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DiamondRock Hospitality Company, (NYSE:DRH)

Q3 2010 Earnings Call

October 19, 2010 10:00 a.m. ET

Executives

Mark Brugger – Chief Executive Officer, Director

John L. Williams – President, Chief Operating Officer, Director

Sean M. Mahoney – Chief Financial Officer, Executive Vice President, Treasurer

Analysts

Jeffrey Donnelly – Wells Fargo

Joshua Attie – Citi

Ryan Meliker – Morgan Stanley

David Loeb – Baird

Andrew Andora – B of A/Merrill Lynch

Dennis Forst – Keybanc

Daniel Donian – Janney Capital

Tim Wingard – Deutsche Bank

Gene Bedsell – RBC Capital Markets

Su Oy Pan – Capital

Will Marks – JMP Securities

Operator

Good day ladies and gentlemen, and welcome to the Q3 DiamondRock Hospitality Company Earnings Conference Call. My name is Marisa, and I’ll be your operator for today. (Operator instructions.) I would now like to turn the conference over to your host for today’s call, Mr. Mark Brugger, the Chief Executive Officer. Please go ahead.

Mark Brugger

Thanks, Marisa. Good morning, everyone, and welcome to DiamondRock’s Q3, 2010, earnings conference call. Today I’m joined by John Williams, our President and Chief Operating Officer, as well as Sean Mahoney, our Chief Financial Officer.

As usual, before we begin, I would just like to remind everyone many of our comments today are not historical facts, and are considered forward looking statements under Federal Securities laws, and may not be updated in the future. These statements are subject to numerous risks and uncertainties described in our Securities filings. Moreover, as we discuss certain non-GAAP financial measures, it may be helpful to review the reconciliation to GAAP in our earnings press release.

DiamondRock’s positive Q3 results met our internal expectations, and reaffirmed our conviction that a sustainable lodging recovery continues to build momentum. Importantly, RevPAR gains in the quarter were led by improvements in average rates, which increased at over two-thirds of our hotels. With favorable demand trends, we continue to benefit from the ability to shift the mix at the hotels away from lower rated segments, into higher rated segments. Particularly our most profitable segment of business transient. In the quarter, business transient RevPAR was up 16%, while lower rated leisure RevPAR was actually down 2%.

To understand the power of mix shift, you only need to know that the average rate differential is over $30 in these two segments last quarter. This all leads to the question of how to improve demand trends and mix shift specifically impacted DiamondRock’s portfolio. Well, performer for acquisitions, RevPAR increased 5% from the comparable period, and even our profit margins extended 33 basis points.

As we discussed in our prior earning conference call, the Westin Boston faced difficult comparison after gaining 15% market share in Q3 ’09. Excluding the Westin Boston, our RevPAR would have increased 6.8% and profit margins would have been about 100 basis points better. The company also reported adjusted EBITDA increased over $2.3 million from the comparable period, and adjusted FFL per share was $0.15.

In the quarter, the company continued executing its business plan to aggressively pursue attractive investment opportunities. Our DL flow came from diverse sources, including financial distress, such as the Allerton deal, our Marriott sourcing relationship, such as the Renaissance Charleston acquisition, or attractively priced opportunities from our relationships, such as the Hilton Minneapolis, or Hilton Garden in Chelsea acquisitions.

In total, during 2010, we’ve invested $325 million in four separate transactions. Our three hotel acquisitions are performing exceptionally well, and all experienced above market growth during the Q3. The Hilton Minneapolis and the Hilton Garden in New York City both grew RevPAR more than 20%, and the Renaissance Charleston’s RevPAR increased a strong 13%. The Allerton Chicago debt deal continues to go as expected, with our foreclosure of equity working its way through the courts.

Additionally, we are exercising our other rights under the law to establish a cash lock box, and collecting close to $2 million in cash interest payments. We continue to be optimistic about our prospects for the well located Allerton Hotel, and are particularly pleased with our basis in the hotel, which we believe is at a 50% discount to replacement costs.

Overall, DiamondRock has terrific liquidity, and remains well-positioned to actively pursue acquisition opportunities as a result of our low leverage, our undrawn $200 million corporate evolver, 13 unencumbered hotels, and over $90 million of unrestricted corporate cash at year end.

Additionally, we expect strong internal growth from our existing portfolio, and through asset management initiatives. The largest opportunity is the renovation and repositioning of the Marriott Frenchman’s Reef Resort in the U.S. Virgin Islands. John will talk more about this $45 million investment in a minute, and there’s a detailed presentation available to you on our website. Moreover, our active management team continues to uncover discreet ROI capital projects at our existing hotels, that range from energy projects to meeting space expansions.

As always, we remain focused on mining value creation opportunities, wherever they may lie. With that, I will turn the call over to John for a more detailed discussion on fundamentals and acquisitions.

John Williams

Thank you, Mark. The Q3 continued the operating trends of 2010, with improving RevPAR led for the first time since Q2 of 2008 by average rate increases for the portfolio. Performer RevPAR increased 5% for the portfolio for Q3, to approximately $112 as result of a 2.8% increase in average daily rate, and 170 basis point increase in occupancy. Overall, occupancy was relatively strong at 75.5%.

The increase in portfolio RevPAR was driven by improvements in several room segments. Business transient revenue, by far our highest rated segment, was up 16.1%. Group revenue was flat, and leisure and discount transient revenue was down 2.4%. Lower rated contract and other revenue was up 13% in Q3, but represents only about 4.1% of our total portfolio room revenue, and the increases were concentrated at LAX, Orlando Airport, and Torrance.

As you’d expect, in the early stages of recovery, rate increases are the result of shifts in segmentation from lower rated leisure and other, to higher rated business and group. But more importantly, from shifts to higher rate categories within segments. In the Q3, corporate and premium demand was very strong. Room rates in these two categories increased 25.4% at a rate 2.4% higher than Q3 2009, resulting in an almost 30% increase in room revenue coming from our highest transient rate categories.

In addition, special corporate revenue was up over 16% in the quarter. Q3 also continued the positive trend of accelerated short term bookings. In the quarter, for the quarter, group room nights booked increased 36% compared to Q3 2009. Portfolio group bookings pays for 2010, after adjusting prior year’s definite revenue for cancellations and attrition is up 3.3%, versus same time last year, as of Q3.

Pace has improved sequentially in each of the last four quarters. 2011 pace continues to improve, as of Q3 group revenue pace is off 3%, versus same time last year, representing continued improvements from Q1 of this year when pace was off over 15%. Pro forma EBITDA margins for our hotels improved 33 basis points. Overall, cost containment and profit maximization remains a high priority for our asset managers and operators.

We’ve had big wins in changing staffing models, focusing on food and beverage profitability, and portfolio wide initiatives, such as our energy conservation program, which ranges from efficiencies in lighting and thermostats to kitchen equipment. However, overall profit margin improvement was restrained in the Q3 by the performance of our Boston Westin hotel, which faced a very difficult comp, and contractual increases in wages and benefits, and the Marriott resort in St. Thomas, which incurred lost revenue and incremental operating costs from Hurricane Earl.

Margins were also negatively impacted by an almost $900,000 reduction in cancellation and attrition fees in the quarter. Food and beverage was a mixed story in the quarter. Total food and beverage revenue in Q3 was down slightly as group banquet revenues fell. In spite of lower volume, margins were up slightly. The margin improvement came from improved profitability in the property restaurant outlets and room service, where margins were up over 300 basis points, in spite of lower volume.

As we mentioned on prior calls, outlet profitability has been a particular focus of our asset managers for the past year, and these results are very rewarding. As a testament to our effort and continuing focus on cost containment efforts in 2010, I wanted to share a few highlights.

Portfolio labor and benefit cost in Q3 remain relatively flat from Q3 2009, in spite of higher occupancy. Sales per man hour improved 6.2% in Q3, and man hours per occupied room improved 6.3%. Support costs per available room, including property level GNA, repairs and maintenance, utilities and sales and marketing were up 5% in the quarter, due mainly to bonus accruals, and Marriott sales initiatives. These two cost categories negatively impacted margins by 81 basis points.

Our Q3 property taxes are $1 million lower than the comparable period of 2009, and were positively impacted by the Q3 multi-year appeal at the Renaissance Waverly. We continue to be vigilant in our efforts to minimize property taxes in our hotels, and are cautiously optimistic that we’ll resolve several appeals during the Q4.

Turning to CAPEX, we’re fortunate that we entered the downturn with a mostly renovated portfolio, and were able to appropriately curtail capital spending during this downturn, to only necessary or truly value enhancing projects. We’re budgeting to invest approximately $37 million in the portfolio in 2010, and the underfunded portion of 2010 CAPEX’s budget would be $7 million, with the balance coming from property level reserves. In Q3, we invested almost $7 million in the portfolio.

Last quarter we told you we were in the final stages of planning a multi-million dollar renovation and repositioning of our Marriott resort in St. Thomas in the U. S. Virgin Islands. We’ve studied and planned this project for the past three years, and have now finalized the plan, and are moving into the implementation phase. The resort enjoys an exceptional location on one of the most airline accessible islands in the Caribbean. As a U. S. Territory, the island requires no passport or customs review of U. S. visitors, and of course the language and currency are familiar. The $45 million renovation and repositioning of this Marriott Flagship Resort will dramatically enhance guest experience, providing significant rate potential, and improve operating efficiency and provide dramatic energy efficiency and savings. Key elements of the project are a major redesign of the resort pool with state of the art features, including multiple pools, cascading waterfalls, body beds, a sun deck, and a new swim up bar, all of which will provide a premium resort experience.

Each of the guest rooms and bathrooms will feature new modern design elements to enhance lighting, comfort, and feel. The renowned interior design firm, Leo Daly, is the designer for the new guest rooms and bathrooms. A completely new, premium spa will be created at the resort. The plans incorporate the creation of a dedicated spa pool, additional treatment rooms, and visual and sensual elements appropriate for a resort spa experience, enabling the resort to attract high rated groups who will not currently consider the hotel.

A comprehensive redesign of the mechanical plant will allow the hotel to generate its own electricity, improve air flow in common spaces, and replace packaged terminal air conditioning units in the guest rooms with a central system. These enhancements will greatly reduce the energy consumption, while dramatically improving the guest experience. In addition, the project will provide for upgrades to the food and beverage outlets, renovation of the main ballroom, balcony upgrades, renovation to the boat dock, and improvements to other facilities designed to enhance the guest experience.

The majority of the renovation and repositioning will occur during the summer of 2011, when the company will close two of the resort’s four buildings, approximately 300 guest rooms, during the seasonally slow period between May and September. Marriott International will participate in the funding of the project, with a cash contribution, and fee concessions. Once complete, the resort will be one of the premier group and leisure destinations in the Caribbean for years to come.

Based on the market work of Ernst and Young, Marriott’s feasibility team and our own expertise, we expect this $45 million project to have an internal rate of return of over 20%.

Now, on to acquisitions. As Mark said, we’ve been very active this year. In Q3, we acquired the Charleston Renaissance Hotel. This 166 room hotel enjoys an excellent location, in the coveted historic district. The $39 million purchase price reflects approximately an 8% cap rate on actual forecasted 2010 NOI. This opportunity was a result of our special sourcing relationship with Marriott International. It was facilitated by leveraging the contractual right of first offer that Marriott enjoyed under its management agreement. Marriott presented us the opportunity at one of our regularly scheduled acquisition pipeline meetings, which enabled us to negotiate a deal with the owner to buy the hotel before it was marketed to other potential buyers.

Also in the quarter, we bought the Hilton Garden Inn in the Chelsea district of Manhattan for $69 million. The price reflects a 7% cap rate on actual forecast 2010 NOI. Adding to our presence in the rapidly recovering Manhattan lodging market, at an attractive going in yield. The hotel opened in 2007, has very significant growth potential, and no significant capital needs.

Our Minneapolis Hilton, acquired in Q2, is performing as expected, and our $155 million investment represents a 7.4% cap rate on actual forecast 2010 NOI. For Q3, our three acquisition hotels grew RevPAR almost 19%, and has profit margin 322 basis points. The acquisition market has evolved with each passing quarter in 2010. While we focused on financial distress earlier on, with deals like the Allerton, we are seeing more deals come to market for a wide variety of reasons. There are a number of opportunity funds that have reached the end of their life and need to liquidate, there are hotels with debt coming due in the next year that cannot be refinanced at the current LTD levels. While not truly distressed, these sellers are very motivated.

Additionally, public reach with a low leverage model continue to have an advantage over private buyers, that have traditionally relied on high leverage, which no longer exists. We intend to continue to work hard and opportunistically to find attractive investments to create shareholder value.

Let me conclude my remarks by reiterating a theme Mark hit on earlier. The strengthening lodging recovery is under way, and our positive Q3 results show that continuing trend in revenue and profitability. As business investment and profitability continue to improve, and new supply remains constrained, the lodging industry should prosper for a number of years. Mark?

Mark Brugger

Thanks. As John noted, operating trends continue to show positive momentum and visibility is improving. Accordingly, we are updating our full year 2010 guidance. We now expect RevPAR growth of 3 to 5%, adjusted even out of $135 to 138 million and adjusted FFL per share of $0.61 to $0.62. The company’s guidance includes only our period of ownership for the three hotel acquisitions, as well as projected cash interest payments of approximately $2.5 million from our senior loans securing the Allerton Hotel.

In conclusion of prepared remarks, let me say that we believe DiamondRock is very well positioned to deliver shareholder value through both internal and external opportunities. Our high quality portfolio, enhanced by our recent acquisitions is primed to take advantage of lodging recovery, as well on continue to benefit from thoughtful management initiatives like the Frenchman’s Reed repositioning. With acquisitions, the company has already demonstrated the ability to source strong deals in this market, and our fortress balance sheet enables us to opportunistically pursue deals going forward. With that, we would now like to open up the call for any questions that you might have. Operator?

Question-and-Answer Session

Operator

(Operator instructions.) You do have your first question, on the line I have Jeffrey Donnelly, from Wells Fargo. Please proceed.

Jeffrey Donnelly – Wells Fargo

Good morning folks. Just a first question about the Westin Boston, and the market share gains that you had last year. How much of that were you able to hold on to in Q3 2010 versus the market, and maybe the followup, did you think about next year for that asset in particular? You put in some expectation that we could continue to see market share get handed back a little bit, so there is growth, but just maybe not as strong as the local market?

John Williams

Yeah Jeff, this is John. There are a couple of things going on in Boston. First of all, last year the Back Bay hotels opened the year without as much group business on the books as it turned out they needed, so they reversed that strategy this year. So we were able to gain pretty dramatic market share, double digit, or high teen’s double digit market share last year. So they went into this year with a lot more group room nights on the books, the market share was – we gave back some of that market share. In terms of next year, the phenomenon in Boston, for us, is the more advanced at the BCEC, the better we do, obviously because we’re attached, so fewer events, even though there are more room nights, tends to be a negative for us, which is what happened this year. Next year, we see a fairly flat city wide pattern, but we still anticipate regaining market share, just because of our ability to put room nights on the books this year in group.

Jeffrey Donnelly – Wells Fargo

That is helpful, and I could switch gear, I guess, to two other properties. The Vail Marriott and Frenchman’s Reef, they just have big seasonal shifts, and those coming up, are you able to give us a sense of how demand and I guess booking pace is looking at in those two assets in Q4 and Q1?

John Williams

Yeah, Q4 at the Vail Marriott is up dramatically in group pace, over 60%. Frenchman’s Reef, was that the other one you asked?

Jeffrey Donnelly – Wells Fargo

Yeah, Frenchman’s – I was just kind of curious what you were seeing down there.

John Williams

Frenchman’s is down a little bit in the Q4, in anticipation of the renovation, and of course next year pace is off dramatically, because they haven’t been booking groups for the 3rd and part of the Q4.

Jeffrey Donnelly – Wells Fargo

And you know, on Frenchman’s, to talk a little bit about your renovation plan, I’m just guessing, but it sounds like you’re up scaling Frenchman’s a little bit, or at least bringing it back alive. Are you going to give us some details on anywhere Frenchman’s RevPAR index was versus its immediate peers, or maybe its aspirational peers? I guess I know what I’m looking for, I’m wondering how much higher the rate is, for example, at the Ritz St. Thomas, because even the presentation you put up online, I’m trying to think about how much of that incremental EBIDTA you see down the road as coming from sort of taking up the rate structure versus lowering its expense structure.

Mark Brugger

Jeff, this is Mark. I’ll take that one. On our website, we posted a presentation on Frenchman’s and the renovation, where we project over the next five years, we think the RevPAR there – there’s opportunity, we’ve commissioned a study to look at the other resorts. Every island is different so you really have to use a lot of judgment in doing a review, but looking at a number of the other resorts in the Caribbean that we think will be competitive after we do the spa, the resort pool and get the better room product in there, we think there is a tremendous amount of rate potential at the hotel.

The other thing that’s going on with this project, and you’ll see this on the website, is we think margin is going to get substantially better, mostly due to the $15 million mechanical improvement project that we have at the property. So we’re going from the local utility generating the power to a new highly efficient self-generated plant, and we’re also getting rid of what they call the Ptech units in the room, and doing a central pipe system throughout the whole hotel. Obviously $15 million is a big investment, but we think there’s substantial return on that, and that should have a great impact on the profit margins for the hotel going forward.

Jeffrey Donnelly – Wells Fargo

That sounds great, and just one last question. Can you give us some color on what you’re seeing in the single asset financing market? You know, increasingly we’re hearing there are more signs of aggressiveness returning to hotel financing, and I guess I’m curious what you’re seeing, just given some of the acquisitions you’ve done. If you’ve had quotes out there, are lenders looking strictly at debt yields, and where have they moved in the last few months, and increasingly I’m hearing signs of people looking at sort of stabilized EBITDA 2012, 2013 levels and I just want to get the color from you.

Sean Mahoney

Sure, Jeff, this is Sean. You know, you’re right. The secured market has gotten much more favorable over the last sort of eight to twelve weeks. What we’re seeing lenders underwrite to now is anywhere from a sort of 12 to 13 debt yield. We’re seeing rates come in at the low to mid fives. SunStone obviously put a great mark in the market with the Times Square loan that they announced a few weeks ago, so we think that the secure market is coming back. We’ve also heard, from our lenders, that hotels are going to be a much more acceptable inclusion within the CMBS pools that are going to be announced shortly, which is obviously very favorable for us. So we think the return market has improved rapidly, and we’ve been talking to lenders to keep abreast of their best status. And the LPV that we’re looking at is limit 60% is what we know people are lending to.

Jeffrey Donnelly – Wells Fargo

Is that 60% on today’s cost? Today’s transaction cost?

Sean Mahoney

Yes. But we have not heard people looking to 2012 to underwrite. I hope that’s true.

Jeffrey Donnelly – Wells Fargo

Thank you, guys.

Operator

Your next question comes from Joshua Attie at Citi. Please proceed.

Joshua Attie -- Citi

Thank you. Can you talk about some of the hotels that were a drag on growth during the quarter? Maybe the two in Atlanta, the Chicago Marriott, Orlando? What caused the underperformance versus the rest of the portfolio, and also the market average, and what the outlook is for these properties?

John Williams

Sure, this is John. In Atlanta, our results are pretty heavily skewed by the Waverly Renaissance which is a large hotel. We’ve known all year that they’ve had a fairly significant Q3 group pace issue, which they were not able to make up. It’s a unique hotel, it’s a regional group meeting facility, so even its RevPAR index is a fairly inconclusive sort of number. They lost share, but it really depends upon the groups that they are able to put in. They’ve been hurt by the new supply in midtown and Buckhead, and to some extent the renovations downtown where those hotels, in a weak market, have gone after groups who traditionally they’ve not competed for, and the Waverly suffered accordingly.

In Chicago, we suffered a little bit by the financial calendar there, but also because Conrad was up almost 15% in RevPAR, they had some margin challenges, mainly with unallocated expenses. But the Chicago Marriott had a pace in the Q3 which we knew was going to be somewhat problematic which held down their results. So Chicago was a little bit soft in that regard. The Orlando market is a very different situation. The situation there is the resort quarter hotels, which had a very tough year last year, went after group business that is really unprecedented for them to go after. So the airport market suffered, because groups that they traditionally cater to were not available.

Joshua Attie -- Citi

Thanks, and for Chicago specifically, what is the outlook for the next 12 months? Better, or is the group issue they had in the Q3 persisting?

John Williams

Well Chicago, first of all, gained market share, has gained market share over the past 12 months, so our hotels are doing well within the market. The market has a fairly flat convention calendar next year. However, the transient pace appears to be on an uptick, and we expect that to continue, and we’re obviously in the initial throes of the special corporate rate negotiations, so we’ll see how that turns out, but in general, our Chicago hotel, and we’ve instructed it to be aggressive, is charging rates that are fairly aggressive compared to the marketplace, so that may cost it a little bit of occupancy in the short term, but we think it’s a good long term strategy. So we think Chicago, next year, will be flat on the city wide calendar, but we hope that the transient trends continue to improve.

Joshua Attie -- Citi

Thanks, and can you also talk a little bit about the dividend philosophy and how you plan to determine the appropriate payout as the cash flow improves next year? And also, what you think the right structure is in terms of Q4 special dividend or a more regular payout?

Mark Brugger

Hey Josh, this is Mark, I’ll take that one. Obviously the dividend, we’re an income company first, it’s obviously a focus of our company, we want to get back to paying dividends as quickly as practically we can. It’s been a discussion with our Board, we had a Board meeting last week where we discussed it. We have another Board meeting coming up in December, it’s obviously a topic. I think for fair enough, going forward, the 2011 dividends, we want to see the 2011 budgets, understand where we are on cash and on acquisitions over the Q4. There’s some things pending that we’re trying to evaluate and see how they play out, and then on the philosophy, you’re right.

There’s kind of two ways to go. There’s kind of rationing out, and paying a percentage of your cap and going forward with that, or doing something that’s going to be sustainable throughout an entire cycle, with a special yearend dividend catch up, if you will. Every year depending how good the results are for that particular year. Our Board hasn’t made a final decision on which way they think is better. There are pros and cons to both philosophies, so we’ll continue to work our way through and report when we have something to announce on that.

Joshua Attie -- Citi

Okay, thank you.

Operator

And your next question comes from the line of Ryan Meliker with Morgan Stanley. Please proceed.

Ryan Meliker – Morgan Stanley

Good morning guys. I just had a couple of things here for you. First of all, I was wondering, in the press release you gave Q1, Q2, and Q3 pro forma RevPAR. Do we have what Q4 09 RevPAR was? And then also, when I looked at, in the press release, you usually break out your hotel operational data, the other fixed expenses, it may not be a huge number, but it was up almost 60% this quarter, after being down I guess 10% year to date through the first two quarters. What was going on there, and is that trend going to reverse itself in Q4? Just help me understand what’s happening there. And then the third and final item was incentive management fees went down this quarter, while RevPAR went up, and margins went up. Can you give us some color as to what is going on there as well? Thanks.

Mark Brugger

Okay, three questions. This is Mark. First one, IMF, three hotels are paying IMF in our portfolio in the Q3, there are a couple of others on the brink of potentially paying in 2011. Hopefully more of them do, because that means our properties are doing better. The bulk of the incentive management fees paid in the Q3 were related to the Chicago Marriott, where the manager there gets 20% of the profits, so we always pay incentive management fees there.

The variation between the 3rd quarter in 2010 and the comparable period last year just depends what hotels are doing better or worse, so each one, obviously, has its own threshold for paying incentive management fees, and it just happened to be the way it played out between which hotels were performing better and which one performed a little worse. I guess to our benefit, that ones that were in incentive management fees last year, some of those hotels performed a little worse this quarter, and some of the ones that were stars in the quarter are well below the threshold to pay the incentive fees. So that’s the story there. On Q4 09 pro forma RevPAR, I think the dollar amounts of RevPAR, it would be – I’m just calculating here – a little over $103. If that’s helpful.

Ryan Meliker – Morgan Stanley

That is helpful, thank you. And then the other fixed expenses, can you give us some color on what was going on there?

Sean Mahoney

Sure. This is Sean. The fixed expenses that are primarily driven both by our rooms department expenses as well as support costs, which are driven by admin as well as sales marketing cost, and what we’re seeing on the cost side is bonuses come back this year into the operating costs, that obviously were not paid last year, which had an impact on our margins and our operating costs, as well as the sales and marketing which is primarily driven by the Marriott properties, who instituted sales force one during the year.

Ryan Meliker – Morgan Stanley

So that change in cost isn’t going to be coming back out in the Q4? It’s not just a move from one Q to the next, we should ultimately expect costs and other fixed expenses to be going up year over year, given sales force one and all the other items you suggested?

Sean Mahoney

Well, in the Q3, there were some true ups in sales force one that are a little heavier in the Q3 than we expect that they will be in the Q4, but there are some ongoing expenses, so we do expect that category to trend higher. The Q3 may be a little heavy compared to the run rate.

Ryan Meliker – Morgan Stanley

And then the other number that went up for both periods is ground rent, and that’s really driven by the addition of the Minneapolis Hilton, where we didn’t have ground rent for that hotel, historically.

Sean Mahoney

Right.

Ryan Meliker – Morgan Stanley

Great, that’s helpful. Thanks a lot.

Sean Mahoney

Thanks, Ryan.

Operator

And you next question comes from the line of David Loeb. Please proceed.

David Loeb – Baird

Hey guys. I wonder if you can just give a little more detail on the Allerton, and where that is in the process, what you think the ultimate outcome is?

Mark Brugger

Sure Dave, this is Mark. Good morning. The Allerton, we continue to prosecute the foreclosure, that process, according to our local counsel, takes a while. We would expect it, if that comes to fruition that filing gain fee title, the property next spring, would be kind of the normal timeline with all the papers that are filed, and counter papers and etc. The MAS lender, at this point, has foreclosed out the equity, so there is only one person behind this now trying to hold the equity position. Our understanding is their goal is to try and sell the hotel and get us paid off. In that event, we get paid off under loan documents, but it’s hard to predict whether that will occur or not, so I’m not going to speculate. But our plan is to continue to enforce our rights under loan documents, proceed with the foreclosure, and then in the spring, if we can’t under shift, then we’ll look at rebraining opportunities and re-positioning the product.

David Loeb – Baird

Okay, but at this point, the way it’s looking, in the spring you may end up just getting paid back.

Mark Brugger

We could get paid back next week. We’re not privy to what their marketing efforts are, on a daily basis. They’re not keeping us informed, they’re obviously working with several potential buyers. They’ve asked for pay off notices at various points over the last two months, but at this point, there’s nothing imminent that we’re aware of.

David Loeb – Baird

But in the meantime, you’re getting interest.

Mark Brugger

Yes, we’ve collected over $2 million.

David Loeb – Baird

Great, thanks.

Operator

And your next question comes from the line of Andrew Andora (sp) from B of A/Merrill Lynch. Please proceed.

Andrew Andora – B of A/Merrill Lynch

Hi, good morning Mark, John, and Sean. I just really had a follow up on Jeff’s question from earlier with regards to the financing market. Obviously you guys have a pretty conservative balance sheet, 13 of 23 properties are unencumbered. When would you consider using some asset based debt, and maybe if you could remind us of some of your leverage ratio goals at this point in the cycle?

Mark Brugger

Sure, we’ve explored some property level financing over the last month or so on specific assets that probably had a more stable profile, vis a vis where they were compared to peak cash flow. I think we would look into actually putting some of the secure financing in place, obviously we need to get through our corporate cash first, of course, using securing financing, but our view today is that assuming the proceeds are where we need them to be, the rates today are attractive for secured financing. We calculate our acquisitions path to be at roughly $200 million of which about $50 million is corporate cash is available for that, so the balance of that is either through secured financing or through our corporate line of credit. So that’s sort of where we are on the secured market.

John Williams

This is John, I would just add that on a secured market, the problem is not interest rates or term, the problem is the value calculations and V and the LTV is calculated on what we consider to be cyclically low cash flows, so it’s not the most efficient way to leverage up.

Sean Mahoney

And to go through it quickly, what our leverage policy is, we use a multi-pronged approach to leverage, and just sort of what we believe is the appropriate target leverage for lodging rates, generally speaking, the answer is roughly 35% debt to cost, but we measure that by making sure we’ve got a minimum fixed charge coverage of about one and a half times trough cash flows. We also have a maximum net debt to EBITDA of trough EBITDA of about seven and a half times. We also have a preference to not have cross collateralized debt, and we also have a preference to keep at least half of our portfolio unencumbered, and we measure that either through EBITDA, number of hotel rooms, there’s various ways to measure that, but when you put that all together, the answer is roughly 35% leverage on debt to cost.

Andrew Andora – B of A/Merrill Lynch

Got it, that’s very helpful. Just one last one, in regard to the Hilton Garden Inn purchase, and now you guys have three limited service properties here in New York. Do you think there are additional opportunities for you to acquire limited service assets in the market, or are there any other MSA’s where you think limited service would fit into your portfolio well?

John Williams

This is John, yeah, I think there probably will be additional opportunities in New York City. There’s nothing immediate, in terms of existing hotels. In other MSA’s, we’ve been clear that in prime top five/ten MSA urban markets, that we like the limited service model because of its ability to attract full service rates, and operate under limited service cost structures.

Andrew Andora – B of A/Merrill Lynch

Got it, okay, thank you.

Operator

And your next question is from the line of Dennis Forst, from Keybanc. Please proceed.

Dennis Forst – Keybanc

Yeah, good morning, guys. I had a couple of questions. There were a couple of one time charges in the Q3, I’m wondering what the outlook is for the Q4. It should be a pretty clean quarter?

John Williams

Yeah, we’re hoping for no hurricanes in the Q4. A lot of the adjustments were one time, we expect them to only be Q3.

Dennis Forst – Keybanc

Okay, and the hotel acquisition cost for the Chelsea was in the Q3?

Sean Mahoney

Correct.

Dennis Forst – Keybanc

Okay, so that won’t go to Q4. And then I need a clarification. I noticed the Waverly numbers, and you had mentioned the Waverly was a weak number, but the EBITDA this year Q3 was more than double last year’s Q3. What was the one time charges in the Waverly last year?

Mark Brugger

This is Mark. The Waverly results are impacted by a real estate tax appeal that came through in the Q3. So you’re seeing that benefit flow through in the EBITDA number.

Dennis Forst – Keybanc

And how big was that?

Mark Brugger

Sean, what was that?

Sean Mahoney

It was about $1.5 million. The other one-time thing that’s impacting our property schedule is the hurricane costs are also in that schedule. This is a follow up to Ryan’s question earlier, of about $1.4 million, which is being added back for corporate adjusted EBITDA, adjusted FFO, but in our detailed schedules in the back of the press release that $1.4 million is not – should not be recurring.

Dennis Forst – Keybanc

Great, and should not that tax adjustment be an offset for that?

Sean Mahoney

That’s there. But of that $1.5 million, roughly, a portion of that, about a half million dollars will relate to the current year taxes. It was a multi-year appeal. So it was reversed in the books this year.

Mark Brugger

Our philosophy is that real estate taxes change constantly, assessments come through constantly, so we build those into the numbers that we report, which is a recurring thing when you have real estate.

Dennis Forst – Keybanc

Okay, and then lastly, stock comp. Traditionally stock comp is higher in the Q4, as you make some true ups. Is that true?

Sean Mahoney

No, we record stock comp on an effectively straight line basis through the investing period. We have some—

Dennis Forst – Keybanc

It seems like last year, and I think the year before was relatively high in the Q4.

Sean Mahoney

Well, the management team has changed, both with the Q4 last year had the impact of our old general counsel, that’s stock comp, as well as from Bill McCarten, our ex-CEO.

Dennis Forst – Keybanc

So this year should be more normal.

Mark Brugger

The Q4 for us, also is a longer – we go by the Marriott period, so our Q4 is actually longer than our Q3, as far as financial reporting, so just by that fact you’re going to have more weighing of the stock comp in the Q4.

Dennis Forst – Keybanc

But in general, stock comp should be normal this year’s Q4 where it was not last year?

Sean Mahoney

That’s correct.

Dennis Forst – Keybanc

Okay, great. Thanks a lot.

Operator

And your next question comes from the line of Daniel Donian of Janney Capital. Please proceed.

Daniel Donian – Janney Capital

Thank you. Just going back to the Q4 numbers, pro forma, is there any way you can give us what the adjusted margin was as well? And if you want to get back to me on that, that’s fine as well.

Mark Brugger

We’re looking through our schedule right now.

Sean Mahoney

The margin for the Q4 last year was about 22%.

Daniel Donian – Janney Capital

Okay.

Sean Mahoney

And that’s with the hotel adjusted EBITDA online.

Daniel Donian – Janney Capital

Okay, right. And then room nights for the Q4 2010. What are you guys assuming there?

Sean Mahoney

It’s $1,231,981.

Daniel Donian – Janney Capital

Perfect. Okay, that’s it for me.

Operator

And your next question comes from the line of Tim Wingard from Deutsche Bank. Please proceed.

Tim Wingard – Deutsche Bank

Thanks, good morning. I was wondering if you guys could provide some commentary on FNB revenues, and what you’re seeing as far as trends go. Are guests spending less than you may have expected in the recovery, and what types of guests are spending less or more?

John Williams

Yeah, Tim, this is John. The Q3 the trend was pretty clear. The group spend was down in both food and beverage, and AD and other ancillary spend. That’s naturally a result of groups being put on the books in a weaker economic environment. What’s encouraging there though, is banquet obviously is the most profitable of food and beverage components, and even with reduced banquet revenue and reduced overall foot and beverage revenue, our margins were actually up a little bit, and they were up 300 basis points for the outlets and for room service, which shows that the efficiency that we tried to put into these operations is paying off. But we see that trend probably continuing a bit. You look at Chicago, the RevPAR was up, the overall revenue was down. That is almost exclusively related to group spend, so there should be a bit more of that, as the groups that were put on in the lower economic times work their way through the system.

Tim Wingard – Deutsche Bank

Okay, great. Thanks. And another question. The Vail Marriott, the RevPAR was up big time in the Q3, and I was just wondering, I know you said that room nights for the Q4 are up 60%, is that right?

John Williams

That’s on group pace, yes. It’s on a relatively small number, I’ll add.

Tim Wingard – Deutsche Bank

Okay. How do booking windows in the Vail Marriott this year compare to last year, and are you able to get any early read on Q1?

John Williams

We haven’t had budgets come out yet, so relying on pace, the pace reports look pretty good. The booking windows probably are getting a little longer, but I don’t think it’s a clear enough trend to really try and identify. Probably the most important thing in Vail is some of the state groups that just didn’t have the budget to meet last year have been able to meet a little bit more this year, and we anticipate that will continue next year. Those groups tend to come in the second and third quarters.

Tim Wingard – Deutsche Bank

Okay, great. Thanks.

Operator

And your next question comes from the line of Gene Bedsell (sp), RBC Capital Markets. Please proceed.

Gene Bedsell – RBC Capital Markets

Hi, good morning, and thanks for taking the question. I just have a quick one on the New York properties there. The strong rate growth that we see there, how much of that is the mix shift you’re talking about, versus just the market benefits there in New York?

John Williams

Well, it’s both, and one kind of lives off of the other, so as the market improves, you reduce your lower rated, particularly OTA types of business, and replace it with the more traditional corporate business, particularly in the case of Third Avenue, and then in both Chelsea and Fifth Avenue, we’ve been able to move up great categories within leisure and other discounted rates, as well as a pickup in corporate, so it’s both. As the market picks up, you’re able to discriminate a little bit better in what business you take.

Gene Bedsell – RBC Capital Markets

Okay, thanks. And I guess, if you’re forecasting a 20% plus for the Chelsea property, is that potentially possible there in the other two properties there in New York, as well? For the Q4?

John Williams

I think the overall New York market, I don’t think we’re forecasting 20% increase, but overall, in the marketplace, we expect the Q4 to be very strong in New York.

Gene Bedsell – RBC Capital Markets

Okay, thank you very much.

Operator

And the next question comes from the line of Su Oy Pan (sp) from (inaudible) Capital. Please proceed.

Su Oy Pan

Morning, it’s Su Le. I was wondering if you could provide some more details on your acquisition pipeline, and also if you could talk about how Westin Boston is affecting your full year guidance, if there is any spill over into the Q4?

John Williams

Okay, on the acquisition side, you know, our pipeline – we’re looking at a number of opportunities. We’ve said in the past, we have passed on many opportunities this year, as the pipeline builds up. I would say there’s nothing imminent in the pipeline right now, but at the same time, things can pop up and become imminent that you don’t anticipate. So we have several opportunities that are sort of in a dormant stage, and then with respect to Boston, you know, the Q4 is not as weak as the Q3, compared to last year. But it is slightly down in pace, and we think the market share situation, because of the dynamics I explained earlier, could persist into the Q4 to some extent.

Su Oy Pan

Okay, thanks.

Operator

And the next question comes from the line of Will Marks from JMP Securities. Please proceed.

Will Marks – JMP Securities

Thanks, hello everyone. I just had one question on the guidance. Has it changed at all? It’s obviously gone up, in terms of how you worded it, but on the same store basis, has it changed?

Mark Brugger

No, this is Mark. It’s about the same as we were projecting. The Q3 came in as expected, and the Q4s generally come in as expected, as well, at our same store properties.

Will Marks – JMP Securities

Okay then, in terms of looking out to 2011, when do you see comp starting to get challenging?

Mark Brugger

This is Mark. They’re starting on a demand basis, but accounts are starting to get challenged in the Q3 of this year, but we’re seeing a lot of positive trends. On the group, and particularly on the business transient that will hopefully drive rate for next year. Obviously they’re beginning, the big brand companies are beginning the special rate negotiations now, it’s a little bit wait and see. The ask is pretty aggressive from the brands, so if the economy continues to kind of – corporate profits are up, which is a big corollary to how we can increase our RevPAR, we feel pretty optimistic about how next year is going to play out.

Will Marks – JMP Securities

Okay, that’s all for me. Thanks.

Mark Brugger

Thanks, Will.

Operator

Once again ladies and gentlemen, it’s star 1 to ask a question. And you have a follow up question from the line of Ryan Melicke from Morgan Stanley. Please proceed.

Ryan Melicke – Morgan Stanley

Thanks, actually my questions were just answered, so I’m all good. Thank you.

Operator

And I show no more questions at this time.

Mark Brugger

Okay, thank you, Marisa. So everyone on this call would like to express our continued appreciation for your interest in DiamondRock, and we look forward to updating you next quarter.

Operator

Ladies and gentlemen, that concludes our presentation. Thank you for your participation. You may now disconnect. Have a great day.

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