Oct 26, 2012
Executives
Jon Bortz - Chairman, President and CEO Raymond Martz - EVP and CFO
Analysts
Jeffrey Donnelly - Wells Fargo Securities Jim Sullivan - Cowen & Company Bill Crow - Raymond James Wes Golladay - RBC Capital Markets Andrew Didora - Bank of America Dan Donlan - Janney Capital Markets
Operator
Good day and welcome to the Pebblebrook Hotel Trust third quarter 2012 earnings call. Today’s conference is being recorded.
At this time I would like to turn the conference over to Ray Martz, chief financial officer. Please go ahead sir.
Raymond Martz
Thank you operator. Good morning everyone.
Welcome to our third quarter 2012 earnings call and webcast. Joining me today is Jon Bortz, our chairman and chief executive officer.
But before we start, let me remind everyone that many of our comments today are considered forward-looking statements under federal securities laws. These statements are subject to numerous risk and uncertainties as described in our 10-K for 2011 and our other SEC filings and could cause results to differ materially from those expressed in, or implied by, our comments.
The forward looking statements that we make today are effective only as of today, October 26, 2012, and we undertake no duty to update them later. You can find our SEC reports and our earnings release which contains reconciliations of non-GAAP financial measures we use on our website at pebblebrookhotels.com.
Okay, so the good news is we have another solid quarter to talk about. So let’s get started.
Our third quarter RevPAR growth of 6.3% was at the lower end of our outlook for RevPAR growth of 6-8%, yet we still significantly outperformed the U.S. industry’s RevPAR growth in the quarter of 5.1%.
This was primarily due to the underperformance of our Manhattan collection, caused by a relatively weak September in New York. However, the rest of our portfolio produced a really solid quarter, despite some sluggish growth in business travel demand.
For our portfolio on a monthly basis, RevPAR increased 8% in July, August was up 7.7%, and September climbed 3.3%. As a reminder, our RevPAR and hotel EBITDA results include all the hotels we owned as of September 30, except for the Milano, since we don’t have verifiable prior year data, W Westwood, since we owned this hotel for less than half of the third quarter, and Palomar San Francisco, since we didn’t acquire this hotel until yesterday.
Our results do include 49% of the results for the Manhattan collection. RevPAR growth in the quarter was led by our properties benefitting from the recent renovations and repositionings, including the Intercontinental Buckhead, Sir Francis Drake, the Argonaut San Francisco, as well as our recently acquired Vintage Plaza Portland.
During the third quarter, we invested approximately $12.3 million in our hotels as part of our capital reinvestment program, with the largest portions related to payments for previous renovation work of Westin Gaslamp and Mondrian Los Angeles as well as payments for the upcoming renovation of Hotel Milano, which are planned to close and commence our comprehensive renovation there on November 1. Year to date, we’ve invested over $43 million into our hotels as part of our capital reinvestment programs.
During the third quarter, rooms revenues increased 7.3%, which is greater than our RevPAR growth, due to the added rooms from the Affinia Manhattan reconfiguration. And due to the continuing success of our asset management efforts and superb work by our operators, our 7.3% increase in rooms revenues and 5.2% increase in comparable hotel revenues turned into a very healthy 15.8% increase in pro forma comparable hotel EBITDA over the prior year period.
Now for the second quarter in a row, our food and beverage revenues were largely flat to last year. This was primarily due to a $1.1 million revenue decline at Sky Bar Asia de Cuba at the Mondrian in West Hollywood.
This is attributable to the loss of a considerable part of our prior customer base following the outdoor deck and pool area renovation and closing earlier this summer. We do continue to have success getting this business back, and expect it to continue to recover over the next several quarters.
We also experienced revenue declines at our Viceroy Miami due to disruption during our refurbishment and relaunch of Club 50 this summer. So combined with our three additional acquisitions, we generated adjusted EBITDA of $35.4 million for the quarter, an increase of $8.9 million, or 34%, versus last year’s third quarter.
Year to date, adjusted EBITDA is up 61%, or $31 million versus last year. Again, this reflects not only the increased number of high-quality hotels in our growing portfolio, but also the elevated growth rate in same-store EBITDA of our existing hotels, which we believe will continue during the next several years.
Now, turning to the acquisition side of our business, on July 9 we acquired the 125-room Hotel Vintage Park in downtown Seattle for $32.5 million and the 117-room Hotel Vintage Plaza in downtown Portland for $30.5 million. On August 2, we acquired the 250-room all-suite W Los Angeles Westwood for $125 million.
And yesterday, we announced the acquisition of the 196-room Hotel Palomar San Francisco for $58 million. This full-service boutique hotel is located in the growing and dynamic South of Market and convention center submarket of San Francisco, which we are very familiar with, since this is the same neighborhood where the Hotel Milano is located.
In fact, Palomar is on the same block as the Milano. The Palomar will be our third kept and managed hotel in San Francisco and our fourth hotel in the city.
As discussed in yesterday’s press release, as part of our Palomar acquisition, we assumed $27.2 million of existing debt, which matures in September 2017 and has a current interest rate of 5.94%. Since this debt is above the current market rate for debt, GAAP requires us to mark-to-market the difference between the 5.9% that we pay on this loan and current market rates.
You’ll see this annualized difference for this mark-to-market adjustment on our income statement going forward each quarter. This accounting adjustment will have the impact of increasing our FFO.
However, for adjusted FFO purposes, we’ll be showing the actual interest rate of 5.9% and will reflect the higher interest cost in adjusted FFO. We believe this is the more accurate way to reflect our adjusted FFO since this is a true cash expense.
So this will have the impact of lowering our adjusted FFO going forward. Now let’s briefly shift our focus to our capital market activities in the third quarter.
As discussed last quarter, into July we amended and restated our senior unsecured credit facility. In the process, we increased our credit facility to $300 million, extended the maturity of the revolving line out to July of 2017, and increased the accordion option on the line up to $600 million.
We also significantly reduced the pricing grid on our new line. And on August 13, we completed a $100 million five-year term loan and entered into a fixed rate interest swap agreement on this loan.
Based on our current leverage, the five-year fixed rate is 2.55%. On the equity side, from July through October, we raised $44 million through our ATM program at an average share price of $24.76.
Year to date, we have raised a net of $105.6 million through our ATM program at an average share price of $23.72. We ask you to please take note of the increased shares outstanding when you update your Pebblebrook earnings models.
In addition, we also refreshed our ATM program and now have $170 million currently available under this amended and restated ATM program. As a result of our capital market activities during the quarter, through October, and reflecting the Hotel Palomar acquisition yesterday, we currently have cash, cash equivalents, and restricted cash of approximately $106.1 million, plus another $19.3 million in our unconsolidated cash, cash equivalents, and restricted cash from our 49% pro rata interest in the Manhattan collection.
I’d now like to turn over the call to Jon to provide more insight on the recently completed quarter as well as our outlook for the remainder of 2012. Jon?
Jon Bortz
Thanks Ray. So the lodging industry continued its recovery in the third quarter.
Fundamentals remain strong, demand growth continued to outpace limited supply growth, which has allowed for healthy increases in rates. However, due to the impact of calendar and day of week shifts for holidays, both in July and September, and economic headwinds and increasing uncertainties due to the impending elections and the so-called fiscal cliff, the third quarter was certainly rockier than prior quarters this year.
In our last call with you, we already discussed the negative impact of the July 4 shift, so no need to repeat that here. But in September, the shift of both Jewish holidays into September versus having just one in September last year and their shift to weekdays this year from a mix of weekday and weekend last year, had a substantial negative impact on business travel in September.
And you can see that in the September Starwood results, which showed industry demand up just 1%, still greater than supply growth of just 0.6%, but the midweek holidays impacted the average rate growth in the month which climbed just 3.4% versus the prior trailing 3-month growth rate of 4.4% in ADR. So RevPAR rose just 3.8% in September, bringing down the third quarter’s RevPAR growth rate to 5.1% from the second quarter’s 7.9%.
September in particular, for both the industry and our portfolio, was impacted far more than we expected. But was September’s weakness fully attributable to the holiday shift?
I think that’s a big question. We think it represents much of it, but not all of it.
When we analyze all of the industry data, I will say it’s difficult to clearly discern the trends from the disruption from the holidays. However, we do believe that business travel has moderated more than we thought it would in the second half of the year.
We’ve not seen the same level of moderation on the leisure travel side, which has continued to grow at healthy rates. In fact, using weekend statistics as a reasonable proxy for leisure travel, and using weekday statistics as a reasonable proxy for business travel, leisure demand has grown at a faster pace than business travel for five of the last six months.
This is true for RevPAR growth as well. Given the weaker statistics for business investment, business confidence, and corporate profit growth, and the relatively stronger statistics for retail sales, consumer confidence, and home and auto sales, these trends shouldn’t be surprising.
At Pebblebrook, as Ray said, we had another great quarter, and while we’re disappointed, our RevPAR growth of 6.3% was in the lower half of our outlook. EBITDA growth on a comparable same-store basis of 15.8% was at the top of our outlook.
This was due primarily to our success with cost controls and more progress than we forecasted on our asset management initiatives. Total expense growth was limited to 1.1%, even though occupied rooms grew by 3.5% and property taxes increased by 5.4%.
I hope this highlights what we’ve consistently stated in the past, that we should be able to deliver significantly enhanced EBITDA margin growth regardless of the strength of overall industry RevPAR growth due to the implementation of our best practices and our laser focus on benchmarking and rightsizing operations at our acquired hotel portfolio. This should continue in 2013 and 2014.
As Ray mentioned, the RevPAR underperformance to our prior expectations came primarily in New York and mostly in September as a result of the holiday shift and an unexpectedly poor turnout for the annual U.N. General Assembly session, which has been described by some as New York’s annual Superbowl.
RevPAR at the Manhattan collection, which represents our presence in New York City, declined by 1.5% in the quarter versus our expectation just 90 days ago of an increase of 6-8% growth. This decline was driven primarily by September, which was negatively affected by the holiday shift and poor UNGA turnout.
The rest of the portfolio, excluding the Manhattan collection, achieved a RevPAR increase of 8.2% in the third quarter, slightly above the upper end of our Q3 outlook of 6-8%. For the portfolio overall, room revenues increased by 7.3%, which was more than our RevPAR growth, again due to the additional 92 rooms at Affinia Manhattan.
Just like the first two quarters, we gained RevPAR share in all three months of the quarter, even with the underperformance in New York, as we continued to recapture significant competitive share loss during prior ownership periods when performance suffered from both a lack of capital investment as well as third-party asset management. Food and beverage revenues in the portfolio increased just 0.3%, which underperformed our occupancy growth.
This was due primarily to expected declines at Mondrian L.A. as we slowly win back our customer base following the closure of Sky Bar and Asia de Cuba’s outdoor seating area during our outdoor renovation earlier this year.
At Viceroy Miami, where we negatively impacted revenues due to the renovation of our rooftop club during the quarter, which we just relaunched in October, and at Skamania Resort and Conference Center, where we suffered from significantly lower banquet revenues that came along with significantly lower group rooms this year versus last year. These few property specific issues masked generally positive underlying food and beverage trends and success at many of our other properties, including the Benjamin, the Argonaut, Intercontinental Buckhead including Southern Art, our now one year old restaurant there, as well as Westin Gaslamp, with our brand new hotel product.
Overall, and outside of New York and Washington DC, most urban markets continued to do well in the quarter, in most cases taking advantage of their high historical occupancy levels, which are now running above prior peak levels in many cities. The majority of the CBD markets in which our hotels are located continues to perform better than the U.S.
industry in the third quarter. RevPAR in San Francisco’s Fisherman’s Wharf Nob Hill submarket was up a robust 12.9%.
Philadelphia city center increased 12%. Downtown Portland climbed 11.9%, San Francisco’s Market Street area was up 10.8%.
Downtown San Diego grew 7.5%. Santa Monica rose 6.5%.
Buckhead was up 6.3% and Downtown Boston increased 6.1%. We expect to continue to benefit from the overall strength and high occupancy levels of these markets going forward.
Overall, transient and group both performed well in the third quarter. Transient revenues increased 7.5% in the quarter with room nights up 2.2% and ADR increasing 5.2%.
Group revenues grew 7.5% also, with room nights up 8% while ADR declined 0.5%. Group rate would have been up significantly but for New York.
Group represented 24% of our room nights in the quarter. That’s down slightly from last quarter’s 26%, which isn’t surprising given the second quarter generally is a stronger quarter for group than the third quarter.
Now let me turn to a discussion of EBITDA margins and provide some highlights. As we reported, portfolio wide hotel EBITDA grew 15.8% on a 5.2% increase in total revenues.
As is always the case with our reporting, these are comparable numbers. In other words, same-store, whether we owned them last year or not, and whether they were being renovated or not, in either year.
We don’t remove hotels when they’re being renovated unless they’re closed. Our hotels continue to benefit from the implementation of our best practices, and the very successful efforts of our asset managers and our hotel operating partners.
Together, they managed to hold expense growth in our portfolio to just 1.1% in the quarter. Like last quarter, undistributed expenses played a big role.
They actually declined 1.7% despite a 6.1% increase in sales and marketing as we continue to work to drive the top line at our properties. Energy again led the way, with a decline of 13.2%, or over half a million dollars, to last year.
We continue to see substantial returns from our energy-saving capital investments but so far we’ve only completed them at a little more than half of the portfolio. So more savings to come.
Departmental expenses increased just 3.4% with departmental margins increasing 70 basis points. This was despite 3.5% more occupied rooms and despite our challenges with growing food and beverage revenues, which also negatively impacted our food and beverage margins, which declined by 134 basis points.
Overall, we’re extremely proud of our increase of 284 basis points and our portfolio wide EBITDA margin. On a year to date basis, portfolio wide hotel EBITDA has increased 23.1%, and EBITDA margin is up 354 basis points on a total revenue increase of 7.2%, RevPAR growth of 9.1%, and expense growth of just 2.2%.
And this has been achieved despite 6.2% more occupied room nights in the first nine months and a 14.5% increase in property taxes, which we’ve discussed before and is due primarily to automatic reassessments at our California acquisitions. In the quarter, healthy margin growth was also widespread throughout the portfolio.
Twelve of our hotels, or half of the portfolio, grew their EBITDA margins by 250 basis points or more. Five of our properties drove up their EBITDA margins by more than 500 basis points.
Those five were the Sir Francis Drake, Affinia Manhattan, the Benjamin, Westin Gaslamp, and Intercontinental Buckhead. The six property Manhattan collection, even with its 1.5% RevPAR decline in the quarter, grew EBITDA margin by 341 basis points on a 4.8% increase in total revenues, due primarily to a 5.7% increase available rooms.
Again, these are Affinia Manhattan’s additional rooms. Now let me provide a quick update on our property renovations.
Overall, there was no meaningful impact on our performance in the quarter, other than the residual impact in food and beverage at Mondrian L.A. This year, we’ve completed significant renovations at Westin Gaslamp San Diego, Sheraton Delfina in Santa Monica, Seattle Monaco, Argonaut San Francisco, and Mondrian L.A., where a lobby renovation and reconfiguration, and a repurposing of the closed spa are now underway, and we expect completion there before year end.
Coupled with the completion of major renovations last year at Affinia Manhattan, Sir Francis Drake, Minneapolis Grand, Doubletree by Hilton Bethesda, and Intercontinental Buckhead, our portfolio is in terrific condition, and we’re primed to continue to take RevPAR share back that was lost for many years prior to our ownership. In addition, we have a couple of properties with substantial upcoming renovations that we previously discussed.
These will add significantly to our growth rate after they’re complete. Specifically, we’re talking about the upcoming repositioning and comprehensive renovation of the Milano in San Francisco, and the complete renovation, reconfiguration, and expansion of the Affinia 50 in New York.
Here’s a quick update on both of these. We expect to close Hotel Milano on November 1 and reopen it late in the first quarter of next year.
Upon reopening, the hotel will be renamed. We’re extremely excited about this hotel and the large opportunity there for such a small property.
Since we didn’t own the hotel until April, it won’t have any negative financial impact on a year-to-year comparison. At Affinia 50, we’re in the process of finalizing design.
We’ve completed and signed off on a model room, and we expect to commence construction in January and be complete by the fourth quarter next year. The reconfiguration will add 41 rooms or 20% of the hotel’s inventory.
As discussed last quarter, due to the very high occupancy this property runs on an annual basis, it will be significantly impacted financially by the renovation. We continue to estimate a reduction in property EBITDA of $5-6 million, with us sharing in 49% of the negative impact.
However, we believe the reconfiguration will essentially pay for the full renovation and will add significant EBITDA and value in 2014 and 2015 as it ramps back up following completion. In addition to these major renovations, let me mention a few minor renovations and projects currently planned for next year.
They include a primarily soft goods rooms renovation at Sofitel Philadelphia, which will commence late this year and be complete by April next year; a partial rooms renovation at the Benjamin, which will commence by early summer and be complete one to two months later; the last phase of the renovation of Affinia Manhattan’s public areas, which includes the entries, main lobby, and arrival experience and should be done by April next year; a public area renovation at the W L.A., which includes the lobby, lobby bar, and outdoor restaurant and bar, part of which will be done next summer and part of which will be done over the winter of 2013-14; and a renovation of the ballroom and all the meeting space at Sir Francis Drake, likely accomplished between late first quarter and early second quarter. Combined, we’re currently forecasting that all of these relatively minor renovations will add up to negatively impact EBITDA next year by approximately $1-2 million.
Though this is a rough estimate at this time, since we don’t yet have detailed schedules for all of these projects. But combined, these projects, excluding Affinia 50, should have less of an impact next year than our projects did impact us this year.
So now let me turn to a quick update on our outlook for the year. We continue to expect 2012 to be a great year for both the industry and Pebblebrook.
For the industry, we’re again narrowing our outlook due to the greater impact of the holidays in September and the more sluggish growth in business travel, particularly as we move toward the end of the year and the fiscal cliff. We now expect industry RevPAR to increase around 6.5%, based on an increase in overall industry demand of around 2.5% and an increase in industry ADR of 4-4.5%, which is a further moderation in the upper end of our previous ADR outlook of 5%.
We expect demand growth to continue to moderate over the course of the remainder of the year, and we expect ADR growth in the fourth quarter to be consistent with the year to date growth rate, instead of a steady but modest acceleration higher as we had previously thought and experienced earlier in the first half of the year. For our portfolio, due to our third quarter results and our more cautious outlook for the fourth quarter, we’re reducing the top of the 8-10% range of our prior outlook for RevPAR growth to 8.5% for the year.
While October is shaping up as a pretty good month, pace is softer for November and December, and while group pickup for our portfolio has been very short term in nature, we’re more cautious about the last two months of the year given the election and fiscal cliff uncertainties. And to give you an idea of how short term the group business has been, we went into the third quarter with group pace flat to the prior year.
Yet even with the issues in New York, we ended the quarter with group revenues up 7.5% for the quarter, which was a pretty successful booking quarter. So as we look at our pace for the fourth quarter, we’re faced with a similar situation to last quarter, with group revenues roughly flat at -0.7%.
Room nights are down 2.4%, and rate is up 1.7%. Transient, on the other hand, is up 3.8%, with rooms down 1.1% and rate up 4.9%.
But unlike 90 days ago, we’re more cautious about the quarter, particularly the last two months, as we think it’s prudent to be more cautious at this time given the uncertainties previously discussed. For the fourth quarter, we expect RevPAR for our portfolio to increase between 4.5% and 6.5%, with the majority of the increase again coming from ADR growth just as was the case this past quarter.
And we expect EBITDA margins to increase 100-150 basis points in the quarter. Although this growth rate and margin is significantly lower than our third quarter growth rate, we’re absorbing four properties we acquired in the second half of the year, which have significantly lower EBITDA and EBITDA margin growth rates than the rest of our portfolio.
Despite this, because we had achieved better-than-expected margin growth in the third quarter, and even though RevPAR and total revenue growth are now expected to be in the lower end of our previous range, we still expect our EBITDA margin growth forecast for the year to be in our previous range of 250-300 basis points. For the year, we expect to deliver a comparable hotel EBITDA increase of a very strong 17-19% for the existing portfolio, even with the negative impact of absorbing acquisition properties for our ownership periods in the second half of the year that have significantly lower EBITDA and EBITDA margin growth rates than the rest of our portfolio.
So our outlook for hotel EBITDA for the year is now a range of $126-128 million, which adds in the partial year benefit of our acquisition of the W L.A., partially offset by a small negative EBITDA for the Palomar, for the portion of the year we expect to own the hotel. For adjusted EBITDA and adjusted FFO for the year, our outlook remains in the prior range.
Our per-share numbers at the lower end of our range are the same due to half a million additional weighted average shares, offset by cash flow from the W Westwood and Palomar and down by $0.04 at the upper end of the range due to the additional shares and our lowered RevPAR outlook. To wrap up, we continue to expect 2012 to be another terrific year for the lodging industry, and an even better year for Pebblebrook.
We’ve got tremendous opportunity in the existing portfolio, following our extensive renovations to recapture significant RevPAR lost in prior years and to dramatically improve margins through the implementation of best practices and lots of focus and hard work by our operators and our team. Combined with annual industry demand growth and little supply growth over the next few years, we should continue to see above-trend growth in our RevPAR, EBITDA, and cash flows.
So that completes our prepared remarks. We’d now be happy to answer whatever questions you might have.
Operator?
Operator
Thank you. [Operator instructions.]
We’ll go first to Jeff Donnelly from Wells Fargo.
Jeffrey Donnelly - Wells Fargo Securities
Just to kick off, and maybe this is a little open-ended, but you had talked about the deceleration in business travel demand. Could you just maybe talk a little bit about the corporate mindset out there, either what you’re seeing in your hotel bookings or what you hear just from your own peers in conversations?
I guess I’m trying to understand whether you feel that is broad-based and the tip of the iceberg, or is this maybe more of a speed bump, just because it’s around companies making year end budgets and concerns around the election and fiscal cliff.
Jon Bortz
Well, I think it’s primarily the latter, although when you say widespread, I do think it’s relatively widespread. I think it shouldn’t be that surprising given the dramatic, fairly meaningful slowdown in business specific data.
And I thought it was interesting this morning, if you had a chance to catch it in the GDP report, but non-residential business investment was reported to have declined 1.3% in the third quarter. And I think that’s indicative of that mindset you mentioned, which is more cautiousness around the impending fiscal cliff, the election, and the uncertainty that revolves around both of those.
And I guess it’s a speed bump, because I’m hopeful that there will be a resolution to those matters, but again, that’s a hope, and certainly there’s no definitive evidence yet that Congress and the administration are going to get their act together and resolve this at the end of the year or even in the early part of next year. I think what’s interesting, Jeff, it’s a dichotomy right now.
Your consumer statistics are reasonably good. Whether it’s retail sales, consumer confidence, whether it’s auto sales, whether it’s home sales, increasing home values, all of those are a positive for the consumer, and that actually is showing up very positively in our week end statistics, where we’ve seen healthy demand growth and healthy RevPAR growth.
I think the other thing that we’ve seen, which is interesting, is that the sluggishness in business travel growth is more evident on the East Coast than it is on the West Coast. And whether that happens to do with the proximity to Washington or the technology base that’s out in California or the what-me-worry attitude on the West Coast, it’s hard to say.
Jeffrey Donnelly - Wells Fargo Securities
Are there any industries that seem to be showing it more than others? I mean, for example, in the New York market.
Is it more evident to you there?
Jon Bortz
Well, I think it’s more evident overall in the New York market, whether it’s specifically related to financial service firms or other firms I’d say is a little less clear. I mean, we haven’t seen cancellations.
We haven’t seen any meaningful increase or noticeable increase in attrition. We’ve just seen a bit of a slowdown in bookings in both the group and the transient side.
And I think that’s translating itself into more moderation in the growth rate overall for business travel. And what we’re worried about, and what we’re cautious about, is will that accelerate into the latter two months of the year and impact those months even more so.
Jeffrey Donnelly - Wells Fargo Securities
And just one last question, I guess two parts, on Palomar. First, I’m curious if you’re able to put a number to it by complexing the hotels that you have in San Francisco with Kimpton.
What sort of margin efficiency do you think is possible across that pool of hotels? And then second, can you just talk about how the ground lease with the Palomar works there?
And is there anything on the horizon that could ultimately trigger renegotiation of that contract?
Jon Bortz
As it relates to the issue of synergies and complexing, Kimpton already does complexing in the marketplace for some of the overall sales approach, just like they do in DC and Boston and a couple of other markets, where they have numerous hotels. So we don’t believe there are any potential efficiencies from the acquisition of the hotel.
I think we’ll benefit from having, basically, two properties, ultimately, on the same block. In terms of marketing knowledge and the customer base in the marketplace, it will be helpful.
And I think we’ll be able to implement our best practices and our efficiency programs into the Palomar based upon our local market knowledge of specific expenses. And so I think we’ll benefit from that and we didn’t underwrite that.
But I think that’s really where the positive efficiencies if you will, or operating advantages, will come from. As it relates to the ground lease, it’s a very long term ground lease with Jamestown.
You know, now’s not the time, with low interest rates, to be renegotiating a ground lease, because all we do today with low interest rates is increase the value of a relatively steady stream of ground lease payments. So there may be a time down the road, and there may certainly be a time, if Jamestown has issues down the road, for us to buy it out, but that’s probably the more likely scenario, somewhere down the road, than a renegotiation necessarily.
Jeffrey Donnelly - Wells Fargo Securities
Oh no, I wasn’t looking for you to do that. I was actually concerned that something you would do might trigger that it had to be renegotiated.
Actually, could you just maybe explain how that payment works? Is it fairly fixed?
Jon Bortz
It’s a combination of base and percentage, percentage based upon room revenues and food and beverage revenues. And the payments today are mostly base, and partly a percentage.
And then the base goes up at the CPI over the long term.
Operator
We’ll go next to Jim Sullivan from Cowen & Company.
Jim Sullivan - Cowen & Company
Jon, quick question on New York and the marketing execution in the third quarter. You had talked about the UNGA week as kind of the Superbowl.
I’m not sure if that was you or Ray, that used that term. This year it was not quite as super, I guess, as it usually is.
And I guess the question is, to what extent do you feel that your team was kind of flatfooted by the weakness this year, and to what extent did that poor performance result from not being prepared for that as opposed to perhaps being able to do something if they did correctly assess the demand?
Jon Bortz
I think that’s part of it, Jim. We did underperform our competitive set in the market, particularly in September, in the quarter.
And I think that had to do with certain decisions made along the way, either to turn down group business or overprice based upon what ultimately happened, or not take certain business that might have been more modestly priced. And you know, everything’s clear in retrospect.
I do think once there was a recognition that the business was going to be weaker, and I guess we can fault not staying in tune with our clients in the marketplace, I think there was an overreaction on a price basis at our properties. And where we lost in the quarter was not occupancy, but it was rate.
So we managed to fill, at much lower rates than we probably should have, and that our competitors filled at.
Jim Sullivan - Cowen & Company
Your comments in the prepared remarks about group pace, I just want to be clear on that. Was that only in relation to New York market, or was that general?
Jon Bortz
No, that was general.
Jim Sullivan - Cowen & Company
And so I guess kind of part two of the question, you’ve obviously as a company decided to allocate significant amounts of capital to the West Coast, where the markets have been robust for the most part. And I just wonder, as you think about going forward here, and as you think about projected supply growth in New York, what your attitude is about the New York market.
There seems to be a significant shadow supply, certainly there’s a lot of starts. There’s also significant shadow supply in New York.
How do you feel about capital allocation to the New York market and I guess the Washington market, as a part of that kind of geographic dichotomy you referred to earlier?
Jon Bortz
It’s a good question. I think our viewpoint on New York right now is extreme cautiousness, and it’s due primarily to the supply side, not the demand side.
We’ve seen very significant supply growth in the market. We’ve talked about this pretty religiously, that New York has changed.
There’s a lot of submarkets in New York that have been opened up due to less crime, whether that’s the downtown market or lower Manhattan, or whether it’s the west side, which is probably even the most active area from a development perspective in New York, including with hotels. I think we feel like the barriers to entry that preexisted in New York are not quite the same as they were, and not as high as they were before.
And so we’re very cautious about New York. We just spent about a week with a fairly meaningful team going through every construction site in New York.
And our estimates on a preliminary basis are that we’ll see a 4% supply growth, which I think is relatively consistent with what folks have talked about for next year. And I say that as 4% the way Smith Travel calculates it, so you actually probably have a few more openings than that.
And then more troublesome is the 8%, or 7-8%, growth in 2014 that we see. And again, this is based upon hotels under construction, not proposed.
So, you know, I think there’s some folks who need to understand what’s going on in New York from a lending perspective, even though those are mostly non-traditional lenders right now, and understand, this is a lot of supply that’s coming into this market. And it’s troublesome.
So we’re very cautious about New York. When it comes to DC, we’re far less cautious.
We don’t have a supply issue in DC. There’s a hotel that’s going up down by the ballpark, and then you have the large Marriott hotel that’s been under construction for some time, that will open in the spring or second quarter of 2014.
And you know, hopefully that’s kind of a wash. It brings more conventions to the market, and that offsets what would be a fairly significant increase in rooms on a one-time basis.
So our viewpoint on the East Coast is not quite as strong as our viewpoint on the West Coast, but I’d say our caution is more so concentrated in New York than it is in the other markets on the East Coast.
Operator
We’ll go next to Bill Crow from Raymond James and Associates.
Bill Crow - Raymond James
Jon, let me follow up on that question line about New York. You’ve talked for years about the growing geographic location of putting hotels in the market and the lack of concentration in the midtown area.
As you look back on it, was the joint venture a mistake, then? Because you’ve seen some of this coming?
Jon Bortz
I don’t think so. We feel really good about what we bought that portfolio at for our joint venture basis.
I think it was very attractive. I think we said at the time, and we’re executing as evidenced by the Affinia 50, that there’s a lot of value enhancement opportunity within the portfolio.
It’s still significantly below replacement cost in the marketplace, and while we are seeing a lot of select service hotels, and that totally depresses the ability to raise rates in the market, and increases the risk, I still believe, and we still believe, that it’s a great long term market to own in in midtown. And so we continue to be excited by our investment there.
We’re in the process of refinancing the asset at an obviously far more attractive basis than what we thought when we bought the asset, and I think that will add to our after leverage returns for the portfolio. So it’s still performing ahead of what we underwrote, despite what’s happened so far on supply.
Whether that will continue with the new supply coming into the market, we’re just going to have to see.
Bill Crow - Raymond James
You talked about the operators gave up rate in New York in September. And I guess we’ve seen through the last few cycles that that’s the way they react.
There’s a panic that goes on, and rate is cut. Are you starting to sense that across more markets outside of New York where there’s a little bit more of a panic on the part of the operators?
Jon Bortz
Well, one, I think that the overreaction that I mentioned I think was limited to September in the market. And I think it was a reaction to a pretty large event that occurred that came in far weaker than what was expected.
And we do see that happen from time to time, particularly in convention markets, when conventions don’t come in and provide the compression that people thought. It’s just not as big a deal overall as it was in New York.
I think the overall psychology continues to be moderate as it relates to price increases kind of across the industry and across markets. I’d say most markets, we continue to get price increases.
We’ll see pretty healthy corporate rate increases, we believe, in this set of negotiations this winter. We think it will be mid single digit to upper single digit as described by both Marriott and by Starwood previously.
And so I do think there continues to be a decent pricing power, and I think we continue to discount less in general and have fewer promotions, and mix our business better. But I think we need a much more positive economic environment in order to get more aggressive.
And I think San Francisco is a good example of that, where you have a much more optimistic view of the economy, with the amount of employee growth going on in the San Francisco and Bay Area. And we’re not seeing demand up at all in San Francisco this year, but rates are up double digits.
So an awful lot of that comes from a much more positive attitude, which I think will be attained once we begin to see an acceleration in economic growth, which we’re obviously very hopeful of. I think we all are.
Which, I think, will come with a resolution of the fiscal cliff and hopefully some reform to the tax code and other aspects of the fiscal issues.
Bill Crow - Raymond James
You mentioned Starwood and Marriott, and they’ve both offered kind of a preliminary outlook on 2013. I just wanted to see what your thought process is, and how your portfolio, which I think now is 20-plus percent skewed toward New York.
How do you think your portfolio does next year relative to the industry overall?
Jon Bortz
First of all, I think we’re going to continue to outperform the industry. I think due to our renovation activity and our asset management, I think we’ll continue to gain back share lost, as we mentioned in our remarks, at the vast majority of our properties.
And I think that will continue to allow us to outperform the industry on a RevPAR growth basis. I think our ownership in New York today represents about 21.5% of our EBITDA, and by the end of the year it will be lower, as our other markets continue to outperform New York, which was what we said going into the year.
We thought New York would be at the bottom end of our range for both the industry and to some extent for our portfolio, excluding what’s going on at the Affinia Manhattan that benefits us. So we feel good.
In terms of next year, there’s a lot of uncertainty about next year, and the range is put out by Marriott and Starwood of 4-7% or 5-7%. It seemed very reasonable with economic growth in the 2-2.5% range, and a more positive outlook from the business community.
But we don’t have those yet, and so we’ll just have to wait and see.
Operator
[Operator instructions.] We’ll go next to Wes Golladay from RBC Capital Markets.
Wes Golladay - RBC Capital Markets
Looking at your acquisition pipeline, which markets are you seeing the most opportunity in?
Jon Bortz
Well, I think we continue to see a fairly healthy opportunity in most of the major markets. It certainly picked up in the second half from the first half, and you see that in our activity level, and in the activity level of others.
So I think the opportunities, there’s still a reasonable amount of good properties in those major markets, and we’ll continue to be active in pursuing them.
Wes Golladay - RBC Capital Markets
Okay, but I guess more specific, if you look at your pipeline now, is it heavily weighted toward the West Coast versus the East Coast? Or spread across the board?
Jon Bortz
It’s not something we tend to talk about in terms of specifics about our pipeline, because we think a pipeline is when you sign a contract and close versus just pursue activities. I think, again, when it comes to the overall industry and what’s available in the market, I think it’s pretty widespread from East Coast to West Coast.
There’s certainly a lot of stuff in secondary markets. We obviously don’t pursue those, but you can see that activity from sales by many of our REIT brethren who have invested in those areas who are now selling in those areas.
So I think there’s activity in all areas, and I don’t think it’s weighted to one particular coast or another, or any particular market.
Wes Golladay - RBC Capital Markets
Okay, and you guys had mentioned the large cash balance you have on the books right now. Should we look into that, say you guys have additional acquisitions teed up in the near term, or just preparing for next year?
Jon Bortz
I think you should think of it a couple of ways, and we’ve talked about this previously. We want to continue to have $200-250 million of capacity at any point in time, because the assets we tend to buy are larger, $80 million on average, and often $125-135 million.
And so we feel comfortable carrying meaningful capacity on the balance sheet whether it be cash or whether it be access to our line of credit. We also want to continue to keep the leverage level of the company low in this 30-35% area for debt to gross purchased assets.
And so I think what you can draw from what you’ve mentioned is we want to continue to be prepared to make acquisitions, and I think as we’ve historically said in the past as well, that we tend to be a match funder for acquisitions and we tend to be a match funder in advance of acquisitions not afterwards.
Operator
We’ll go next to Andrew Didora from Bank of America.
Andrew Didora - Bank of America
Jon, a follow up to an earlier question. Does the recent slowdown and the business travel uncertainty you’re seeing now change your view at all on the cycle, whether it be to duration, ability to get back to peak, or anything like that?
And then does it affect your outlook as well on the pace of acquisitions and plans to grow your portfolio?
Jon Bortz
As it relates to the cycle, I would say that what we’ve talked about in the past is to the extent that the recovery is slower, it’s likely just to stretch it out. Now, we’ve also said that the cycle could end tomorrow, and I heard the CEO of Black Rock on the TV this morning saying that he believed that if we don’t get this fiscal cliff resolved in some manner, we’d like see a recession in the first quarter.
And there’s certainly a lot of talk about that. So does that end the cycle?
It ends the economic cycle for what many believe is a short period of time. Hopefully wiser and cooler heads will prevail, and we’ll get a resolution.
But certainly if you take 5% of spending off the table through the sequestration and the tax increases it’s going to have an impact in a negative way on the economy. And we can’t avoid that in our space.
But that will stretch out the supply growth cycle, and maybe that will create more opportunities for us on an acquisition basis. So I think from our perspective it’s both good and bad what might happen.
But I tend to think we continue to go through this bumpy recovery, and we’ll have slower periods of growth and higher periods of growth, and this is one of those slower periods for growth. And I think our business will pop back up as we see higher periods of growth.
So I think it’s more likely temporary, but there’s certainly a chance we could go into a recession in the first part of next year.
Andrew Didora - Bank of America
And my final question, just looking at the Affinia 50 renovations next year, I know you outlined the $5-6 million of total renovation disruption expected, but can you give us a sense of how you came up with that estimate, whether it’s how much EBITDA the hotel generates, or something along those lines? And then what kind of return requirements do you typically have on projects like this?
Jon Bortz
The displacement is estimated based upon the actual schedule for rooms out of service, and our schedule for the public areas. So we go through and we do a day by day, week by week analysis with our operator and we come up with the amount of inventory we’re going to have and how much we’re likely to sell and at what rate we’re likely to sell it at based upon what we’ve done in the past.
And you know, the good part of this is both we’ve done this very often in our portfolio and when I was at LaSalle, and [Denahan] has done this already twice in their existing portfolio with us. Both the [Shelborn] and the Manhattan both had almost exactly similar renovations and displacement.
So that’s where the numbers come from. As it relates to your second question, if I got it right, which was does our viewpoint on the economic cycle change our view on making acquisitions?
Andrew Didora - Bank of America
Well, I was just more interested in terms of when you do big renovation projects like this, what type of return requirements do you have?
Jon Bortz
Typically we’re looking for similar kinds of returns to the investments we make in new acquisitions. So we’re looking at that 10-12% unlevered IRR return hurdle.
And generally, even though we think the risk is lower than in a new acquisition, because we obviously have a lot more knowledge of our existing asset than we do of anything new that we’re going to buy, we do tend to still look for similar returns because of the potential disruption and the possibility that we’re going to underestimate what that impact is going to be.
Operator
We’ll go next to Dan Donlan from Janney Capital Markets.
Dan Donlan - Janney Capital Markets
First question, for Ray, Can you maybe talk about the negotiations on the Manhattan collection debt and how it’s progressing?
Raymond Martz
It’s a very competitive debt market, certainly for our sort of product, and in New York there’s a lot of interest from a wide range of lending sources, including banks and CMBS providers. Certainly what we’ve seen over the last 45 days with QE3, that’s certainly helping the CMBS, pretty significantly, with pushing and repressing rates down.
Has a positive impact for us. So that’s all very good, and certainly where we stand today is better than where we thought we would be from an our options let’s say 90 days ago.
Now, we’re talking with a number of folks right now. We are diligently working through.
We have nothing signed up at this point in time, in terms of the definitive, but we’re working through that. We feel good about it.
We hope by the end of the year, early January, we’ll have something announced publicly. I know there’s been some things in the press about the different rumors, because this is a particularly high profile transaction, but for us it’s not news until we say it’s news.
So we’re ongoing. We feel pretty good about where things are, and I would just say stay tuned as we make progress.
Dan Donlan - Janney Capital Markets
And then Jon, as it pertains to your external growth via acquisitions, given the kind of softness you’ve seen, is your expectation that we could see some more assets shake loose toward the end of the year? And just also curious if you could kind of comment on, given the strength that Ray’s just talked to on the CMBS market, have you seen more private equity bidders when you’re going to the acquisition table?
Jon Bortz
I think it’s too early to think that what we’re seeing right now is going to shake loose more assets. I think what’s shaking loose more assets is as performance has continued to improve, and values creep above debt amounts, that those assets, to a greater extent, are the ones that have come to market.
And I think that will continue. I think it will take a little more time.
The market reacts slowly to these kinds of changes in the wind. So I think as it relates to us, we’ll continue to be cautious.
I don’t think the CMBS market had an impact on the acquisition market yet. I don’t think it’s had an impact on the construction market at this point.
But I do think it’s become much more attractive for borrowers overall. The challenge to an acquirer is CMBS still takes significant time to get done, and to try to arrange that coincidentally with an acquisition is challenging.
And sellers who have other choices like us and other all-cash buyers continue to have the advantage in the market for assets that we have an interest in.
Dan Donlan - Janney Capital Markets
And then just as it pertains to L.A., was just curious, obviously you own two assets now in West L.A. Was kind of curious as to your thought process on Downtown L.A.
given kind of the revival going on there, the talk of potentially getting a stadium. Do you think that they’re going to take market share from you?
Or do you think it just compresses the overall market in general?
Jon Bortz
That’s a good question. I think the answer’s probably both.
I think it’s really great to see the revival of Downtown L.A. I think you began to see it with residential development, or redevelopment, down there.
I think that’s always what has to come first. And then you’ve seen the entertainment venues get developed, and some hotels.
And so I think actually Downtown L.A. is getting better, and I think it will continue to get better as we see more entertainment development down there potentially, with a football stadium and the redevelopment of the hotel by Korean Airlines, which will add a new product into the market.
But it’s never been a great convention market, because the convention center’s not very large, and it’s not considered a particularly attractive venue in terms of overall Downtown L.A. I think that’s improving, and I think with the development of the theater down there you’ve seen some business go from Hollywood to Downtown.
Some of the award shows have gone downtown from Hollywood, and I think that has had an impact in the West Hollywood market. But I do think the entertainment and numerous media businesses that are growing today are replacing that business, although potentially not as attractive because those tend to be pretty high compression events.
So I think the answer is both. I think you’ll continue to lose some business.
I think the market will generate some business that pushes out to Santa Monica and out to Hollywood and West Hollywood as it becomes more successful. So I think it will be kind of a combination of the two.
Dan Donlan - Janney Capital Markets
Okay. And since you mentioned Santa Monica, just curious, I think the Sheraton flag could potentially come off, or is allowed to come off, I think maybe third quarter of ’13.
Maybe it’s the fourth quarter. Any thought process there on what you may do?
Jon Bortz
We’re really just starting the analytical process with looking at what our alternatives are, including obviously keeping the Sheraton flag on the property. We wanted to get through our renovation.
We wanted to see how the performance improved, which it has meaningfully. And we wanted to see what the customer reaction was to the new product, which has been very favorable.
And we wanted to have sort of better post-renovation numbers to utilize in order to do the evaluation. So nothing to report at this point, Dan.
And my guess is our decision making will go pretty deep into next year.
Operator
We’ll go next to Jeff Donnelly from Wells Fargo.
Jeffrey Donnelly - Wells Fargo Securities
Just one quick follow up. Jon, I think you had mentioned in your remarks a handful of small renovations going on in calendar 2013 that I think have about a $1-2 million EBITDA impact.
Do you have what the total cost is of those renovations?
Jon Bortz
I don’t think we have that. We’ll probably have to get back to you.
We certainly know what it all is, we just haven’t… We’re just starting the budget process, and there may be some other things that come up through the budget process where we can give you a more complete number for the full year. But the numbers aren’t huge.
The projects tend to range anywhere from $1.5 million at the Sir Francis Drake to I think roughly $3 million for the Sofitel. So they’re all relatively small numbers.
Jeffrey Donnelly - Wells Fargo Securities
And did you give us the disruption you expect from closing the Milano for three or four months?
Jon Bortz
We didn’t give you any disruption, because it wasn’t included in our hotel EBITDA numbers. The comparative numbers.
And its impact on this year’s performance was relatively minor and it will be open again. And we didn’t own it until April of last year, so from a comparative basis, actually, Milano will add to next year, not have a negative impact.
Operator
At this time, we have no further questions.
Jon Bortz
Thank you again for participating in our call, and we look forward to updating you early next year. We’ll give you a view on 2013 at that point in time, and many of you we look forward to seeing you at NAREIT in San Diego next month.
Thank you.