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Hersha Hospitality Trust (NYSE:HT)

Q2 2012 Earnings Conference Call

August 1, 2012 9:00 AM ET

Executives

Jay H. Shah - CEO

Neil H. Shah - President and COO

Ashish R. Parikh - CFO

Nikki Sacks - ICR

Analysts

Andrew Didora Bank - Bank of America-Merrill Lynch

David Loeb - Robert W. Baird & Co. Inc

William Marks - JMP Securities LLC, Research Division

Ryan Meliker - MLV & Company

Smedes Rose - KBW

Tim Wengerd - Deutsche Bank

Nikhil Bhalla - FBR Capital Markets & Co., Research Division

William Crow - Raymond James & Associates, Inc.

Daniel Donlan – Janney Capital Markets.

Operator

Good morning ladies and gentlemen, and welcome to the Hersha Hospitality Trust Second Quarter 2012 Earnings Conference Call. Today’s call is being recorded. At this time, all participants are in a listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

At this time, I would like to turn the conference over to Nikki Sacks of ICR. Please go ahead.

Nikki Sacks

Thank you and good morning, everyone. I want to remind you that this conference call contains forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934 as amended by the Private Securities Litigation Reform Act of 1995.

These forward-looking statements reflect Hersha Hospitality Trust’s plans and expectations; including the Company’s anticipated results of operations through capital investments. These forward-looking statements involve known and unknown risks, and uncertainties and other factors that may cause the Company’s actual results, performance, achievements, or financial provisions to be materially different from any future results; performance, achievements, or financial position expressed or implied by these forward-looking statements. These factors are detailed in the Company’s press release and in the Company’s SEC filings.

With that, let me turn the call over to Mr. Jay Shah, CEO.

Jay H. Shah

Thank you, Nikki, and good morning to everyone. I’m joined today by Neil Shah, our Chief Operating Officer, and Ashish Parikh, our Chief Financial Officer. On today’s call we will touch on some highlights from the second quarter, discuss our portfolio strategy and update you on our lodging markets and impact from the overseas and particularly, European travel as it impacts our portfolio.

The second quarter portfolio result reflect the Company’s continued outperformance as Hersha delivered industry leading results as our consolidated and same-store portfolio generated RevPAR growth of 8.2% and 7.8% respectively. A particular note is our EBITDA margin. With our same-store hotels recording the highest quarterly EBITDA margins in our history at 43.9%.

This performance is the direct result of our urban gateway portfolio, which is focused on the high rated trend in business traveler combined with effective yield management and our aggressive asset management programs. Additionally, with the young age of our portfolio, the significant capital that we’ve reinvested in our assets and the high occupancies in our markets, we expect a meaningful runway in our multi-year growth platform.

Although we’re pleased to be harvesting the positive result of this strategic transformation, we’re even more pleased knowing that the inherent organic growth in the portfolio will be significantly bolstered in the coming quarters by over $350 million of newly developed or acquired assets, that will begin delivering EBITDA contributions later this year.

We’ve assembled a portfolio of high quality hotels in key urban markets with a variety of robust demand drivers and our portfolio wide occupancy at 81% is indicative of the strength of the markets and our assets. In fact, seven of our top 10 properties by EBITDA contribution had occupancy of approximately 90% or higher during the second quarter. And 8 of those top 10 EBITDA producers had an average daily rate of greater than $200. And the one that didn’t is the Courtyard Miami, which is undergoing significant construction.

Another demand indicator regarding our concentration in urban gateway markets is international travel. Through the end of the first quarter, total overseas visitation to the U.S. was up 13.4% with Western European travel up almost 10.1%.

Now let me turn specifically to New York City, vis-à-vis international travel. As a percentage of our total revenue in New York City year-to-date, international travelers on average account for approximately 18.5% of our room revenues, with roughly a quarter of that coming from Canada and the U.K. That means all other international guests comprise less than 14% of our business.

Among the top 10 international revenue contributors to our New York City portfolio, European countries represent approximately 5% of our total room revenues, while the Eurozone countries represent only 3.1% of total room revenues. From another relevant perspective, a hypothetical decline of 20% of European business to our portfolio would translate to less than a 1% decline in total room revenues and that is assuming that we cannot replace the lost rooms in a portfolio that consistently runs over 90% occupancy.

We had noticed a slowdown slightly in inbound Eurozone travel, but at the same time we’re seeing overall growth in international inbound travel suggesting that the strong growth in travel from Canada, Japan, Mexico, Brazil, China, Korea, and India seem to be displacing any loss experience from the Eurozone.

Now let me give you a little color on each of our key markets. Our Manhattan Hotels were again among the top performers in our portfolio. RevPAR growth of 12.3% was driven by a 6.8% increase in ADR and a 4.5% increase in occupancy to 92.3%. Running occupancy at this level means our hotels were effectively sold out five nights a week. In comparison, Manhattan as per the Smith Travel Research data achieved a 7.3% RevPAR growth, with ADR growth of 5.2%.

This shows the appeal of the mid scale and upscale segment of the cost conscious and value oriented business in leisure travel and it indicates that overall demand for the market should continue to outstrip supply growth in the near future. Other top performing markets during the quarter were Boston, and urban Philadelphia, which recorded RevPAR growth of 14.3% and 13.6% respectively.

Our Marriot Courtyard Hotel, Los Angeles Westside also performed very well with RevPAR growth of 19.6% as the LA market remains strong for us. Our Urban Washington DC hotels also had a strong quarter relative to the market with the Hampton Inn, Washington DC delivering 7% RevPAR growth, while the Capitol Hill Hotel delivered the second highest RevPAR growth in our portfolio of 22.7% over the same period prior-year.

We recently completed a redesign of the lobby and public areas to fully transform the look in the feel of the Capitol Hill Hotel and are clearly seeing a positive benefit from these renovations. As anticipated the Courtyard Miami underperformed in the market as we commenced construction of the new tower. But we’re very pleased to have kept our ADR relatively stable during the quarter.

The early phase of construction included, digging, driving piles in laying the foundation, which is quite loud and disruptive. Even with this disruption we maintain occupancy in the mid 80s and ADR of $165, reflecting the strength of the Hotel and the market which continues to be one of the best markets in the country recording double-digit gains in the second quarter market wide. We remain focused on growing our portfolio and strengthening our financial flexibility and have completed several notable transactions during the quarter.

We completed two acquisitions of strategic assets during the quarter. The first acquisition provided us with an extremely attractive entry point into the Boston Central Business District, a core market for us where we had been underrepresented. This hotel is the 80-room Bulfinch Hotel in Boston’s West End neighborhood which we acquired for $18.2 million, or $228,000 per key.

We’ve also begun renovations and we plan to invest approximately $2.5 million in the hotel to upgrade guest rooms, improve the food and beverage platform, reconfigure the fitness and business amenities and to add an additional guest room. Boston is expected to be one of the best performing markets in the country for the next several years with continued strength expected in the cities technology, healthcare and education industries, in addition to a very strong convention calendar. It’s an attractive asset in a very desirable location, which will be further enhanced by the implementation of sales and revenue management initiatives.

The second was the purchase of the remaining 50% interest that we did not previously own in the 228-room Holiday Inn Express 29th Street in Manhattan. Inclusive of our initial investment at the commencement of operations in February 2007, the total acquisition price is $87.5 million or approximately $384,000 per key. Based upon the financial performance of this asset, we anticipate that we’ve purchased this asset at an extremely attractive cap rate of 8.2%.

Through this transaction not only did we add another strong Hotel to our portfolio, but it further simplifies our capital structure by reducing one more joint venture from our balance sheet. Along the same lines, we’re currently working on clearing up several other joint ventures by the end of the year.

In terms of additional acquisition opportunities, the pipeline in our target urban market hasten somewhat. We will remain opportunistic that we’re extremely pleased with the extremely strong portfolio that we’ve already assembled with meaningful organic growth yet to be realized. Additionally, we’ve produced our own internal pipeline that I referred to earlier that will begin generating earnings by the end of the year with the anticipated opening of the two new Manhattan Hotels, the 175-room Hyatt Union Square and the Hampton Inn Downtown, on Pearl Street.

To sum up, in our markets the urban transient guests continues to travel and continues to drive the growth in lodging fundamentals. Given the quality and location of our portfolio, Hersha has been the beneficiary of the resiliency in recovering strength of the urban transient market. The supply-demand dynamic remains compelling and as we continue to fortify our business we remain confident in our outlook and the embedded value in our portfolio that has yet to be realized.

I’m going to turn the call over to Ashish now to provide some more details on our operating results and financial position. Ashish?

Ashish R. Parikh

Thanks, Jay. I will start by providing some additional detail on the operational results of the portfolio and end with our outlook.

On a consolidated basis, our Hotels realized RevPAR increase of 8.2% comprised of ADR growth of 5.9% and a 172 basis point increase in occupancy. While our consolidated EBITDA margins of 41.4% were down 120 basis points for the – from the prior-year quarter. The negative variance was primarily driven by the addition of the Rittenhouse Hotel and the Sheraton Wilmington South, which were acquired or opened within the past year and are full service hotels with a meaningfully lower average operating margin than the portfolio average.

Excluding these two assets, Hotel EBITDA margins for our consolidated portfolio increased by 90 basis points to 43.5%. Although these assets due impact the overall margin performance of the portfolio this year, we’re confident that the performance of both of these assets should help drive RevPAR growth and margin performance in future periods. For example the Rittenhouse Hotel drove RevPAR growth of 14.4% during the quarter, and excluding one-time charges drove operating margins by almost 850 basis points.

Let me provide some additional color on our same-store and New York City margin performance. As Jay mentioned, on the same-store basis, our portfolio delivered a 43.9% EBITDA margin, which represents the highest quarterly in portfolio margin performance in the Company’s history. We achieved these margins with our portfolio wide occupancy of approximately 82% allowed us to continue to push ADR resulting in 7.8% RevPAR growth.

Our Manhattan portfolio of assets delivered equally impressive performance as we grew RevPAR by 12.3% and expanded our margins by a 160 basis points to 48 – 49.8% during the quarter. Our ability to drive outperformance in our New York portfolio is due to our focus on the high rated trending segments, which allows us to more effectively yield manage these hotels. These revenue and asset management strategies are helped by the inherent stabilization that is still occurring at our newly opened assets in New York as our NYC portfolio maintains an average age of less than 2.5 years.

With our New York City portfolio occupancy covering around 92% for the quarter, we’re confident that the new supply continues to be absorbed and the inherent demand is more than adequate for absorption of expected future supply.

Turning to our balance sheet, our financial position continues to be strong and we completed a few transactions during the quarter, which further enhance our flexibility and help to simplify our capital structure. As of June 30th, we had approximately $58 million in cash and escrow deposits and $30 million drawn on our $250 million line of credit.

During the quarter, we completed an equity raise and filled 24 million common shares for gross proceeds of approximately $134.4 million. We use the net proceeds of the offering to pay down our revolver and to complete some of the acquisitions and investments that we’ve previously discussed. We’ve also been very active on the refinancing front and have taken advantage of the favorable rate environment to refinance some of our existing loans.

During the quarter, we refinanced loans on the Hotel 373 Fifth Avenue in Manhattan and the Holiday Inn Express, South Boston. Subsequent to quarter end, we also refinanced the outstanding debt on our Courtyard Miami Beach property with a $60 million loan net of fixed interest rate of 4.32%. At this new interest rate, the debt service on this asset is slightly lower than the existing debt service on the $32 million loan that the company had assumed when we acquired the asset last year.

With respect to our capital plan, we remain on track with the plan we communicated earlier in the year. We’ve spend approximately $19 million through the end of the second quarter and continue to expect our 2012 capital expenditures to be in the range of $25 million to $27 million as the majority of our renovation activity has been completed.

As Jay mentioned, we’ve been very pleased with the performance of the Washington DC portfolio during the second quarter and we attribute a significant portion of the outperformance of the Washington DC and New York portfolio to the renovation activity that we undertook during the first quarter of 2011 and the first quarter of this year.

I will finish with our outlook for the remainder of the year. Despite all the macroeconomic chatter, we’re pleased that we’re not experiencing the slow down as compared to industry projections or our internal forecast. This perspective is supported by the most recent GDP report, which showed a 7.2% increase in private business investment spending in the second quarter. This was an acceleration from the 5.4% growth in the first quarter and it is an encouraging indicator for business travel.

For the month of July our portfolio has continued to see strong growth with our same-store consolidated portfolio driving RevPAR growth of approximately 7.5%. Our Manhattan outperformance continuing as that cluster delivered approximately 7% growth and most of our other core urban markets including Boston, Philadelphia and Washington DC registering double-digit RevPAR growth during the month.

Looking to our third quarter, while we still expect strong performance from our New York Hotels, it is important to recognize that July and August are much more leisure transient driven, which is a harder segment with which to push rate. With that said, September has some historically proven demand drivers including the U.S. Open Tennis Tournament, the UN General Assembly and Fashion Week. There are also strong convention calendars in September in Philadelphia and Boston, which typically drive overall compression in the markets.

I will finish by addressing our outlook for the remainder of 2012. We posted strong year-to-date results and given our high levels of occupancy and the strong demand trends in our markets. We remain confident in our outlook. For the full-year 2012, we continue to expect total consolidated portfolio RevPAR growth to be in the range of 7% to 9% and same-store RevPAR growth between 6% and 8%.

In terms of margin, Hersha continues to deliver industry leading absolute hotel EBITDA margin. We anticipate that consolidated portfolio Hotel EBITDA margin where we’re consistent with 2011 at approximately 38.6%, but excluding the impact of our new full service assets along with the Hyatt Union Square and the Hampton Inn Pearl Street, that are anticipated to open later this year, we anticipate total Hotel EBITDA margin expansion of 125 to 175 basis points in our total consolidated portfolio and approximately 100 to 150 basis points of improvement in our same-store portfolio.

That concludes my formal remarks. And I will now turn the call back to Jay.

Jay H. Shah

Thank you, Ashish. That concludes our prepared remarks. Now operator we can open the line for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we will go first to Andrew Didora with Bank of America.

Andrew Didora Bank - Bank of America-Merrill Lynch

Hi. Good morning, guys. Certainly appreciate the additional color you gave on the European and international travel to New York, but just wanted to ask you, such a (indiscernible) on margins in the market, I know in the New York margin keep hitting highs on an absolute basis, but the growth was a little more than I would have expected, given where the RevPAR came in. Are there any cost pressures or something going on in the market in the quarter that held back the growth in the portfolio or is it just simply a function of a higher base?

Ashish R. Parikh

Sure. Andrew this is Ashish. I mean, as far as Manhattan EBITDA margins, we’re very pleased to see the 160 basis points improvement. Our New York portfolio was impacted by some weakness in the JFK markets that did impact the margins. I think overall during the quarter what we saw is, certainly there was a little bit more occupancy growth in the RevPAR growth number than we would have anticipated driving high single-digit RevPAR.

So that does affect the flow through there in impacted margins, in addition when you get to a level as we have in the second quarter when you’re at 43%, 44% overall then closer to 50% in New York. It is certainly harder than the first quarter when you’re running kind of 28% to 30% margins.

But we still think that there is plenty of margin opportunity in the portfolio, we actually look back at our 2008 numbers and our New York portfolio same-store was doing about 300 basis points better in margin than we’re doing today. So, clearly there is room for growth in these type of quarters is just a little more difficult than maybe in the first quarter or the fourth quarter.

Andrew Didora Bank - Bank of America-Merrill Lynch

Okay. That’s helpful. Thanks, Ashish. And then just on the balance sheet, you guys have done a pretty good job in terms of opportunistically refinancing some maturities this year. Some of your competitors have done term loans recently, so you – do you see any opportunities in terms of doing something like types of deals and maybe hopping to the lower yield cost of capital a little bit more?

Ashish R. Parikh

Sure. We are exploring a couple of things like that, a term loan and potentially even a revamp of the credit facility, with just the rates at an absolute level being as good as they’re. Right now about a third of our portfolio when you take into a third of our EBITDA, when you take into account the assets that are secured by the credit facility, assets that could be refinanced and really unencumbered at this point. So, there is a lot of opportunity there, but we will be mindful of keeping our leverage in check.

Andrew Didora Bank - Bank of America-Merrill Lynch

Okay. That’s all from me guys. Thank you.

Ashish R. Parikh

Thanks, Andrew.

Operator

And we will go next to David Loeb with Robert W. Baird.

David Loeb - Robert W. Baird & Co. Inc

Have a couple of my usual questions. Can you talk a little bit about the supply outlook in all of your markets, I guess, particularly New York? I know in previous quarters you’ve suggested that it looks like that the opening cycle in New York is really weaning and there is not a lot going into the pipeline, but can you just give us an update on that and other markets?

Jay H. Shah

David, as you mentioned in your preface to the question, we do see much less supply on the horizon across at least the next 12 months for most of our markets. Where we felt the most kind of pinch from new supply was in lower Manhattan across the last two to three quarters, and most of that new supply is now completely open. And so where we were the most vulnerable, I think we’ve passed through the worst of times from supply point of view. And even in the Times Square, Chelsea area across the next couple of quarters we have very little kind of head on the new supply in our space.

David Loeb - Robert W. Baird & Co. Inc

Other markets?

Jay H. Shah

David, with other markets; our supply/demand dynamics are looking very good and probably driven both by strong demand as well as low supply. We look at Boston and we have across the next two to three years effectively no new supply of any significance. Philadelphia, there’s been some chatter about a couple of retrofit project, but we wouldn’t expect anything in Philadelphia to come online for at least another 24 to 36 months.

In Miami and Los Angeles, in Miami particularly in the South Beach area there’s always the opportunity for retrofitting of existing buildings. So, it would be less of a supply risk and more of -- more assets being repositioned into our segment. But even that at this time there has not been a lot of talk about it.

So generally speaking, across all of our six major gateway markets we’re very pleased to be, anticipate a supply growth across the next 24 to 36 months at the low historical averages. And it’s a very encouraging -- that’s a very encouraging fact particularly considering some of the macroeconomic headwinds we’ve been facing. I think the very low supply growth has been very helpful in this recovery.

David Loeb - Robert W. Baird & Co. Inc

Okay. And then can you give us an update on the acquisition environment. Do you see opportunities that kind of thing? Where are you in the acquisition (indiscernible)?

Jay H. Shah

Yeah, on the acquisition side David, the market has been – there has been more volume of deals in terms of that are being brokered today than there were a quarter or two ago. But there’s still not a significant volume of opportunities in our markets or in our target kind of investment hurdles. There’s a lot of – there’s some more high quality assets starting to be at least brought to market.

We’ve looked at some things in each of our kind of six core markets across the last quarter. Not feeling particularly likely on many of those opportunities. I think for us, I would say pricing for our kind of assets in our key markets, you can find call it five to seven cap range assets available on leverage cap rate basis. But what remains unclear is whether there is strong enough growth underlying some of those markets or those assets to get to the kind of double-digit yields that we target at stabilization.

So, there isn’t an opportunity for real value added operational advantage or there isn’t a clear upgrade to the quality of a particular opportunity. And so I’d say that the market might be a little bit more volume and velocity than we’ve had towards the beginning of the year, but still nothing that approximates anything of even 2010 period, let alone 2006 or 2007.

David Loeb - Robert W. Baird & Co. Inc

Well at the same time your acquisition deposits line on the balance sheet went up by $9 million. Is that related to the under-construction assets or is that related to some other things you’ve been looking at?

Jay H. Shah

David, this is Jay. Those deposits, we’ll typically put down deposits to particularly -- these days we’re putting down deposits to be able to tie assets up while we continue due diligence in underwriting on them. And so, that number reflects – that reflects a couple of deals we’re looking at. In our markets, sometimes these are very desirable potential acquisition opportunities we’re looking at in order to be able to take the time to do due diligence and the appropriate underwriting we do have to put up some earnest money deposits and that’s what that represents, but they’re far from definitive, otherwise we’d be happy to share that with you.

David Loeb - Robert W. Baird & Co. Inc

Okay. But $9 million would suggest that it was the number of assets, right? You don’t have to put down $15 million deposits on several $100 million hotels; you’re talking about smaller deposits, correct?

Jay H. Shah

There are a couple of opportunities that we’re spending time really kicking the tires on, very significant here.

David Loeb - Robert W. Baird & Co. Inc

That’s fine, I’ll stop pressing. And then finally dispositions, how is the ongoing search for potential dispositions going particularly interested in your consideration of core market dispositions of hotels that have maybe stabilized as much as you think they will?

Jay H. Shah

We’re currently marketing about four to six assets. I assume we’re marketing four of them a little more actively than two, but a total of four to six assets are being marketed right now. One of them is a core urban asset. We think that a stabilized asset of the nature that we’re marketing should fetch a very, very strong value. And so we’ll continue to see how that goes. Three other assets are also being marketed. Those are relatively stabilized secondary market assets. And I expect there to achieve a fair valuation.

We don’t believe -- these are very high quality assets in strong markets and we’re not all that excited to be selling them at a discount. So, we’re continuing to market them and I think we will be able to find a buyer at the right price. We’ve seen several other secondary market transactions be consummated and so that gives us some good optimism for them. And then there’s two other assets in two of our other markets, one would be a joint venture asset and the other one is in a secondary market of New York City. So, we’ll continue to keep you all updated on how that marketing is going.

But as I mentioned before, these are stabilized. We expect to see growth from them, though not as a significant growth as the rest of the portfolio, but as you would more normally see on a run rate for a stabilized asset. But, I think they’re really high quality and we should be able to find good buyers for them.

David Loeb - Robert W. Baird & Co. Inc

Great.

Jay H. Shah

So yeah, so let me finish by saying on that David, I just told you a lot about the marketing on them, but currently the EBITDA from the remaining stabilized hotels and secondary markets on our portfolio is approximately 9% to 10% of our EBITDA this year. By next year with the additional EBITDA coming online, even if these assets aren’t sold, the stabilized secondary market assets will represent about 7% of our EBITDA. If we can consummate as I mentioned even two-thirds of the four to six that we’re anticipating, that number will drop down below 5%.

David Loeb - Robert W. Baird & Co. Inc

Great, helpful. Thank you.

Operator

And we’ll go next to Will Marks with JMP Securities.

William Marks - JMP Securities LLC, Research Division

Thank you. Good morning everyone. I wanted to ask you, towards the end of your prepared remarks you made some comments on the third quarter. Can you give a little more specific guidance, it sounds as the fourth quarter maybe will be stronger than third quarter or maybe I’m reading into it too much.

Jay H. Shah

Will, I think that’s pretty accurate actually. When you look at our fourth quarter not only should we have the addition of the two new, New York assets which will help alter the RevPAR growth in the portfolio. But, third quarter typically is much more leisure trendy and driven and when you get into the core urban markets especially in July and August you lose a big segment of the business traveler. So as much as you’re able to push occupancies in these markets you can continue to do that. You usually don’t have the same pricing power as you do in quarter of two and certainly in New York fourth quarter is the best quarter for New York and our portfolio EBITDA – probably 55%, 57% of our EBITDA comes out of New York in that quarter. So we’re looking at good strengths coming out of New York in the fourth quarter, still consistent strengths. I think July is indicative. July was a difficult month with 4th of July falling on a Wednesday, but we were still able to record 7.5% same-store RevPAR growth and I think if that’s indicative third quarter is shaping up quite good for us.

William Marks - JMP Securities LLC, Research Division

Okay, thanks. And just one other question on your portfolio; in California I guess you have three assets I think, and I’m wondering if you plan to expand, if it really makes sense to even be on the West Coast and if you’d consider just getting out completely?

Jay H. Shah

Will, actually with the three assets there it’s – I have said this before, first of all, the Courtyard – The Marriott Courtyard Westside is a very significant asset and it was our determination that there’s enough EBITDA being generated just from that asset that justified, are having an asset management – having an asset management presence there and we don’t even have a permanent presence there, but meaning that its worthy of our asset management program for [mindshare].

If you add the two additional California assets to it and actually it’s a pretty attractive cluster for us and it’s not geographically clustered but it is by State. I think, as we continue to think about California, Southern California particularly the Los Angeles sub-markets that we are focused on continue to remain very attractive and I think that, that we’ll continue to hold on to that asset and selectively acquire more there should it come available.

Now we haven’t found – I mean, we haven’t found that there is a great number of opportunities that are presenting themselves in the market, but nonetheless I think we plan on keeping our flagstick there because it really is a very attractive market with very strong fundamentals.

Northern California, the two assets that we have there I think those, we’re expecting strong performance from them in the coming years and we’ll continue to consider the market up there and see how things go across the next couple of years before we make a final determination on those assets in that market place, Pleasanton and Pleasant Hill.

William Marks - JMP Securities LLC, Research Division

Okay. That’s all from me. I appreciate the color. Thanks guys.

Jay H. Shah

Okay.

Operator

And we’ll go next Ryan Meliker with MLV & Company.

Ryan Meliker - MLV & Company

Good morning, guys.

Jay H. Shah

Hi, Ryan.

Ryan Meliker - MLV & Company

Just a couple of quick things. First of all, with regards to F&B revenue, I know it’s not a huge component of your income statement. But obviously with the food service hotels it shot up pretty dramatically over the past couple of quarters. Can you give us a good idea in terms of how we should think about modeling out F&B revenue going forward?

Ashish R. Parikh

Ryan, it is – obviously it’s becoming a greater portion of our total revenues. I think that, when you look at the new assets coming online now, the Hyatt Union Square is going to be a leased F&B operation. There will be some amount of F&B coming through the income statement from the way of the Lobby Bar and the Roof Top Bar. But it’s difficult for us to sort of give guidance on that pre-opening.

Outside of that it’s really a function of primarily The Rittenhouse and Wilmington South and both of those, with the Rittenhouse being a little more stabilized obviously Wilmington South is still very much at ramp-up. So, unfortunately we’re not at a point right now where I could tell you percentage wise how to look at it next year, but I think over the next couple of quarters you’ll start seeing more of a trend line.

Ryan Meliker - MLV & Company

Okay. So, I mean, can you give us any color on seasonality, I guess, if I look at consolidated F&B per occupied room, it was about 40% higher in the second quarter than the first quarter. How should we look at that during the back-half of this year?

Ashish R. Parikh

Certainly it won't be at the – we don’t think it will be at the same level in Q3 for F&B revenues, because Q2 is traditionally probably the strongest quarter for the both of these newer assets. And then Q4, you’ll see -- won't be as low as the first quarter but even lower than the third quarter. So, I think you’ll continue to see a trend downwards in F&B for the rest of the year.

Ryan Meliker - MLV & Company

Okay, that’s helpful. And then, I guess talking a little bit about margins here. You guys obviously run the highest margins across the public companies at the property level and as you’ve highlighted it gets a little harder to push growth when you’re at these margins.

Should we be thinking about your margins more in the lines of flow-through maybe where you’ll see 50% flow-through until we start to see the rate become a larger component of overall RevPAR growth, and then what's it going to take to get those 300 basis points that you talked about.

Is it really just a function of rate growth that’s going to take time, I guess, I would have expected a little more rate growth this quarter with occupancy over 80% than you saw. So, some color on how we’re going to get from where we are to where you guys want to be or you think you can be would be helpful.

Ashish R. Parikh

Yeah, it’s a good question and certainly we had about 30%, 35% of our RevPAR increase was attributed to occupancy. And as we mentioned we saw some weakness in the JFK markets and some of our other more secondary markets. The urban markets really performed for us. I think that if you isolated just the urban markets, our margin performance would have probably been up in the 125 to 150 range even during this quarter. So from a revenue standpoint, you should be able to do 50% to 55% flow if its 50-50 occupancy to ADR growth.

I think when you look at something like Manhattan and you see that most of our growth is ADR based. We have consistently run flow-throughs in New York probably for the last four to six quarters in excess of 75% to 80%. And I think that’s -- as you look at this portfolio going forward, our year-round occupancy will be above 80% from quarters, two, three and four with quarter one kind of in the high-to-mid -- let’s say in the mid 70s or low 70s.

So, quarters two, three and four you should consistently see going forward sort of a better than 55%, 60% flow as long as ADR keeps driving that RevPAR.

Ryan Meliker - MLV & Company

Great. That’s really helpful. Thanks a lot.

Operator

And we’ll go next to Smedes Rose with KBW.

Smedes Rose - KBW

Thanks. I was wondering if you could just give us an update of the dates for the opening of the two hotels in New York.

Jay H. Shah

Sure Smedes, this is Jay. We are targeting the opening of the Hyatt Union Square to be early in the fourth quarter, to say the second week of October. As we’re getting to the end we have experienced a little bit of a slippage, its nothing of note, it’s just a sort of typical construction delays and delays around finished materials coming in and things. And then we would expect that the Hampton Inn would open approximately 30 days after that, so say middle of the fourth quarter.

Smedes Rose - KBW

Okay. And then, how long would you expect the Sheraton, Wilmington and the Rittenhouse properties to drag on your overall margin, if it’s just a matter of just comping those or is there something you can do to, that to improve results there, I guess sooner than just owning them for a year?

Ashish R. Parikh

Unfortunately from a – they just run such different margins, but service means that it just going to – you almost need to do a lap around the year for that not to be a drag. I mean, there is going to be growth in those assets certainly and we saw it in the second quarter, but even with that growth they will drag the remainder of the portfolio down a little bit.

Jay H. Shah

Yeah, and I think, Smedes comping them – the difficulty here with the Rittenhouse and Ashish mentioned that outside of the one-time cost we would have seen close to an 800 to 850 basis point increase in margins. And so in this first year as we’re taking over and sort of adjusting (indiscernible) and flipping some switches, there are some costs, we’re going to be – we’re also going to be spending some capital there. So, I think the best answer for the Rittenhouse is that there will be, I think comping them in the coming year is going to be probably the easiest modeling solution.

I think there we’re going to be able to drive significant margin growth in the coming years, but it’s going to take us about -- it’s going to take us the remainder of the year to position ourselves to be able to drive that kind of strong EBITDA growth. So it won't show-up in consolidated for the year.

And then the Sheraton, Wilmington, there it’s pretty much a traditional ramp-up story and so I think there beyond earning them for a year and continuing to drive yield management strategies and our above property level sales initiatives there, I don’t know that there’s much more that can be done.

Yeah, as we have said before, that was a very opportunistic acquisition. Our basis in the asset is extremely attractive and we are working very hard on getting that asset ramped-up and then consider alternatives there.

Smedes Rose - KBW

Okay. And then finally just your – the G&A looks like it’s running a little bit over $5 million a quarter, I am just wondering is that a good run rate for the second-half of the year as well?

Jay H. Shah

I think the cash G&A should be around $2.5 million for the quarter, and I think that’s a pretty good run rate for the rest of – for the third quarter and then usually we do the incentive accrual comp in the fourth quarter, so it’ll probably be a million above that.

Smedes Rose - KBW

Okay. Thank you.

Operator

And we’ll go next to Tim Wengerd with Deutsche Bank.

Tim Wengerd - Deutsche Bank

Hi, good morning. Thanks for taking my question. I’m just wondering if you could talk a little bit about how you expect the New York city or Manhattan hotel market to evolve over the next five years. And just long-term which sub-markets are most undersupplied and where do you see the real changes happening?

Jay H. Shah

I’ll have to charge you for that one. The Manhattan market across the next five years feels to – just have among the best hotel fundamentals of any other market in the country. I think a lot of people around the world these days also consider it to be one of the best markets in the world. I think the, the kind of the, on the top-line international travel will continue to drive a big part of the growth in New York city. As we’ve mentioned for whatever slowdown there may be coming from Western Europe.

There is a commensurate and increasingly a much more significant amount of international travel coming from Korea, Brazil, China and India and other countries from around the world. So great from a kind of tourism point of view, from business fundamentals across Manhattan.

Lower Manhattan has been for the last 5 to 10 years has been underperforming relative to Midtown Manhattan. I think that we’ll see that turn across these next five years and we see much more new office development coming online and being leased in Lower Manhattan.

In addition to the corporate fundamentals of Lower Manhattan there’s great new infrastructure for retail, residential as well as transportation infrastructure. So we see the Lower Manhattan market continuing to be a very strong one, but we think that we might see even higher growth there than we have in Midtown Manhattan.

That said, in Midtown I think one of the areas of kind of the upper part of Manhattan that’s been a concern from a new supply point of view from our company, this team as well as others has been that kind of Garment District, Chelsea area where zoning allowed for – zoning and alternative uses allowed for a lot more hotel development to get done.

That market across the last few years has been less robust growth than Midtown or Lower Manhattan. But there has been some very great developments for – since you’re asking for a five year time horizon, you see the kind of the Hudson Yards and then the area south of Hudson Yards towards Madison Square Garden and then out to Jacob Javits really developing today and it’s no longer just master plans being dented about by politicians, but there’s actually cranes in the ground and very strong owners like Brookfield, like Vornado, like related really building not only residential towers but big office blocks as well.

So, we’re seeing this kind of far Westside of the 30s and 40s really develop into a real neighborhood which I think speaks very well for all that new supply that has been absorbed in that part of town recently. Midtown East remains I think the most, the biggest office market in the world and the highest barriers to entry of any others in New York and will continue to remain and strong market.

That area, kind of the, the one other neighborhood that that I’d mention is, and this is not just self serving because we have the Union Square Hotel opening, but that kind of the 20s and Park Avenue South down to Union Square and into the village has been one part of New York that has received very little hotel supply across the last 15 years. And we believe that that market has developed even further from both a business and tourism point of view and so we expect very strong growth there. So we feel very good about Manhattan.

I think the outlying markets around Manhattan it becomes much more hit or miss, because there is much less barriers to entry in some of the outer boroughs, and much less dedicated kind of corporate as well as leisure demand generators. But overall we feel very strong about New York.

Tim Wengerd - Deutsche Bank

Thanks Neil. Thank you very much.

Operator

And we’ll go next to Nikhil Bhalla with FBR.

Nikhil Bhalla - FBR Capital Markets & Co., Research Division

Hi, good morning. Just a question on the tower being constructed in Miami next to the Courtyard. If you could just remind us; one, about the timeline of this project and two, are the rates going to be higher at -- in the tower than they are right now in the existing hotel?

Jay H. Shah

Nikhil, the tower should be -- like I mentioned we're getting through the foundation, I think we’ll be completed with the foundation September, October and then start into the super structure. The tower is expected to deliver, say end of first quarter, beginning of second quarter of next year. We talk about the rates at the tower; obviously it’s going to be a brand new tower. It’s being built with a significant design orientation and consciousness.

Every room in the tower will be an ocean-front room and it will be brand new. So, the intention is to be charging premium rates at the new tower. And that tower it’s been modeled and it’s kind of how we’ve been, that’s how we’ve been guiding towards it internally. I think the market is going to be able to bear some significant rate growth generally.

So, we’re trying to stay somewhat dynamic as we think about the tower because, I think even where we’ve underwritten it I think there’s going to be some upside in the numbers there.

Nikhil Bhalla - FBR Capital Markets & Co., Research Division

Got it. And just a follow-up on that, on a stabilized basis, is there a way to handicap what the EBITDA accretion would be from the entire project?

Jay H. Shah

After completion?

Nikhil Bhalla - FBR Capital Markets & Co., Research Division

And more on a stabilized basis maybe two or three years ahead.

Jay H. Shah

Yeah, yeah.

Ashish R. Parikh

I think that Nikhil, we were looking at probably an additional – from the tower itself an additional $2 million to $2.5 million of EBITDA coming out of it.

Nikhil Bhalla - FBR Capital Markets & Co., Research Division

Got it, perfect. Thank you.

Operator

And we’ll go next to Bill Crow with Raymond James.

William Crow - Raymond James & Associates, Inc.

Good morning, guys.

Jay H. Shah

Good morning, Bill.

William Crow - Raymond James & Associates, Inc.

A couple of questions. Jay, theoretically or strategically here, as you think about all the internal growth buttons that you’re pushing and the demand that takes, you’re looking at a stock price that hasn’t been as strong as, I am sure you would have hoped and a more certain -- uncertain economic landscape. Why not take your foot off the gas from an external growth perspective at this point and kind of finish up all these opportunities and then reassess what the market looks like before you go out and buy additional hotels?

Jay H. Shah

It’s a very relevant point, and I think generally that is how we’re thinking about it. I referred to an embedded pipeline of about $350 million of assets that we would expect to stabilize just (indiscernible) deliver around the 10 cap and I think that that’s going to be some great growth that’s generally paid for already. I think as we continue to look at external acquisition opportunities we’re being extremely selective.

I mean, effectively we could [conceivably] kind of completely take the foot off the gas. But I think there are some opportunities that have bubbled-up here and there in this dislocation that of an extremely attractive in the Bulfinch is just an interesting example of one. But I think generally speaking, we’re going to do just as you are suggesting, I think across the next three to four quarters unless there is something extremely compelling, I don’t see us embarking on too many external growth opportunities. Our expectation is with all of these – with all of the embedded pipeline starting to deliver and generate EBITDA towards the end of the year and into next year, we would – sort of our view that we want to allow some time for the company to realize some of the gains from those assets versus buying new opportunities that will have additional ramp up stabilization or repositioning timeframes involved.

So, I think generally speaking we have taken our foot of the gas, we do stay very active in the acquisitions market just so that we don’t miss a – we don’t miss an opportunity that might be historically extremely attractive, but generally speaking we don’t – we’re not as aggressive with our acquisition program as we’ve been in the past.

William Crow - Raymond James & Associates, Inc.

Fair enough. And you may have talked about this and I may have missed it, but how the yield expectations from Union Square and Pearl Street chains that all given some of that commentary in European demand?

Jay H. Shah

No, Bill, I will tell you the – despite some undulations in European demand, I think generally overall international demand is hanging in quite well. As we’ve mentioned before this – that New York is one of the markets that just has such a diversity of demand generators and there is always at the type of demand we’re running in the 90s there always appears to be another segment to take the place of anything that – anything that’s not going to materialize.

So generally speaking, that Western – sort of Eurozone demand as I mentioned before comprises about 3% of our overall New York revenues and you would have to see a drastic drop of in that demand to even experience a 1% decline in overall New York revenue. So we’re tracking it. We are certainly – its something we consider, but at this stage we’re not as concerned about it. But we will keep everyone updated on that.

William Crow - Raymond James & Associates, Inc.

Right. And then finally from me, you talked about a demand segment that might fall off and we’re, I think many of us were focused on what the government per-diem discussions and negotiations may do to the industry next year. How do you look at your portfolio relative to maybe peers as far as your exposure to government per-diem and – government per-diem demand and do you think you would get hurt, given your price point would you be helped, how are you thinking about that as you look forward to next year?

Jay H. Shah

You know we’ve been watching some of the changes and, I apologize if this is redundant for folks, but the previous methodology included when they were calculating per-diems, it included everything, it included an average of the rates between mid scale through luxury. And then the per-diem rate was sort of a 5% discount to the average of those. Generally speaking, the per-diem methodology as its going to change is going to exclude luxury and upper upscale from the calculation, which is going to bring the lodging per-diem rate down somewhat.

Generally speaking, with our yield management in place and so that we’re – we’re guarding against not having to rely on per-diem business when we’ve peak business at the hotel. I think generally speaking, we’re going to have a greater capture from the change in methodology because we’re going to – the upper upscale and luxury hotels are not going to be able to accommodate the per-diem business, the government business in the past. So, we will continue to keep an eye on it. We already limit government rates as it is during mid week and peak periods, but generally speaking, we think that this could really be a benefit to us in our shoulder periods.

You know for DC might be a good example. For us, DC we currently a lot of the government business – we’ve two assets in the CBD and then we have five or six assets in the outlying areas of Alexandria, in Greenbelt, in Tyson's Corner, in the (indiscernible) I think what we will see in DC is that for those government, there will be some government travelers that will now stay in the outlying suburbs, rather than the CBD because they’ve less options to use their per-diem in the CBD. And for those that do decide to stay in the CBD they will be more restricted to kind of the mid scale opportunities or the mid scale or upscale Hotels in that area and which should benefit our Hampton Inn, in Washington DC.

So, I mean, it’s a – its hard – whenever our rate is going down, its hard to say that its going to be a benefit for us, but its not clearly negative news for our portfolio, particularly for Washington DC.

William Crow - Raymond James & Associates, Inc.

Very good. Thank you very much.

Operator

And we will go next to Dan Donlan with Janney Capital Markets.

Daniel Donlan – Janney Capital Markets

Thanks. Just real quick on the Rittenhouse Hotel, could you maybe talk about how you’re able to drive margins 850 basis points higher in the quarter ex one-time times?

Ashish R. Parikh

Hey, Dan. This is Ashish. I mean, primarily its just the fact that, we’ve brought in our operation as we’ve discussed, we’ve had date change around staffing models pretty significantly at the Hotel and we’ve kind of quoted the numbers before, but the Hotel was externally managed before it really in the same management company for the last 23 years. So a lot of it is us going in, asset managing and HHM being able to go in and run the property much more efficiently than it had in the past.

Jay H. Shah

Yeah Dan, also from the top line perspective, we’ve driven ADR at the property year-over-year for the second quarter by about 16% in our first quarter of owning it. The RevPAR has increased by $45. And we’ve increased our index by almost 3%, 4%. So the top line is helping there as well. We hit our first $571 ADR week in the history of the hotel during our first quarter of ownership.

Daniel Donlan – Janney Capital Markets

Okay. And does that lead you to maybe start considering other type of full service assets that, maybe we don’t have quite the amount of meeting space that you think you can bring in HHM and to the – into as an operator and you kind of boost margins that way?

Jay H. Shah

Yeah, I think – when we look at hotels, we really are very much focused on being a pure player urban transient portfolio and there are certain hotels in our gateway markets that are in varying segments, but are primarily driven by corporate urban transient travelers. So, we will take a look at them. I don’t know that its as much of a segment play as it is just finding opportunities that fit within our strategy. As we’ve mentioned before the Rittenhouse Hotel, its really one three meal restaurant that’s being operated and some limited meeting space. And it – that the food and beverage component is not insignificant there, I’m not suggesting that. But it is a relatively non-complex platform. The second restaurant is on a full lease, the spa is leased and the parking operation is outsourced. So really we are able to drive great value at this hotel just by boosting the rooms operation. And if there are ways we can bring value to and I think its really the only reason we’re buying any hotels, as when we can bring an operating advantage to the hotel and we feel that we do that best at urban transient hotels. So that’s kind of we keep our eyes open for.

Daniel Donlan – Janney Capital Markets

Okay. Thanks. That’s it from me.

Operator

And with no further questions in the queue, I would like turn the conference back over to Jay Shah for any additional or closing remarks.

Jay H. Shah

Well, I just take a moment to thank everyone for being with us this morning. Neil, Ashish and I are in the office for the rest of the day. If any questions to clear anyone, most call feel free to give us a call in the office. And again thank you for being with us this morning.

Operator

And this does conclude today’s conference. We thank you for your participation.

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