Jul 27, 2010
Executives
Mark Brugger – CEO John Williams – President and COO Sean Mahoney – EVP, CFO and Treasurer
Analysts
David Loeb – Baird Chris Woronka – Deutsche Bank Jeff Donnelly – Wells Fargo Shaun Kelley – Bank of America Will Marks – JMP Securities Ryan Meliker – Morgan Stanley Smedes Rose – KBW Mike Salinsky – RBC Capital Markets Dennis Forst – KeyBanc Bill Crow – Raymond James
Operator
Good day, ladies and gentlemen. And welcome to the second quarter 2010 DiamondRock Hospitality earnings conference call.
My name is Chandelle, and I will be your facilitator for today's call. At this time, all participants are in listen-only mode.
We will conduct a question-and-answer session towards the end of today’s conference. (Operator instructions) As a reminder, this conference is being recorded for replay purposes.
I would now like to turn the presentation over to your host for today's call, Mr. Mark Brugger, CEO.
Please proceed, sir.
Mark Brugger
Thanks, Chandelle. Good afternoon, everyone.
And welcome to DiamondRock’s second quarter 2010 earnings conference call. Today I’m joined by John Williams, our President and Chief Operating Officer, as well as, Sean Mahoney, Chief Financial Officer.
As usual, before we begin, I would just like to remind everyone many of our comments today are not historical facts and are considered forward-looking statements under federal securities laws, and may not be updated in the future. These statements are subject to numerous risks and uncertainties described in our securities filings.
Moreover, as we discuss certain non-GAAP financial measures, it may be helpful to review the reconciliation to GAAP in our earnings press release. DiamondRock second quarter results exceeded our original expectation as lodging industry benefited from positive demand trends.
We believe that these demand trends couple with limited new supplier are the key ingredients for robust multi-year in lodging fundamental. Despite the recently release of mixed economic data, the positive momentum in lodging fundamentals appears to have a strong footing.
The following data points are indicative of the early stages of the strong recovery. First, year-to-date domestic demand for up rev scale hotels has increased to healthy 10%.
Second hotel rate trends are improving as a result of positive business mixed shift, particularly the research for the most profitable customer, the business traveler who is displacing lower rates leisure and contract business. Third, group booking pace has continue to improve with relatively short booking windows and lastly, industry forecast show supply growth to be well below (inaudible) for the next several years.
The positive operating trends are evidence that our second quarter numbers. DiamondRock reported strong second quarter results with adjusted EBITDA of $35.8 and adjusted FFO of $21.6 million.
These results are derived from RevPAR growth of 6.1%, a positive margin growth of 67 basis points as we continue to reach the benefit of cost containment efforts. 11 of the company’s hotels recorded double-digit RevPAR improvements during the second quarter and almost half were able to increase averaged daily rate.
More significantly, Chicago's surpassed expectations with RevPAR Chicago Downtown Marriott and Oak Brook Hills Marriott increasing over 30% in the last year-to-date of the quarter and over 8% for the entire quarter. In addition, RevPAR Conrad held in Chicago increased 28% in June, which will be reflecting in our third quarter results.
We are also excited about the exceptionally strong trend in New York with our two hotels achieving RevPAR gains above 20% during the quarter. Our Courtyard Fifth Avenue alone experienced RevPAR growth up 31% in the last period of the quarter.
Our hotel located just outside of San Francisco and Washington D.C. were also strong performers of the quarter.
DiamondRock continues to execute on its business plan, the company work diligently during the last two years to navigate with economic downturn. We focused on operating efficiencies and creating a conservative balance sheet that will give us the ability to seize upon acquisition opportunities that would not only rise from financial stress or simply for well-time deals at the start of the recovery.
Earlier this year we begin recovering these type of opportunities and during the second quarter acquires Hilton Minneapolis hotel and senior notes from Allerton Chicago hotel. Additionally, our Marriott sourcing relationship, and recently entered into a binding contract to acquire the Renaissance hotel in Charleston Historic District.
It is worth noting that two of these three transactions were sources to off market. We're excited about the growth prospects of our announced acquisition.
In 2010 RevPAR growth of three hotels was up 10%. Moreover we believe that the pricing was attracted by the all three transactions, but the Hilton Minneapolis and the Renaissance Charleston hotel acquired for than 11 times projected for EBITDA and Allerton that acquired at $8.5 million discount to par or stated alternatively less than $140,000 for key.
In total, DiamondRock was able deploy over $0.25 billion through investment in these three hotels. Consequentially, in keeping with our business strategy and maintaining adorable balance sheet with the competitive level of investment capacity, company has successfully completed an overnight equity offering in the second quarter raising approximately $185 million.
Today, DiamondRock has one of the balance sheet in the industry. By the end of 2010, even after closing on the Renaissance Charleston we expect to have unrestricted cash of approximate $160 million, pro forma net debt to EBITDA of only 4.4 times with accordingly no preferred equity outstanding and no corporate debt and lastly, unsecured $200 million corporate revolver that was completely untapped.
In short, we believe that our high quality portfolio, strong growth prospects, conservative capital structure and significant drive part are all combined to create a powerful platform to drive shareholder value. DiamondRock will continually prudently evaluate potential acquisitions to opportunistically grow our platform.
I would note that we are seeing attractive opportunities and believe that we are pioneer recovery where history has acquisitions yield the strongest return. With that, I will turn the call over to John to discuss fundamentals and acquisitions.
John Williams
Thanks, Mark. Let me begin by saying that we were pleased with performance of our portfolio and the trends remain very strong.
Specifically for DiamondRock's 20 hotel portfolio the second quarter marked the first quarter of RevPAR growth in two years. Period Six mark the first period of ADR growth since period 10 in 2008.
Even more encouraging were house profit margins up 44 basis points in Q2, in a phase of higher occupancies and relatively flat ADR’s. The margins are even more encouraging when you consider the cancellation and attrition fees were down $1 million in the quarter, a 40 basis point house profit margin hit.
For the second quarter overall portfolio RevPAR was up 6.1% driven by a portfolio occupancy increasing 370 basis point to 72.7% and ADR increasing less than 1% to $160.29. Occupancy trends have been improving for the past three quarters and we have period reach the inflection point for rate.
RevPAR comparison was positive in the quarter for 16 of our hotels. The strongest performance came from hotels in the Chicago and New York markets.
Oak Brook Hills Marriott RevPAR was up 32.5% in the quarter and RevPAR at our Chicago Downtown Marriott was up 8% and was exceptionally strong in period six, which ended in mid June. Both New York City Courtyards were up over 20% in RevPAR.
Our Renaissance continue to perform well with RevPAR increasing over 16%. Our Westin Atlanta was up over 13% and Salt Lake City Marriott RevPAR was up 10% for the quarter.
The Boston Westin RevPAR increased 6.3% in Q2. The portfolio did have a couple of laggards, the Orlando Marriott and the Atlanta Waverly Renaissance experienced RevPAR declines in Q2 of 11% and 9%, respectively.
The Orlando markets will take time to absorb the large supply increases and Waverly had a weak group portfolio. For the portfolio, all three major segments continue to trend well in the quarter.
Business transient revenue was up 7.2%, group revenue improved 5.4% and leisure transient’s revenue was up 1.8%. Lower rated contract and other revenue was up 42% in Q2 but represents only about 4.7% of our portfolios rural revenue and increases were concentrated at LAX, Orlando Airport and Thomas.
As you'd expect in the early stages of recovery, rate increase by the result of shifts in segmentation from lower rated leisure and other to higher business and group, but more importantly, from shifts to higher rate category within the segments. In the second quarter corporate and premium demand was very strong.
Room nights in this category increased 13.2% at a rate 5.7% higher than Q2 2009, resulting in a 20% increase in room revenue coming from our highest transient rate category. In addition, special corporate revenue was up over 14% in the quarter.
Q2 also continued positive trend of accelerated short-term bookings. In the quarter for the quarter group room nights booked increased to 124%, compared to Q2 2009.
Portfolio grew booking pace for 2010 after adjusting prior year’s definite revenue for cancellation and attrition is up 2.3% versus the same time last year as of Q2. Pace has improved sequentially in each of the last three quarters.
Food and beverage are the great story in the quarter, particularly as our focus on profit maximization, plans for fruit. Total food and beverage revenue in Q2 was up 6.7% and after nine consecutive quarters of decline, margins were up 118 basis points.
The margin improvement came from improved profitability in the property restaurant outlets and room service where revenues were up a modest 3% in the quarter but margins were up over 500 basis points. As we’ve mentioned on prior calls, outlet profitability has been a particular focus of our asset manager for the past year.
So these results are very rewarding. Cost containment and profit maximization remain high priority for our asset managers and operators.
We've had big wins in changing staffing models, focusing on food and beverage profitability and portfolio-wide initiatives such as our energy conservation program ranging from efficiencies in lighting and thermostat application equipment. During this recent downturn we were able to work with our operators to put in place new and creative staffing models to reduce cost and changed the way hotels are managed.
Some of these costs are temporary, such as wage freezes, utilizing PTO and reducing bonuses. However, a number of them still persist, such as reduced staffing remodels for smaller hotels, as well as new management models for larger hotels.
Productivity initiatives and housekeeping have fundamentally reduced the time and thus the expense of cleaning stay over rooms, and we will work hard to continue and expand food and beverage profit improvement. As a testament to our operator continued to focus on cost containment efforts in 2010, I want to share a few highlights.
Portfolio, labor and benefit cost in Q2 remained relatively flat from Q2 2009 in spite of higher occupancy. Sales per man hour improved 7% in Q2 versus Q2 of 2009.
Man hours per occupied room improved 6.8%. However, support cost per available room including property level G&A, repairs and maintenance, utilities and sales and marketing were up 5.6% in the quarter, due mainly to bonuses accruals and Marriott sales initiatives.
These two cost categories negatively impacted house profit margins by 60 basis points. Turning to CapEx, we are fortunate that we ended the downturn with mostly renovated portfolio and we are able to perfectly curtail capital spending during this downturn to only necessary are truly value enhancing projects.
We're budging to invest approximately $35 million in the portfolio in 2010. The only funded portion of 2010 CapEx is budgeted to be $7 million with the balance coming from property level reserves.
In Q2, we invested $5.7 million in the portfolio. Our team continues to look for creative ROI CapEx projects.
For example, in 2010 we're adding pavilion to our Griffin Gate Marriott to capture more group rooms. Additionally our team is spending considerable time in evaluating a major multimillion dollar 2011 renovation and repositioning of the Marriott Frenchman's Reef Resort.
We'll have more details on that project during our next earnings call. Turning to acquisitions, we’ve been very active this year.
In June, we acquired 821-room Minneapolis Hilton for $156, representing a 7.5 cap rate on actual forecasted 2010 NOI. We are very bullish on growth prospect of the hotel and some potential ROI opportunities.
The property results continue to improve with room revenue up nearly 30%, total revenue up 22% and house profit up 30% in June, compared to June 2009. The forecast for July, August and the fourth quarter are strong.
Moreover, 2011 is shaping up nicely, with group booking pace at the hotel up 8.5% and group revenue represents two-thirds room revenue at the hotel. Continuing on the acquisition front, we have the Charleston Renaissance under contract and expect to close the transaction in August.
The 166 room hotel enjoys an excellent location in the coveted historic, with $39 million purchase price reflects approximately an eight cap on actual forecasted 2010 NOI. This opportunity was a result of our special sourcing relationship with Marriott International.
Ti was facilitated by leveraging a contractual right of first off where Marriott enjoyed under its management agreement. Marriott presented us this opportunity with one of our regularly scheduled acquisition pipeline meeting, which enabled us to negotiate a deal with the owner to buy the hotel before it was marketed to other potential buyers.
Lastly, we purchased the first mortgage on the Allerton hotel, which enjoy an A-plus location on North Michigan Avenue in Chicago. This was another off market transaction.
The mortgage which is in the fall and came due last January was acquired from Wells Forgo for $60.5 million, a significant discount from base value. Our cost base is less than 140,000 per key and it compares very favorably with recent trades in Chicago.
We're pursuing our rights by foreclosing on the hotel either get repaid par with default interest or alternatively gain simple ownership is a hotel. If we gain this simple ownership, we’re likely to convert the hotel to a global brand in order to maximize its value.
Our acquisition pipeline continues to be strong as higher quality deals are coming to market. However, we remain very disciplined, would it be the past or been outbid on numerous opportunities where we felt the pricing was too rich.
After we close on the Charleston transaction, we would have invested $250 million this year. We will project to have year-end cash surplus of $160 million, plus our under $200 million line of credit.
So we will continue to look for acquisitions that drive shareholder value. With that I'll turn the call back over to Mark.
Mark Brugger
Thanks. As John noted, operating trends continue to show positive momentum and difficulties improving.
As previously announced, we revised our outlook to reflect these trends and incorporate our recent acquisitions. For the full year 2010, the company now expects its portfolio to experience RevPAR growth of 2 to 4%.
Quarterly, we expect adjust EBITDA of $132 to $136 million and adjusted FFO of $83 to 85 million which assumes income tax expense range from $3.5 to $5.5 million. Consequently, adjusted FFO per share is expected to be between 57% and 59%.
Let me conclude by saying that with our high quality portfolio, enhanced by our recent acquisition, along with the company's acquisition pipeline and related investment capacity, DiamondRock is well situated to take advantage of both larger recovery and the acquisition environment going forward. Now, we'd like to open up the call for any questions you might have.
Operator
(Operator instructions) First question come from the line of David Loeb of Baird.
David Loeb – Baird
Good afternoon, gentlemen. I have just a couple, probably both for John.
In the Charleston, when you did your underwriting and certainly, when you are talking about Marriott, how big of a consideration was the pending conversion of the holiday inn to the courtyard, expansion of that. Was that something you took into consideration something that Marriott shared during that process?
John Williams
Yes, David. When we underwrite these things, we try and capture all of the potential supply increases, obviously.
What really impressed us in Charleston was the location of the Renaissance. You can make arguments for the potential courtyard location, but because of the central location closer to Historic District and in Historic and close to some of the historic attractions as well as all the revenue and retail available on meetings and society streets.
We just feel this Renaissance location is going to get first crack at Marriott business when this comes into the city because of location. Number two, when we went down to Charleston, we were pleasantly surprised to find that not only it is a stable asset that really didn’t have a pick peek to cross swing but there’s actually great growth potential down there with a new Boeing 787 assembly plant that’s under construction by the airport which is just a few miles from the hotel and southwest entering the market next May.
Those worked very well for hotel demand. One of the great things about this market and this brand for this location is that even the business that's working out at the airport would prefer to be down at Historic for all the amenities.
So increased commercial business will obviously help our growth rates but and then obviously the tourist business, which is a staple in Charleston is a very reliable return business.
David Loeb – Baird
Sounds like both hotels have very good prospect for growth then?
John Williams
That's our feeling yes.
David Loeb – Baird
Second question, John, your discussion of margins was very thorough and I appreciate that. And clearly looking at hotel-by-hotel results, there's a lot of up and down in portfolio.
A lot of likes it correlates fairly to ADR increase. What about cancellations fees a year ago?
Was that a significant factor?
John Williams
Yes. It was David.
It was particularly impactful at the Chicago downtown Marriott. Right offhand, I don't remember the percentage or the total roughly million dollars attrition in cancellation fees coming from Chicago, but it was obviously disproportion.
Boston had the same phenomenon and the both Renaissance hotels were the big contributors. As you may guess the major groups take the bulk of that hit.
David Loeb – Baird
That makes sense. And LAX as well?
John Williams
LAX to a lesser extent. And your observation on margin are correct, I mean food and beverage were big drivers of margin this quarter, which we’re really excited about, but what we saw occupancy gains at the expense of rate margins, we’re challenged and vice verse, we saw average rate gains and slightly lower or flat occupancy margin tended to improve.
David Loeb – Baird
Okay. Great.
Thank you very much.
Operator
Your next question comes from the line of Chris Woronka of Deutsche Bank. Please proceed.
Chris Woronka – Deutsche Bank
Hey, good afternoon, guys. Thanks for the color on the cost.
And on the support cost that you mentioned, what – can you give us a picture of kind of how they compared to maybe peak levels or some other metrics how should we kind of, benchmark those going forward?
John Williams
Hi, Chris; this is John. That's kind of a tough question; if you look at kind of peak support cost is a percentage of revenue.
You know you're in the 22% to 24% range and it's higher now but obviously you target to get there or lower again. We have some unusual things bonus accruals coming back into the equation for the first time and probably two years.
Had a fairly significant impact on A and G, as well as some of the departmental profits, but too much lesser extent. And then the Marriott sales initiative, sales force one which has been rolled out in a couple of our regions and impacting our Chicago hotels and some others, it had a start up cost associated with that had a measurable impact on support cost, sales and markets.
If you take those two out, the year-over-year – quarter-over-quarter growth, year-over-year I should say, is only about 2% in support cost, which is pretty defensible. And as I said in the remarks it's about 60 base points on total margin here.
Chris Woronka – Deutsche Bank
Okay. That’s helpful.
And if you begun accruing some of the bonus expense, I mean, we shouldn't necessarily look for big ramp up or what drive that really?
John Williams
They're based on their forecast they're estimating their bonus accrual requirement, so we – as volume increases and profit improve throughout the year you’d anticipate that process to continue. It's a one year phenomenon and it should not disproportionately impact next year.
Chris Woronka – Deutsche Bank
Okay. Great.
And just on the few you mentioned there were little bit kind of, underperformers Orlando LAX, you mention pricing environment is pretty strong in terms of sales, do you look to sell those or how do you look at recycling at this point?
Mark Brugger
Hey Chris this is Mark, I’ll take that one. On dispositions, I think we are going to look over the recycle to be more active in the capital recycling business over the cycle.
This doesn't seem like the ideal time to sell those, kind of assets, but we’re see the most activity and the most profit and lot of the markets things that are in bid today are in urban EBDs. So may be in LAX that would make sense, but we think we would probably get a better price for it as we hold on to it for a couple more years, then less cash really return closer so what they were last peak and try to sell out like that.
Chris Woronka – Deutsche Bank
Okay. Very good.
Thanks.
Operator
Your next questions come from the line of from Jeff Donnelly of Wells Fargo. Please proceed.
Jeff Donnelly – Wells Fargo
Mark, this is Jeff. Actually, if I could just build up, the answer to your last question.
I guess, when we think about that old versus sale analysis, I mean are you able to share with us and I guess, how you sort of, put a discounting back into the those future values versus selling today, I think that's a debate in everybody's mind. Is it good to take advantage of the pricing today even though cash flows are low versus awaiting?
Mark Brugger
It's a balance. And as you know, certain markets are attracting more attention than others.
And then, for each individual loss we've come over, kind of, a long term view of where we think cash flows are going. Some are going to return clearly with the past peak.
Some aren't going to get back to peak because of the supply in the market or other thing that may have shifted. So it’s a different story, for different assets and we will try to do is take one asset at a time.
What we go through the assets probably that are at the top of our list disposal probably are not the ones that would get the most attention in the marketplace today. So we think it will be more optimal, we get a better return for our shareholder on those types of assets, if we wait it out.
Now with that said, we made decide to test the market with one or two assets over the next 12 months. Just to see what the level of interest would be and to see if we clear our whole price if you will.
Jeff Donnelly – Wells Fargo
Again, just – I guess backing up and looking at guidance, you know Mark back in – way back in the fourth quarter 2009, I think DiamondRock towards call to low end of guidance some on your peers for RevPAR that is and today I guess you're more towards the midpoint, which you know I suspect, I guess we characterized you guys, someone who’s initially cautious and is become more confident, beyond the absolute result we seen so far. Are there underlying detail that maybe visible to flock like us, really led you to become more believer or more confident in this recovery?
Mark Brugger
Well, I think just the demand level that we saw over the first half of the year, you’re continuing to or we’ll have a budget well, we keep exceeding forecast on a period or fourth period basis, you can see the trend lines firming up, although things like (inaudible) remains short. You can see the trends are increasing and kind of the solid line continues which give us you more base in it.
We see the corporate spend up at the hotels there's a lot of things going on here, which are typical what you see in the beginning of a recovery and there are things we're focused on that give us greater confidence.
John Williams
And Jeff, if I could just add this is John. We said, I think beginning third or fourth quarter last year that what we were looking for was operators to outperform budget on a periodic and quarterly basis and at the same time raise forecast for the balance of the year.
We didn't see that at all in 2009 and it was not a pair of early this year, but we begun seeing that and so that combined with sort of what's called the funnel in the group business or tentative that are being put on that look like they are going to be converted and the definite is going forward. Some lead time statistics have led us over the last probably quarter and a half to become more convinced that this is enduring recovery.
And having said that we're all reading the economic news and it's a little scary, but it's not showing up in our numbers yet.
Jeff Donnelly – Wells Fargo
I guess just one or two last question. John on the acquisition front, I mean are you able to talk a little bit about what your pipeline looks like remaining for the back of the year and I guess, how likely is it that, the next few month could look like, what we see and you guys were asking months for acquisitions?
John Williams
Well, the marketed pipeline is definitely built in volume and quality. What we're little taken back by is the pricing that we're seeing or at least hearing from price expectation and direction given by brokers or sellers.
We've seen a couple of transaction that did close at those very high prices and we're waiting to see what some of those portfolio deals are going to look like, which we have passed on. So, quality and volume definitely higher, I think there's a certain amount of price testing going on in the markets place.
We've been able to find the once we’ve been able to find uncomfortable with cap rates, but we’re not comfortable with the low cap rates. So, I don't know what activity you'll see from us in the future.
We are fairly close on one asset that we think may materialize in a top five MSA that looks good but that was another one that we really kind of worked pretty hard to get close to.
Jeff Donnelly – Wells Fargo
Just the last question; how do you guy think about bring back your dividend in 2010, 2011. I know a lot of unknown’s ahead that obviously is an important part of the story for people and how do you think about its growth?
Mark Brugger
Yeah. Jeff this is Mark.
The dividend is obviously very important. Well, we talked with our Board during the last meeting; we're going to make final evaluation as we move toward the end of the year and have better fiscal in the next year.
And then we’ll see where we are from a cash and acquisition standpoint. And then how confident we are in the 2011 and 2012 performance and hotel and we'll make a decision.
It's something we're very focused on.
Jeff Donnelly – Wells Fargo
Thanks guys.
Mark Brugger
Thanks, Jeff.
Operator
Your next question comes from the line of Shaun Kelley of Bank of America. Please proceed.
Shaun Kelley – Bank of America
Hey guy, good afternoon. Just really want to ask a couple of questions about a couple poor market.
First of all, it was on Chicago since you saw some pretty significant growth there, well, it sounded like in period six. Can you even just talk to us a little bit obviously it’s a big convention town could you talk to us a little bit about, obviously it’s a big convention town, could you talk just a little bit about the calendar there how you guy think about the back half and then probably more importantly how you think about 2011 on that side?
John Williams
There are a couple things going on here. This is John.
We – one of the drags on, you're right it's a huge convention down and it drags the whole city. One of the drags on the booking process in Chicago was the work rules associated labor issues that they had for several years and that we're really causing some big groups even cancel or threaten to cancel.
The state and city and the convention business bureau and then convention bureau all got together and they basically solved the work issues associated with McCormick place and therefore they made a much more user friendly environment for the exhibitors and therefore the meeting planners are feeling much more sane about booking groups in the McCormick place. That has huge implications with the city; it’s going to take time for that to translate into increase booking.
The second quarter was stronger than we anticipated in Chicago. The third quarter had some tough comps last year but you know it looks pretty good.
In Chicago in particular downtown Chicago at the Marriott we're really pushing rate just to test the market and so far as the results are pretty good, not great but pretty good. So we would anticipate the convention contribution for the balance of this year and 2011 will still be sort of average if you will by historic standards.
The next big year appears to be '12. There may be some short term bookings in 2011 that improve that.
Right now it looks similar in 2010, which is pretty average by Chicago standards.
Shaun Kelley – Bank of America
Thanks John I appreciate that. And then I guess, the second question is really on the New York asset that you guys have the two courtyards obviously posted some pretty phenomenal RevPAR in margin growth, kind of, what else – how do you guy think about those assets and have you seen any other deals on the limited service side in kind of major metro MSAs that might hit the portfolio since that day, a kind of segment that you guy are tapped into some of the other guys have not yet?
John Williams
Yes, we – there are some limited service urban assets for sale. Some of them don't look too bad on a cap rate basis but when you look at per key and replacement cost, they get to be a little bit disconcerting.
So there's one big one in mid Atlantic, Urban Area that’s trading, that looks like a decent cap rate, but when you look at the price per key it kind of scares you away. There are some in New York that are being marketed.
And, yeah, we are pursuing more of those but they have to be major urban areas, where these hotels can act like full service hotels with a limited service cost record.
Shaun Kelley – Bank of America
Got it. John any sense on just kind of general range per key values right now in New York City on some of those assets?
John Williams
Well, the recent trades have been in what low to mid 300 per key range, per limited service hotels, that's New York and then in Washington there haven't been too many but the one we heard about is sort of in the same range which is a little unusual.
Shaun Kelley – Bank of America
Got it. That's helpful.
And then I guess, just one last question, you mentioned in your kind of, response setting a prior question that obviously some of the cap rates are extremely low in some of these urban, kinds of areas. How important is cash flow when you underwrite relative to what you think at, kind of end of cycle valuation, because we have seen some assets obviously, I think – as interest rate in San Francisco being the most obvious one, where it was a very low kind of front end cap rate but obviously somebody seeing some value there.
John Williams
Yes. I guess, I put it this way.
We find certain markets to be kind of yield challenged if you will. They are great capital gains opportunity frequently, every timing is good.
We kind of view our role as a public real estate investment trust to be more yield focused in capital gain focus. This was a call San Francisco specifically that we made last cycle when they were all trading – when all of these assets were trading in free cab and we made sort of a macro call that that was not going to be the market we are going to plan.
We looked carefully at the San Francisco transaction that we have and or shortly will transact in San Francisco and I guess we sort of making the same macro call at this point that we're going to search for yield before we search for capital gains, not exclusively in these cases we came to those conclusions.
Shaun Kelley – Bank of America
Great. That's helpful.
Thanks, guys.
Operator
Your next question comes from the line of Will Marks of JMP Securities. Please proceed.
Will Marks – JMP Securities
Thank you. Hello everyone.
I have a question just on the share account. You gave in your guidance 144 million average, if you take the third quarter of the current one 156 you average that over the second half of the year.
I think you come up with the higher number than the 144; can you explain or give any more detail?
Sean Mahoney
Hello, this is Sean. The second quarter number the shares came in at the very end of the quarter which was due to calculation but we're comfortable with that $144 million weighted average calculation.
Will Marks – JMP Securities
So – may be you can help me. What should the third and fourth quarter prospect share numbers be?
Then I guess lower than the 156?
Sean Mahoney
No, we're in the mid 150 for the third and fourth quarter, the weighted average number of shares at the end of the quarter.
Will Marks – JMP Securities
Got it. One final question on you gave plenty detail on Chicago.
Related to that, how much of Chicago is transient versus group?
Sean Mahoney
It’s the whole market?
Will Marks – JMP Securities
Let's say for your assets and the whole market?
Sean Mahoney
For asset I can say that big downtown Marriott is 55% to 60% of group business. The Conrad is only 25% to 30% of group business, the function of whole size and meeting space.
But that's pretty much where we come in ' year-after-year.
Will Marks – JMP Securities
Is transient pick up there in line with national average?
Sean Mahoney
It's started out in the first quarter below I would say. As second quarter roll through and it improved dramatically and it was above for the end of second quarter.
I'm not sure in period 7 where it came in.
Will Marks – JMP Securities
That's helpful. That's all for me.
Thank you.
Operator
Your next question comes from the line of Ryan Meliker of Morgan Stanley. Please proceed.
Ryan Meliker – Morgan Stanley
Good afternoon guys. Couple of quick question, I think the first thing is you spoke a little bit earlier about improving trends.
I know the actual number might not be relevant but I want to talk little bit portfolio and really how it's trended from may be the start year to now both in terms of room night and a rate. Any color on that?
John Williams
Sure. It basic improved the definite pace of revenue for group has improved the last three quarters.
It just by way of example for the next two quarters, one statistic I've got in front of me, it as of the first quarter of this year, the group pace was down 16%, it’s currently down about 2.2% Q3 of this year. Q4 was down after the first quarter about 1% and it's up about 5.7% as of the second quarter.
And that's a fairly consistent trend that we've seen going back to third quarter of last year. And it's mainly room nights –- the improvement is mainly room nights, but rate has pretty much flattened out now too.
Ryan Meliker – Morgan Stanley
Great. That's helpful.
I don't know what you guys can comment on what you can't so obviously – you know with regards to the Allerton hotel, can you give I guess some color on what's going on there and what the potential outcomes are. It seems odd to me to see a borrower funding debt service during a foreclosure period.
I guess, I know there's a lawsuit that you can't provide much information. Which is – What's going on what Dave said they are looking for as an outcome, just try to give any color ton that situation will be helpful.
Mark Brugger
Sure this is Mark. On Allerton hotel, we actually own senior note.
There was a cash management agreement that was put in place when they did the result, so we’ve been placed – asset cash generated so can fluctuate from hotel and the AXON cash was it is cash deposit is getting you to play interest on the default, that's why we're talking about interest realize realized on that hotel during this year. Now, as far as potential outcomes, they have to right to pay off a loan at par.
We realize a gain and it will be in IRR north of 25% for us because this year, that's one outcome we understand that the junior fees to us or the people behind us are in the process of trying to market their interest and if they do, we presume that we would get paid off. If they are unsuccessful, we will file foreclosure or process you file foreclosures starting in April that's usually a 9 to 12 month process as that’s getting prosecuted in the State Courts and we're moving forward with all these feats on that process.
So our potential outcomes are we get paid off with par and realize a good gain or look forward for closure and potentially get control of the hotel, relatively expensive basis, sometimes in the middle of next year.
Ryan Meliker – Morgan Stanley
And from timeline standpoint, I guess, it really comes down to the foreclosure proceeding so they have until you guys actually are successful in foreclosure to pay off the note in full? Is that correct?
Mark Brugger
Yes.
Ryan Meliker – Morgan Stanley
And then one last question regarding better acquisitions, the Hilton Minneapolis and the Renaissance Charleston. I don’t know if you looked into it.
I’m assuming you have. Are there additional opportunities for cost savings of those properties, particularly may be complexing.
I know, you looked at complexing support cost assuming other properties, so that’s why you are looking into these markets. Do you think you got other owners that are – that might be open to that type of idea to help maximize cash flows of those properties?
Mark Brugger
I’ll take one at a time. The Minneapolis Hilton is extremely well run property.
We think the opportunity there is from recently added meeting space and some potential new meeting space that we think may be potentially to be added, which would really help the group base there. Historically, they kind of peaked out in the mid $135,000 group room nights.
We think with the new meeting space what they did was a – they’ve added 5,000 square feet combined with some other face and have nice 10,000 square foot junior ballroom. We think that 135 can go to more like 155 which helps not only overall occupancy but with the compression on the remaining 70,000 or so transient room night pricing power.
And then on the Charleston asset, we do see some opportunities with – on the cost side of things, particularly on the food and beverage. It’s been a kind of a thrust of asset management across the portfolio and we some of the same opportunities there.
May be there is opportunities to Hilton, we haven’t uncovered yet. So yes, we see potential cost saving there and then SFO at the Charleston hotel will reduce total sales and marketing cost of about $83,000 this year.
So it has been a very successful program.
Ryan Meliker – Morgan Stanley
Great. It’s helpful.
Thank you very much guys.
Operator
Your next question comes from the line of Smedes Rose of ABW. Please proceed.
Smedes Rose – KBW
KBW. I’m just wondering, looking back at 2007 where you had peak margin around 29% and given, you’ve talked fairly extensively about changing the business model.
I mean, is it fair to assume then you can return to those kinds of margins, I guess, without getting the same kind of absolute RevPAR numbers on the same store basis and I’m just sort of wondering could you kind of quantify like how many – if you had this business model in place now in 2007 where the margin have been more like 31% instead of 29. What's your sort of sense of how much you’ve taken out of the business?
Mark Brugger
It's hard to answer that question because there are so many moving parts. I mean, things like utilities, things like just overall weight increases that are inevitable, benefit increases that are unfortunately inevitable.
There have been cost increases just in the normal inflation, cost inflation that offset some of the functional savings that we found. I would say without the RevPAR recovery, it would be difficult to get back to those margins again.
I think the RevPAR recovery is critical. I think we’ve saved the cost.
We're going to be able to save in these hotels and the next step is to gain revenue. But I do think the margin, speaking historically coming out the last downturn which was supposed to be the worst ever; I found that it can always get worse.
The margins were at peak were better than the previous peak and we would expect that to happen again, assuming we get the revenue recovery we all anticipate.
Smedes Rose – KBW
Okay. And then, go ahead.
Sorry.
Mark Brugger
We've done some analysis with NAREIT [ph]. As we return, we haven't done variations of what we don't return to next peak.
But assuming that we return back to kind of '07 levels of RevPAR with some more relation of SSE [ph] and REIT, a number of these programs especially the new operating models and some of the consolidation cost with the sales program across the portfolio, we do envision that margins to potentially be a 100 to 150 basis points better than they were last week. Obviously, there is a lot of (inaudible) John said and you have some related costs and other things across the industry in returns (inaudible) but based on some cumulative [ph] analysis that’s what we’re projecting.
Smedes Rose – KBW
Okay. That's very helpful.
That's exactly what I'm looking for. On the credit line, you announced some incremental detail.
I’m just wondering do you still have to hold back four assets unencumbered and are there four assets, if so, are the four that are specified or is there any four that you choose.
Sean Mahoney
Smede, this is Sean. The new facility does have a minimal number of unencumbered borrowing based assets.
As you know, from our capital structure, we have currently 12 unencumbered assets after the Charleston deal. So we're not going to have an issue with respect to holding back their asset.
But under the new facility, there are certain assets within an unencumbered four that had restrictions on them than other cost of being the largest one of those assets but generally speaking, we have great flexibility under the new facility to take asset in and out of your encumbered borrowing base.
Smedes Rose – KBW
Okay. And then I guess my final question just on Chicago, I guess, the JW Marriott opening, I think later this year and I’m wondering are you starting to – when you talk to your guys, I guess, mainly at the downtown Marriott, are you hearing any competitive impact from that in terms of going after groups?
John Williams
Yeah. We anticipated – this is John.
We anticipated that we would feel more than that we have. We ask the question if not hourly, daily and we've been pretty pleased that we have not been impacted on the group side according to our local management by that JW Marriott.
It's in the loop. It inevitably, we'll have some impact when it opens.
It's a late opening. But, it’s a lot of rooms, lot of meeting space; and at some point, I would anticipate that we would feel the competitive pressure.
Smedes Rose – KBW
Do you know when it's supposed to open?
John Williams
I haven't heard recent estimate. It certainly is not June as it was originally schedule.
So may be September, I think September was the last date we heard but that was a quite a while ago.
Smedes Rose – KBW
Okay. Thank you very much.
Operator
Your next question comes from the line of Mike Salinsky of RBC Capital Markets. Please proceed.
Mike Salinsky – RBC Capital Markets
Good afternoon, guys.
John Williams
Hey, Mike.
Sean Mahoney
Hey, Mike.
Mark Brugger
Hi, Mike.
Mike Salinsky – RBC Capital Markets
First question, just looking going back to your pipeline there. How much that's coming to Marriott relationship.
I mean, you got Charleston, I'm curious, how much you're seeing coming through that the relationship at this point versus how much is marketing transactions?
Mark Brugger
You know, we're having an increasing level of conversation with Marriott about opportunities. But it's not – I wouldn't say it's a particularly robust portion of the pipeline at this point.
We were thrilled to get Charleston and that was clearly a result of that relationship. We're talking about a couple of others that are very complicated and pretty poor down the line.
But I would say it's not robust at this point.
Mike Salinsky – RBC Capital Markets
You guys do anything on the debt side, acquire a discount note similar to Allerton, through the Marriott relationship, you’re going to take over?
Mark Brugger
At this point, Marriott doesn't owe particularly no debt positions unlike when we came out of the last downturn. So I don't think there's a lot of opportunity.
Allerton was a really a unique situation where we were able to get the deal off markets. We knew what the brand alternatives were.
Obviously, we owned a lot of products at Chicago. So we are looking for product on direct potential.
So those opportunities are relatively unique in the marketplace. So yeah, we had one that came through that had all those unique characteristics, we would look at it but it's clearly not our core mission.
Mike Salinsky – RBC Capital Markets
Okay. That's fair.
Switching gears here, just to going back to the dividend question, based upon your current guidance there's no special dividend or anything required at this point? Correct.
Mark Brugger
Right.
Mike Salinsky – RBC Capital Markets
Okay.
Mark Brugger
Trust me, what we said before we anticipate paying out at least our taxable income and based on our latest projections, we don’t think we’ll have taxable income in 2010. The board may always decide to pay out a dividend above that level but that we will get into.
Mike Salinsky – RBC Capital Markets
Okay. And John, I apologize if I missed this.
Did you talk about your group pace for 2011 at this point and also how ADR stacks up for those at this point?
John Williams
We did not mention that and it's a little – it's not exactly comparable to the 2010 pace because we have not adjusted obviously 10 for some of the later year's cancellations that we may get. But at this point, we're down in revenue about 10% versus same time last year as of Q2.
Because of the trends, we're seeing in short term bookings and pick. The pickup in the last few quarters has been 100% and 125% greater than last year.
As that continues and we anticipate it well, we expect that it will cross over into next year with our target number of group room nights and revenue. But we had some work to do in the third and fourth quarter.
Mike Salinsky – RBC Capital Markets
How much of that revenue is ADR driven versus how much is occupancy at this point?
John Williams
That’s the – room night is about 5% and rate is just over 5%.
Mike Salinsky – RBC Capital Markets
Okay. That's helpful.
Then finally the Charleston acquisition seems like it's going to be paid for with cash. I'm assuming beyond this you guys are going to work out the cash balance.
At what point in cycle, you guys look comfortable starting to look to the debt market again to start putting mortgage debt on some of these properties to increase your purchasing power?
Mark Brugger
Michael, this is Mark. I think from our kind of preliminary strategy is obviously to use the cash we have on our balance sheet is that most efficient use in the capital structure than the use and probably to use the line of credit to some level and then as the secured debt market improves which we will anticipate over the next 12 and 24 months, potentially use the secured markets on individual amount of reverse basis as a financially strategy going forward.
Obviously, that needs to remain flexible depends where rates go and how they secure market develop.
Mike Salinsky – RBC Capital Markets
Okay. So the near term, you're still not comfortable with the secure market where it stands?
Mark Brugger
Well, I think, clearly, having 160 million in cash in balance sheet, it's more efficient to deploy those in good acquisition. So that makes the most for the initial funding for the next acquisition and then line of credit is pretty well price so that's a attractive and it's got four years including one year extension as soon as we get this new line closed.
So it's got decent term on it. I think, on the secured market, we also like to see the term linked in out rate.
Now, the market has five years and we prefer to see it lengthen out to 10 years to its locking at lower rates, assuming that the spreads continue to come in.
Sean Mahoney
Mike, this is Sean. Another comment on the secured financing market, rates are coming quite a bit.
They're in the sixes now for hotel financing. We're still struggling a little bit.
They’re still being – the proceeds are being raised from attracting 12 cash flows. Unfortunately in today's market you're getting attractive rate but you're still not getting the proceeds that you want to get.
They have efficient terrifying incremental deal. As you look forward, you'll see those proceeds which feel like 55% LPB today quickly turning into 30% or 35% LPB on more normalized earnings which we don’t think it’s efficient for individual asset.
Mike Salinsky – RBC Capital Markets
That's very helpful guys. I appreciate the color.
Thank you.
Sean Mahoney
Thank you, Mike.
Operator
Your next questions come from the line of Dennis Forst of KeyBanc. Please proceed.
Dennis Forst – KeyBanc
Good afternoon. I wanted to see if I could flush out, get a little more color on the comment about acquisitions being attractive on a cap rate basis but not on a per key basis.
Kind of how do you go about lining up those two different factors?
Mark Brugger
Well, when we’re looking at acquisition, obviously we're looking target cap rate ranges depending upon the market. And I think we tend to be a little more conservative on that scoring until we see the market tell us we need to consider it otherwise.
But in a couple of cases, one was limited service and one was full service, the cap rate led you to numbers where the – actually the hotel operators were kind of victim to their own successes but led you to numbers that were significantly over our view of replacement cost and that's sort of where we begin to think twice about attractiveness of obtaining a good cap rate.
Dennis Forst – KeyBanc
And why is that?
Mark Brugger
Because if it trades over replacement cost then the likelihood of new supply increases dramatically.
Dennis Forst – KeyBanc
Okay. Thanks.
Operator
(Operator instructions) And your next question comes from the line of Bill Crow of Raymond James. Please proceed.
Bill Crow – Raymond James
Hey, good afternoon. Couple of questions.
On the acquisition philosophy, I guess, you talked about the being more yield oriented buyers. Do you think about what the CAGR on EBITDA, your core portfolio is?
And are you sensitive to whether it's an acquisition be it accretive or dilutive to your existing portfolio’s growth potential?
Mark Brugger
Bill, this is Mark. I think the kind of the first metrics and you need to look at is IRR basis.
So we need to make sure it’s a minimum hurdle rate and we’re looking at unlevered IRR in a low double digit. So that the first screen, kind of the second screen, there's other things out there, price to key and other things you need to use in your judgment about determining the quality of that IRR calculation.
But we're looking for assets that generally improve the portfolio quality and improve the average growth, so your comment to CAGR of the portfolio over the next 5 to 10 years. So that’s an important consideration now, You would balance that, if you kind of – it has to finally have slightly slower growth but you can get a great price, you can turn up because you have higher IRR.
Conversely, you might do a cap rate deal that has greater growth because you’re going to still get the IRR, you’re going to get the better than average growth rates, going forward. So it's always a balancing act.
But certainly, it’s something we take in consideration.
Bill Crow – Raymond James
Okay. Good.
Seems like a market is paying for growth potential as much as anything else right now. The other question, I had really was brands and as we go through this cycle, how much you're going push expenses down to the owners.
The reason, I asked the question is because you alluded to a Marriott sales initiative and higher cost coming from that. Can you kind of describe what that initiative is and the benefits you think you're going to drive from that additional cost?
Mark Brugger
That question merit as very long response which I'm not going to give you here because we don’t have time for it. But basically the SalesForce One initiative is an initiative by Marriott to centralize their sales efforts into enterprise offices and regional sales offices, taking people out of the – sales people out of the hotel.
In terms of – it's being rolled out across the country. It's been rolled out in the mid Atlantic region, being rolled out in the northeast region, being rolled out in the Midwest as we speak and then on the west coast I think it starts very shortly.
There are initial start-up costs associated with that office space, hiring people for the central offices. There are also some saving as you take people out of the hotel but the benefit is that the customer is receiving fewer sales calls but more targeted sales calls.
So the enterprise accounts the largest accounts that Marriott faces one person of Marriott is in charge of that relationship. So that customer is not being called on by eight or ten group sales people from various hotels across the country, that’s the idea.
So it's intended to be cost neutral. At the startup phase, it’s proving to be not cost neutral but I don't think that was completely unexpected.
And on the revenue side, it's extremely difficult to measure because of the wild ride we've had in the overall economy and The Lodging space.
Bill Crow – Raymond James
Right. Okay.
And then just a housekeeping question, your quarterly RevPAR if you put than on a calendar basis, do you have that number?
Sean Mahoney
It's roughly the same is what it would be for the second quarter, within 25 basis points one way or the other.
Bill Crow – Raymond James
Okay. Good.
Thanks, guys.
Mark Brugger
Thanks, Bill. No more calls.
Operator
At this time, we have no further questions in the queue and I’d like to turn the call back over to Mr. Mark Brugger for closing.
Mark Brugger
Thank you, Chandelle. To everyone on this call, we would like to express our continued appreciation for your interest in DiamondRock.
I look forward to updating you next quarter. Enjoy the rest of your summer.
Operator
Thank you for your participation in today's conference. This concludes the presentation.
You may now disconnect. Have a wonderful day.