow generated.

Mark Kleifges

Right. Yes, yes, that for now will be drawn on the line, yes.

Smedes Rose – KBW

Okay. And then, just as a reminder, when you make these incremental investments, you do get – you get sort of a guaranteed return on the incremental investment, right, in terms of your rents going up?

John Murray

Yes. The returns in rents that are due to HPT for these capital expenditures are rent increases as we fund those improvements.

Smedes Rose – KBW

Okay. At about 10%, is that right or…

John Murray

On the Marriott 1 and 2 portfolios, yes, that's correct.

Smedes Rose – KBW

Okay. Thank you.

John Murray

Thank you.

Operator

We have a follow-up from Jeffrey Donnelly with Wells Fargo.

Jeffrey Donnelly – Wells Fargo

Yeah. Actually just a question on TA, I know it's a way off, but as you guys think about the restructuring of the TA lease, I guess how do you weigh that tradeoff between maybe maximizing your collections from TA but arguably sustains some coverage risks in the future and might make TA uncompetitive versus conversely giving them a bit more breathing room under a renegotiated lease. And while you get less cash, that could increase the value of the lease to HPT because of the reduced risk. I mean, have you guys given that much thought one way or the other at this point or is it still a little early?

John Murray

I think that's across of the decision making process that needs to take place and I'm sure we're going to vet that all very carefully but I don't want to pre-negotiate it over the phone on the call today I guess.

Jeffrey Donnelly – Wells Fargo

I can understand. But actually one other question on the same topic is some of the more admittedly, I'll call them retail convenience store oriented sale leasebacks, do have a gas station component to them, but they're not diesel for trucks.

They tend to get down around 1.5 to 2 times cash flow coverage of the market rent. Do you think that's going to be something like these market comps that get factored into renegotiations or do you think it's less driven by that?

Mark Kleifges

I think it will be based on what we believe the earnings; the long-term earning power of TA is not market comps.

Jeffrey Donnelly – Wells Fargo

Okay. Great. Thanks, guys.

John Murray

Thank you.

Operator

That concludes our question-and-answer session. I'll turn the conference over to John Murray for any additional or closing comments.

John Murray

Thank you very much for joining us today. We look forward to seeing you at upcoming conferences and on our call next quarter. Have a nice day.

Operator

And that does conclude today's conference. Thank you for your participation.

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Source: Hospitality Properties Trust Q2 2010 Earnings Call Transcript
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