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Hospitality Properties Trust (NYSE:HPT)

Q2 2012 Earnings Call

August 07, 2012 1:00 pm ET

Executives

Carlynn Finn

John G. Murray - Principal Executive Officer, President, Chief Operating Officer, Assistant Secretary and Executive Vice President of Reit Management & Research LLC

Mark Lawrence Kleifges - Chief Financial Officer, Principal Accounting Officer, Treasurer and Executive Vice President of Reit Management & Research LLC

Analysts

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

Wes Golladay - RBC Capital Markets, LLC, Research Division

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

Operator

Good day, and welcome to the Hospitality Properties Trust Second Quarter 2012 Financial Results Conference Call. This call is being recorded. At this time, for opening remarks and introductions, I would like to turn the call over to the Senior Manager of Investor Relations, Ms. Carlynn Finn. Please go ahead, miss.

Carlynn Finn

Thank you, and good afternoon. Joining me on today's call are John Murray, President; and Mark Kleifges, Chief Financial Officer. John and Mark will make a short presentation, which will be followed by a question-and-answer session. The recording and retransmission of today's conference call is strictly prohibited without prior written consent of HPT. Before we begin today's call, I'd like to read our Safe Harbor statement.

Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on HPT's present beliefs and expectations as of today, August 7, 2012. The company undertakes no obligation to revise or publicly release the result of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC.

In addition, this call may contain non-GAAP financial measures, including normalized funds from operation or normalized FFO. A reconciliation of normalized FFO and EBITDA to net income, as well as components to calculate AFFO, CAD or FAD, are available in our supplemental package found in the Investor Relations section of the company's website.

Actual results may differ materially from those projected in these forward-looking statements. Additional information concerning factors that could cause those differences is contained in our Form 10-Q to be filed with the SEC, and in our Q2 supplemental operating and financial data found on our website at www.hptreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.

Now I would like to turn the call over to John Murray.

John G. Murray

Thank you, Carlynn. Good afternoon, and welcome to our second quarter 2012 earnings call. Today, HPT reported second quarter of normalized FFO of $0.75 per share. Focusing first on our travel center investments, this morning TA reported improved quarterly results with second quarter 2012 net income of $29.9 million, compared to net income of $21.8 million in the 2011 second quarter, a 36.8% increase.

TA second quarter performance of HPT's 185 travel centers included continued strong per gallon fuel margins on slightly reduced fuel volumes, and increases in nonfuel sales and gross margin.

Property level rent coverage for

HPT's travel centers was approximately 2.1x for the quarter.

Turning to HPT's hotel investments. Second quarter RevPAR increased 0.9% at our comparable 288 hotels. RevPAR increased 1.5% at our 290 hotels including the 2 recently acquired Royal Sonesta Hotels. The result of the 3.7 percentage point decrease in average occupancy to 72.6%, offset by a 6.7% increase in average daily rate to $102.42.

During the quarter, we had 72 hotels under renovation for all or part of the period, including hotels in our Marriott No. 1, Marriott No. 234, IHG, Hyatt and Radisson portfolios. The impact of these renovations, primarily from reduced occupancies because rooms were out of service, was significant as RevPAR was up 4.6% quarter-over-quarter from nonrenovation hotels, but was down 9% at comparable renovation properties. GOP margins at the 218 nonrenovation hotels increased 90 basis points.

Importantly, we have credit support from each of these operators in the form of guarantees of security deposits. Accordingly, even during this period of significant renovations and impacted operations, HPT will continue to receive its priority returns in rents from these portfolios.

Average daily rate growth for our 290 hotels was 6.7% in the second quarter of 2012, an increase in each hotel portfolio and for 16 of our 17 brands this quarter compared to last year, as our operators continue to manage guest mix and pushed rate during peak travel periods. Despite the unsteady macroeconomic environment and excluding renovation hotels, we have seen continued steady RevPAR improvement in 2012 as we did in 2011.

However, the impact of renovations, some renovation delays and post-renovation ramp up continues to weigh on hotel performance. This will continue throughout 2012 and 2013. Nonetheless, we are pleased with the operating performance of the 35 hotels that completed the renovations in 2011, with RevPAR up 8.6% and GOP margin up 310 basis points at these hotels in the second quarter of 2012 versus 2011.

There is optimism about the ongoing lodging recovery in the U.S. as a result of constrained supply growth, steady demand and increases in average daily rate and GOP margins. However, sluggish economic growth at home and continued economic weakness in Europe and Asia continues to create uncertainty about the sustainability of this recovery. Most of our managers are taking a more conservative view now than they did earlier this year, and their full-year 2012 RevPAR expectations now range from 3.5% to 7.5%, with an average around 4%, down from the 5% to 8% range they previously forecast because of the extent of renovations and projected post-renovation ramp up timing in the current economic environment.

We told you last quarter that second quarter RevPAR would be flat because of the volume of renovation activity. There will continue to be renovations in the third and fourth quarters, but the pace will slow compared to this quarter and the first quarter of 2012. We expect 29 hotels will be under renovation during all or parts of the third quarter and about 20 in the fourth quarter.

Renovation activity is expected to pick up again in the first quarter of 2013. We have tried to schedule as many innovation projects as possible for periods when they may create the least disruption to hotel performance. Nonetheless, there will be projects underway during each quarter and the impact will partially offset growth from properties not under renovation.

Part of our strategy in acquiring the 2 Sonesta hotels and establishing an affiliated relationship with Sonesta was to improve our growth opportunities. During the second quarter, HPT and Sonesta converted 4 hotels from our IHG portfolio in Hilton Head, Baltimore, Burlington, Massachusetts, and Philadelphia to Sonesta brands. Since the end of the second quarter, we have rebranded an additional 7 hotels from IHG to Sonesta brands, and by the end of August, we expect to convert 6 more IHG-branded hotels to Sonesta and 2 Marriott Residence Inns to Sonesta ES Suites.

Renovations are planned at all of these hotels, which will occur in 2013 and 2014. We plan to sell 2 hotels, which are going to be rebranded to Sonesta ES Suites, to entities affiliated with Sonesta, and we are currently evaluating possible acquisitions to continue to grow the Sonesta relationship.

The Sonesta relationship is not our only growth opportunity. Last week, we closed on the new management agreement we announced in May with Wyndham Hotels and Resorts, whereby Wyndham converted 15 Candlewood Suites and 1 Staybridge Suites hotel to Wyndham's Hawthorn Suites brand. Wyndham also converted 4 Crowne Plazas to Wyndham Hotels. We are currently evaluating other possible acquisition opportunities with Wyndham and plan to grow this portfolio.

On July 13, we sold the St. Louis Airport Marriott for $29.25 million. Taking into account the above conversions, planned conversions, the St. Louis sale, the planned sales of 2 Staybridge Suites and ignoring potential new acquisitions, going forward, HPT's portfolio will be made up of 122 Marriott-managed hotels, 91 hotels managed by IHG, 22 hotels managed by Hyatt, 21 hotels managed by Sonesta, 20 hotels managed by Wyndham, and 11 hotels managed by Carlson.

As we have discussed, we are in the process of returning each of these hotels to a like-new condition during the present ongoing renovation process and expect the long-term performance of our hotels to remain strong.

I'll now turn the presentation over to Mark to provide further detail on our financial results.

Mark Lawrence Kleifges

Thanks, John. First, let's review the second quarter operating results for our hotel properties. As John discussed, we had 72 properties or about 25% of our hotels under renovation for all or part of the second quarter. As would be expected, this level of renovation activity had a negative impact on the operating results of our hotel portfolio, with revenue growth at our 288 comparable hotels up less than 1% versus the prior-year quarter. Results were more favorable at our 216 hotels not under renovation during the second quarter, with revenues at these hotels up $8.8 million or 3.7% quarter-over-quarter.

Our strongest performing portfolio was our Marriott No. 1 portfolio with a revenue increase of 7.6%, while revenue for our IHG portfolio, which had 44 properties under renovation during the quarter, declined 1.6% quarter-over-quarter.

Renovation activity also took its toll on hotel profitability, with gross operating profit for our comparable hotels down approximately $700,000 or about 0.5% quarter-over-quarter and GOP margin percentage down 54 basis points to 38.8%. Excluding hotels under renovation during the quarter, gross operating profit increased $5.9 million or 6.5%, and GOP margin percentage increased 102 basis points to 38.9% at our comparable hotels.

Performance this quarter was strong at our Carlson portfolio and Marriott No. 1 portfolio, which each had only 1 hotel under renovation during the quarter, with 16.4% and 12.7% increases, respectively, in gross operating profit, and 250 and 224 basis point increases, respectively, in GOP margin percentage.

Despite the negative impact of renovation activities on hotel revenues and gross operating profit, cash flow available to pay our minimum rents and returns for our comparable hotels increased $12.5 million or 15.6% quarter-over-quarter. This increase was a result of the temporary deferral of the requirement that our managers make FF&E reserve contributions for our IHG and Marriott 234 agreements and the improved operating performance of our Marriott No. 1 and Carlson portfolios this quarter.

Turning to coverage of our minimum returns and rents for the 2012 second quarter. Our Marriott 234 and IHG portfolios had coverage of 1.08x and 1x, respectively. Coverage for the Marriott portfolio benefited from the second quarter contract amendment, which included a provision to defer the requirement to fund FF&E escrows, retroactive to the beginning of 2012. During the second quarter, after giving effect to this change in FF&E reserve requirements, the amount available under the Marriott 234 guarantee was replenished by $6.5 million, resulting in a remaining balance of $30.5 million at June 30.

During the quarter, we also replenished the IHG security deposit by the $1.5 million of cash flow in excess of our minimum returns for the quarter, resulting in available security deposit of $41.1 million at the end of the quarter.

At quarter end, all other payments due under our hotel operating agreements were current. Information regarding all of our security deposit and guarantee balances at quarter end will be included in our Form 10-Q, which will be filed tomorrow.

Turning to our travel center portfolio. Performance continued to improve this quarter, with property level EBITDAR at our 185 centers, up $11.6 million or 12% versus the 2011 second quarter.

Fuel volumes for the second quarter were down slightly from the prior year, but per gallon fuel margins increased this quarter, resulting in an 11% increase in fuel gross margin compared to the 2011 quarter.

Nonfuel revenue and gross margin increased 4.1% and 2.2%, respectively, quarter-over-quarter.

Property level rent coverage improved from the 2011 second quarter and was 2.11x for our TA centers and 2.08x for our Petro centers.

Earlier today, TA reported second quarter 2012 corporate level EBITDAR of $94.1 million, a 13.5% from the -- 13.5% increase from the 2011 second quarter.

TA's EBITDAR coverage of total cash rents at the corporate level was very strong at 1.74x for the second quarter. On a trailing 12-month basis, the coverage was also strong at 1.36x.

Turning to HPT's operating results for the second quarter. This morning, we reported normalized FFO of $93 million or $0.75 per share. This compares to second quarter 2011 normalized FFO of $110.2 million or $0.89 per share. The majority of the decline in normalized FFO in the 2011 quarter is due to the temporary elimination of FF&E escrow funding requirements for the Marriott 234 and IHG portfolios, which had the effect of reducing HPT's reported 2012 normalized FFO by $14.3 million or approximately $0.12 per share from the 2011 quarter, but more importantly, did not reduce HPT's cash flow from operations or cash available for distribution.

EBITDA was $139.9 million in the second quarter, and our EBITDA to total fixed charges covered ratio for the quarter remained strong at 3.2x. In May, HPT paid a common dividend to $0.45 per share. Our normalized FFO payout ratio was approximately 60% for the 2012 second quarter.

Before opening the call to questions, I would like to provide an update on where HPT stands at the end of the second quarter with its capital funding commitments.

We've agreed to fund up to $145 million for renovations to the 68 hotels in our Marriott 234 agreement. As of the end of the quarter, we have funded $45.2 million. We expect to fund an additional $38.8 million in 2012 and the remainder in 2013.

We have also agreed to fund up to $290 million for renovations to 91 hotels in our InterContinental agreement. As of the end of the quarter, we have funded $126.8 million. We expect to fund an additional $123.8 million in 2012 and the remainder in 2013.

We have also agreed to fund up to $75 million from renovations to the 20 hotels in our new Wyndham agreement. As of the end of the quarter, we have funded $430,000. We expect to fund an additional $25 million in 2012 and the remainder in 2013.

We are currently working with Sonesta to develop renovation budgets for the 19 hotels that have been or will be converted to Sonesta brands. Our preliminary estimate is that we will fund between $130 million and $150 million for these renovations. We expect to fund $10 million in 2012 with the remainder taking place in 2013 and 2014. We also expect to fund up to $93 million for improvements to our travel centers in 2012. As of the end the quarter, we have funded $18 million.

With respect to our balance sheet and liquidity, at quarter end, we had cash of approximately $25 million, which excludes $47.5 million of cash escrowed from improvements to our hotels and had no amounts outstanding on our $750 million revolving credit facility.

As of today, we have approximately $75 million of cash on hand and $750 million of borrowing capacity under our credit facility available to fund our remaining capital commitments and future acquisitions.

In closing, we remain optimistic about the prospect of continued improvement in the operating results at our travel centers, as well as the positive impact our extensive renovation program will have on the long-term performance of our hotels.

Operator, we can open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] We have a question from Jeffrey Donnelly from Wells Fargo.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

John, can you just talk a little bit more and specific about the renovations. I'm just trying to get a sense for, I guess, as how invasive and disruptive they've been and so what we can expect from sort of a before-and-after potential of these, sort of the largely lobby renovations or the guestroom renovations? And do you have any sense of how many rooms have been going in and out of service?

John G. Murray

And to the last part first, I don't have a number handy on the rooms count in and out, but the renovations have been extensive. They've been complete rooms renovations in almost all of the hotels and lobby renovations as well. So in the Courtyards, there've been -- they're refreshing lobby, Marriott's new lobby concept for Courtyard. There's a new gate house design for Residence Inns that we've been upgrading to, as well as upgrading the rooms. In the Candlewood Hotels, it's been [indiscernible] rooms, some kitchen renovations including cabinetry and bathroom renovations. In Staybridge Suites, it's been rooms and kitchen renovations. So it's been a very substantial renovation in each of the hotels.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

And what's your expectation? I guess how are you thinking about -- to measure their success or failure post-renovation? I mean, are you looking for them to recover their lost occupancy and some degree of rate in the 12 months that follows? How -- I guess, how should we set our expectations for that?

John G. Murray

Yes. We've -- the hotels have -- as rooms have been out of service, they've been trying to hold rates at pretty good levels in the extended stay hotels, which many of these hotels are. They've been focused more on short-term stays during the renovation process because it's a -- you probably never see a customer back again if they had to stay for 3 months, all of which was during the renovation period. So -- but the expectation after is that we will regain the occupancy that we've lost. We were lucky in that we've traditionally run somewhere between a 15% and 20% premium to the industry in terms of occupancy levels. And so even though we've been losing occupancy during this renovation process, we're still running at a premium. So we are optimistic that we'll regain occupancy once the renovations are complete and the hotels are in much improved condition. And we're also optimistic that we'll be able to charge higher rates as a result of the improved condition and more competitive nature of the properties. But, I guess, I would point out that, particularly with the extended stay hotels, it does take some time to rebuild that base of longer-term stays, which are the more profitable stays in an extended stay hotel. And -- but if you're planning to be working on a project or involved in training or otherwise staying in an extended stay hotel for a month or 3 months or a year, there's a lot of planning and advanced planning that goes into selecting what hotel you're going to stay at, and as a result, it takes a little bit more time to build that base of business. So we're not expecting that as soon as we finished the punch list, we're going to jump right back in the first month to the 2007 levels. But we are expecting that there will be a steady increase back towards that level of performance. And I guess there other thing is just that in any salesperson, who's competing with our hotels, if there are any good has been calling on as many customers as they can saying, "Do you really want to stay at that hotel? It's scheduled for a renovation soon. It's going to be in renovation during the period where you want to want to have your meeting or you want to have your stay or event." And so there's market pressure they have to sell against so once you complete the renovation, too. So we are expecting performance to come back, but it won't be immediate.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

And just a housekeeping question or 2, do you guys have the Marriott and IHG home security deposit balances as of today rather than quarter end. I'm just curious where they're maybe at.

John G. Murray

Let me see if I have that with me, Jeff. I don't think I brought it.

Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division

And maybe while you're looking, I'll just ask John, I saw in your notes that RMR purchased 2 of the hotels. Just to be clear, that's not one of the other RMR-affiliated REITs. I assume that's the adviser and I guess why did RMR step into that position?

John G. Murray

Yes. That's a good question. As you know, there are REIT requirements that to be a qualified -- it's a technical answer, I apologize in advance. The REIT requirements to be a qualified third-party manager, you have to manage for -- Sonesta has to manage for other parties besides just HPT. And when we acquired Sonesta, and today, we believe that Sonesta easily met those requirements because they manage a number of hotels, 5 or 6 hotels in the Middle East and in Egypt and Qatar, and they manage a hotel in Coconut Grove, that's not owned by HPT. However, the business in Egypt is very fragile, and the situation there, I think everybody knows, is not very good. So to be sure that we weren't going to go run into any technical issues with IRS requirements, a couple of other entities were set up and they bought 2 of the least well-performing Staybridge hotels that we had in our portfolio. And those will be owned by affiliates of RMR and managed by Sonesta and it ensures compliance with that technical REIT requirement.

Mark Lawrence Kleifges

Jeff, getting back to you on your question about the Marriott guarantee and the IHG security deposit, as of today, the Marriott guarantee has increased since quarter end from $30.5 million to $31.8 million available, and the IHG security deposit has increased from $40.1 million to $41.9 million at August 7.

Operator

And our next question comes from Dan Donlan with Janney.

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

Just real quick, Mark, could you kind of explain what's going on with Marriott 2, 3 and 4. You guys, I think, you had to have some rent come in or Marriott had to replenish some of the rent, but then yet you saw the security deposit go up or guarantee go up. Could you kind of explain kind of what went on there?

Mark Lawrence Kleifges

Are you talking about the $6 million-plus replenishment of the guarantee during the quarter?

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

Right, right. Why was it replenished if it was $2.4 million less than the minimum rent? Maybe I'm reading that wrong, I'm just kind of...

John G. Murray

No, no. It is -- let me see if I can explain it in a simple way because obviously, there's somewhat complex waterfalls behind that contract. But to start with, during the quarter, we entered into an amendment to that the contract with Marriott that eliminated the need for them to escrow FF&E reserves, and that amendment was retroactive back to the beginning of the year. So during the second quarter, we not only did not record any income from FF&E escrows from the Marriott 234 agreement, but we reversed the income that we had recognized in the first quarter. Now when you eliminate the FF&E reserve, what that does is if you think about our typical cash waterfall, it's hotel revenues, less operating expenses, less the FF&E reserve and then what's left goes towards payment of our minimum return. So if you eliminate the FF&E reserve, that increases the amount of cash that's available to pay our minimum return, and because the Marriott guarantee is capped at 90% of our minimum return, that increase in cash flow, we only get up to 90%. But if we had retained all the excess cash flow, it would've been over 90%, so we gave some of the cash back to Marriott, which was used to replenish the guarantee. If you want to talk about that off-line, I can walk you through the actual numbers. Okay?

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

No, I mean, that actually made sense. I've got it. Okay. And then, has all the properties that you're going to convert to Sonesta, has that been decided or is there still potential for some of the Marriott, IHG or any other remaining hotels to be converted to Sonesta?

John G. Murray

There are no other hotels in our portfolio other than the ones we've already identified that will be converted.

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

Okay. And I guess looking out to maybe a normalized number, what percentage of your minimum rents or your call it hotel EBITDA you think will be associated with Sonesta?

John G. Murray

I think it's around 6%.

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

Okay. It's pretty small. And then what could you -- on the $130 million to $150 million that you're looking to spend on the Sonesta hotels, what is that on a per key basis if you have that?

John G. Murray

There's 3,300 keys. So you can do the math.

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

Yes, no problem. And then I guess just lastly kind of on moving to Sonesta from Marriott and IHG-branded hotels, how are you guys mitigating the loss from the loyalty programs in the brand systems. It would seem to me that an extended stay product, if you're staying a month, you'd want to be able to get the points from Hilton and Marriott. So how are you guys looking to mitigate that loss from not having a loyalty program as you're -- are you building a loyalty program with Sonesta? Any thoughts there would be helpful?

John G. Murray

Yes. There's a few components to that. I guess the first thing is that the -- as you would expect Marriott and IHG and the other major brands don't deliver those loyalty points and systems at no costs. So when the -- while there is an expected drop-off when those are taken out of the equation, there's a substantial cost component that also comes out. So that's part of the mitigation. Part of the mitigation is by working hard on guest relations and customer service and delivering good product through the renovation process that we're embarked upon. And then the third component, as you mentioned, is that Sonesta has their own reservation system and is working on developing their own guest affinity program. And over time, as their recognition improves in the marketplace and as their service levels are high and their product quality is high, we expect that guests will develop a preference for Sonesta hotels equal to some of the other major brands.

Operator

And our next question comes from Wes Golladay from RBC Capital Markets.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Quick question. You mentioned possible additional acquisitions with Wyndham, would these be one-off assets, maybe a portfolio or relatively newer hotels, older hotels that might need renovation? Where are we looking at here?

John G. Murray

Obviously, on almost every acquisition opportunity that you look at, there's confidentiality agreements involved. So I can only answer that in a vague way. But we have looked at very large portfolio acquisitions with Wyndham this year involving -- even involving brands, and we've looked at several different one-off transactions, where we would add existing hotels that are in key markets and reasonably well performing. But where we think that whereby putting the Wyndham brand on the property, we can collectively improve and perhaps spending some money on capital can improve performance. And where we could take those new hotels and add them to the existing Wyndham portfolio that we now have. So it's been a combination. We've got a pretty open dialogue and a fairly healthy pipeline.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Okay. And would you say that pipeline's better now versus the last time we talked on the call?

John G. Murray

The last time we talked we didn't have the Wyndham deal yet. So...

Wes Golladay - RBC Capital Markets, LLC, Research Division

Oh, shoot. I mean, I guess, with the overall deal pipeline, guys, I mean it's...

John G. Murray

The pipeline has been very full and active. We've been bidding on a number of different marketed transactions for large portfolios and individual hotels, we've been bidding and developing leads outside of the sort of the brokerage communities, marketing process. And -- but I'm not sure that I can say that we've ever been busier on an acquisition's front than we are today. It's a very active pipeline.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Okay. That's good to hear. And on the Capital market's front, I mean what is the plan for all the renovations, lets some of it go in the line and once it hits a certain threshold, would you tap the debt markets, preferred market, possibly, the equity? How do you plan on financing the whole 2013?

Mark Lawrence Kleifges

Yes. Well, to date, we've been -- we don't have anything out on the line today and about $75 million of cash. So it's going to be a little while before we've got enough on the line to where we have enough to actually access the capital markets. We're probably going to end the year with $220 million or so out on the line, and at that point, we'd have -- we'd be getting close to the size of a raise where we could access the capital markets. And I would think debt would probably be the way we go to clean that out.

Wes Golladay - RBC Capital Markets, LLC, Research Division

Okay. So you have like a sweet spot of maybe $250 million, $300 million and then just clean it out?

Mark Lawrence Kleifges

Yes.

Operator

And our next question comes from Ryan Meliker with MLV.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

Just a couple of quick questions. First of all, I'm sorry if I missed it, but you said in your opening remarks that your managers were averaging about 4% RevPAR growth for the year. Is that after renovation or before renovation?

John G. Murray

That's factoring in the renovations.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

That's factoring in the renovations. So I mean correct me if I'm wrong, but given that factoring in the renovations, you guys were only up 0.4% year-to-date. That basically implies close to 8% RevPAR growth post -- inclusive of renovation impact in the back half of the year, is that correct?

John G. Murray

Yes, we're expecting that performance will pick up once the hotels are renovated, that's correct. And we expect to see both some pick-up in the occupancy and improvement rate and the mix of properties. It's some are coming -- some are prepping to go into renovations, some are being renovated and some are coming out of renovations. So when the exact timing is whether they all hit their numbers exactly as they project, we're hopeful. It remains to be seen, obviously.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

That makes sense. And then with regards to renovation impact in the back half of the year, you guys have indicated that it sounds like you're going to have a lighter CapEx implications in the back of the year than the front of the year, but from what Mark just disclosed, it sounds like it's going to be over $250 million in CapEx in the back half of the year and year-to-date, you guys were only around $167 million. So help me understand why the higher degree of CapEx is going to have less implication on RevPAR?

Mark Lawrence Kleifges

Some of it just has to do with the timing of when you actually pay the bills.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

Sure. So it's really just timing-driven. It's not about what you're doing or -- okay.

John G. Murray

And a lot of the FF&E, you put up a 50% deposit on. And -- but there's only a fairly long lead time on when that stuff shows up and is installed. So there's a lot of moving parts to that.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

Sure, I figured as much. That's helpful. And then just lastly, with regards to the Marriott No. 1, obviously you guys have indicated in the past that Host is -- that's going to revert back away from Host to your TRS. Are you -- is the minimum guarantee guaranteed by Marriott as the operator or by Host? And then is there going to be any type of, I guess, security to that minimum guarantee given that there's no deposit on that portfolio?

Mark Lawrence Kleifges

The credit support for that contract comes in the form of the security deposit put up by Host. There is no Marriott guarantee and when it converts back to us, there will be no credit support.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

There will be no credit support and no minimum guarantee, so it would be basically like a typical hotel like the rest of the REITs, in other words.

Mark Lawrence Kleifges

There's a minimum. The contract is still a little different. The way the contract would work is there'd be the cash waterfall that exists today would stay in place. So hotel operating expenses before management fee would be the first deduction and then an FF&E reserve. Then our minimum, after we get paid our minimum, Marriott would get its management -- based-management fee and then there's a, as I recall, a 50-50 split of residual cash flow after that.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

So there's a minimum? You still have your minimum before Marriott gets their fee?

Mark Lawrence Kleifges

Yes.

Ryan Meliker - McNicoll, Lewis & Vlak LLC, Research Division

And that doesn't change. It's more of there's no credit support if the properties don't cover the minimum. Okay.

Mark Lawrence Kleifges

Correct.

Operator

[Operator Instructions] Our next question comes from David Loeb from Baird.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

Gentlemen, I just want to clarify a couple of things just for starters for my own understanding. Mark, if we go back to that debt-raise question. Essentially, I guess, I'd have a question about free cash flow and I want to make sure I'm looking at free cash flow the way you do. All of these capital investments are essentially into earning assets, correct? You're getting a percentage of every dollar you put in?

Mark Lawrence Kleifges

Correct. Our minimum return or minimum rent depending on the contract as we make FF&E reserve fundings, as we call them. Our minimum rent or minimum return goes up anywhere from 9% to 10% -- 8% to 10%, I'm sorry.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

So when you look at free cash flow, do you even look at that as a factor in it or is that rather something you view as a use of free cash flow?

Mark Lawrence Kleifges

We view it as -- we and our board view it as a use of free cash flow.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

So if I'm understanding the dynamics correctly, you're talking about going to the bond market, borrowing at, depending on the term, 4%, 5% to fund investments that are going to yield you 8% or 10%?

Mark Lawrence Kleifges

Correct.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

Sounds like a pretty good deal. And then as you do that, I wanted to ask about the dividend. And given that your board is viewing free cash flow as being free cash flow before you choose to make new investments, as you make these new investments, increase the taxable income, is there upward pressure on the dividend over the next 6 months, 18 months, whatever?

Mark Lawrence Kleifges

From a tax standpoint?

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

Yes.

Mark Lawrence Kleifges

No, because depreciation comes into play, which is a great shelter of taxable income. So I don't think we'll -- I don't think that will be the reason that there's dividend pressure. I think as we get farther through the renovation process and as returns start to -- rent coverage and return cover start to improve in our agreements, there'll be more focus by the board and management on increasing the dividend.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

Okay. The reason I asked about that was because the last year, 2011, 100% of your dividend was taxable income. But it sounds like you're not necessarily bumping up at against paying out 100%?

Mark Lawrence Kleifges

No, I mean, there's -- without getting into a long technical discussion, you're correct, it was 100%, it will probably be 100% this year, but we'll be okay from a federal tax distribution standpoint.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

Okay. And then back to the question about the change in the way you account for the Marriott agreement. Essentially, was there any cash flow change or was it merely the way your accounting for CapEx and the like?

Mark Lawrence Kleifges

Well, there's no impact on free cash flow to HPT or cash available for distribution. Think of it this way, is that we essentially get 2 payments from our managers related to our hotels. They pay us an FF&E reserve, typically equal to 5% of revenues. They distribute cash to us equal to that. And they distribute to us our minimum return. Both of those items are included in both net income and normalized FFO. When you get to cash flow from operating activities in the cash flow statement or cash available for distribution or FAD or whatever you want to call it, in the cash flow statement, we deduct that piece, that first payment related to the FF&E. We deduct that to get to cash flow from operations because we're putting that cash in a restricted cash account. And then looking at CAD or determining cash available for distribution and evaluating our ability to pay a dividend or increase the dividend, we have always deducted the amounts escrowed for FF&E reserves. So the point we're trying to make is that from a cash flow from operations or CAD standpoint, there's change in FF&E escrow requirements had no impact on either.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

So essentially the economics didn't change, but the where it goes through the income statement changed, is that correct?

Mark Lawrence Kleifges

Well, the economics did change in the sense that the manner that we're not growing the escrow account. So think of it this way, if the Marriott escrow account isn't increasing while we're doing the renovations, we're going to have to fund, make more FF&E or renovation fundings and our minimum return's going to go up, as a result, a little higher.

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

That's improved economics, essentially?

Mark Lawrence Kleifges

Well, long term, if you look at it that way.

John G. Murray

And in the short term, it takes a little bit of pressure of what would otherwise be a tight cash flow situation for our operators where they might be drawing on credit support more than they would prefer. So it's a balance like all of our REITs [ph].

David Loeb - Robert W. Baird & Co. Incorporated, Research Division

That makes sense. It's all very helpful. Last question, as you look at acquisitions, at what point do you feel like you will need to balance the additional borrowing with some additional common or preferred? And which of those do think you'd look towards?

Mark Lawrence Kleifges

Well, I think in terms of looking at our capital stack, I think that we've got the right mix right now of preferred common and debt. Our -- even if at the end of 2012, we fund the remaining. I think we've got about $270 million more of renovations we're going to fund this year. Our debt to total book capitalization is still only going to be about 45%. So from the renovation standpoint, I don't think there's any need to raise equity. If we were to go out and do a significant acquisition or significant number of acquisitions, we want to continue to run the company in that -- around that 45%, 40% to 50% debt to total book capitalization. So at some point, there may be a need to raise common equity if we're successful on the acquisition front.

Operator

And we have a follow-up question from Dan Donlan from Janney.

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

Just wanted to go back to the acquisitions real quick. In the past, you guys have said that you think you could still achieve your minimum rent structure on the potential acquisitions. Is that still the case or could you maybe characterize maybe some of the opportunities in terms of the way they'd be structured.

John G. Murray

I think what you just said is still accurate. We've -- the transactions that we've been looking at have been within the construct of a typical HPT deal structure, where we have a waterfall, as Mark described, where there's -- the operators bring in the revenues, pay the operating expenses, fund an FF&E reserve, that there is a return and paid to the owner, a management fee paid to the manager, and the returns are in the range of the deals that we've been recently doing or recently restructuring to. And they involve credit support and the structure that we've had in the past. So...

Daniel P. Donlan - Janney Montgomery Scott LLC, Research Division

That more than answers the question. I guess, the other thing would be are these going to be more full service type of assets or limited service type of assets or a combination of both?

John G. Murray

We've looked at both. We've looked at portfolios of select service hotels. And individual urban properties in major markets. So when it's a one-off deal where we're adding to an existing portfolio, which I'd say the focus has been on, most recently, has been on the relationships that we have with Sonesta and Wyndham, we've been looking at, primarily, there at full-service hotels on the Sonesta case, at potential conversions for the ES Suites brand, a new extended-stay brand.

Operator

And there are no further questions at this time. So I'd like to turn the conference over to John Murray. Please go ahead.

John G. Murray

Thank you, all, very much for joining us today. We look forward to speaking with you soon.

Operator

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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