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Sunstone’s Strategy: Hotel Seller, Not Buyer

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Sunstone Hotel Investors Inc., Orange County’s 11th-largest public company by market value, is a hotel investor in name only these days.

The $3 billion-valued firm (NYSE: SHO) has slimmed down its portfolio of hotel properties from 30 at the end of 2014 to 20 now.

Over the same time, the number of rooms the real estate investment trust runs has shrunk from 14,303 to 10,609, following Sunstone’s sale in the past month of a 187-room property next to Los Angeles Airport.

The firm’s last big acquisition was in mid-2017, when it paid $175 million for Key West’s Ocean Edge Resort & Marina.

Since then, it has shed numerous hotels, including its last two OC-based properties, the Fairmont Newport Beach and Hyatt Regency Newport Beach, in 2017 and 2018, respectively, that brought in close to a combined $219 million.

Its biggest move locally of late has been a corporate one: relocating its headquarters from Aliso Viejo to the top of the 200 Spectrum Center tower in Irvine.

The consolidation strategy is by design, according to Chief Executive John Arabia.

The firm has sold smaller, less prestigious properties, as well as those with underlying ground leases—the Hyatt Regency Newport Beach had such an underlying landowner that Sunstone paid rent to—while reinvesting funds into its remaining collection of largely upscale holdings, a plan that “consolidates our portfolio into long-term relevant real estate,” Arabia said.

$730M in Cash

The firm has the capital and the balance sheet to make deals.

It ended the third quarter with “significant financial liquidity,” including more than $730 million of unrestricted cash and an undrawn $500 million revolving credit facility, according to Chief Financial Officer Bryan Giglia, speaking to analysts this month following Sunstone’s latest earnings.

The market for hotels, though, is very much a seller’s one, Arabia told analysts.

“So what are our plans for our war chest? Well, we continue to struggle with the current pricing expectations” on top-end hotel buys, Arabia said, noting that private investors are willing to pay much higher prices for those properties than their publicly traded peers.

“We clearly have struggled with some of the pricing expectations by some sellers as evidenced by the fact that we haven’t been active in the acquisition market recently,” he said.

“It’s hard for us to make sense of cap rates sometimes in the 3% to 4% range.”

That type of pricing was just seen in L.A., where Sunstone sold the Courtyard by Marriott Los Angeles for $50 million.

The 187-room hotel, at 6161 W. Century Blvd. next to Los Angeles International Airport, sold for about $267,000 per room. Arabia said the property traded hands “materially above the price” it had been valued at, which was in the low $40 million range, he said.

The name of the buyer for the L.A. property, which was subject to a ground lease, wasn’t disclosed; Sunstone said it was a privately held investor who has other holdings in the immediate area.

The latest sale “just makes good business sense and adds to our war chest,” Arabia said.

“I think the Sunstone team is doing a great job navigating the cycle,” said Ken Cruse, chief executive of fellow hotel investment firm Alpha Wave Investors in San Clemente, and who from 2011 to 2015 was CEO of Sunstone.

“They have sold legacy assets, improved their existing portfolio, built up a huge war chest of cash and continued to deleverage their balance sheet,” Cruse told the Business Journal last week.

Share Repurchases

The company is not opposed to acquisitions: “There’s idiosyncratic assets that we could change our minds on,” Arabia told analysts this month.

A more likely near-term use of the company’s cash is a share-repurchase program, company officials said this month.

“I don’t believe that we’re going to be sitting on this much cash for that long of a period,” Arabia said.

“It’s a very high-quality ‘problem’ to have,” he added.

Sunstone isn’t alone. “We are seeing a lot more selling from the REITs,” said Alan Reay, president of Irvine’s Atlas Hospitality Group, a hotel consultancy and brokerage.

“It is a combination of the high prices that hotels are trading for today, low cap rates and low interest rate financing,” Reay said.

REITs in turn are often selling assets and buying back shares with the proceeds, he said.

Lessons Learned

Sunstone’s shares are up fivefold from a decade ago, when the company’s stock bottomed out during the Great Recession and the firm, under different management, turned over the keys to several properties it owned.

Sunstone’s stock has largely stayed in the $13 to $15 range the past two years, during the recent period of asset sales.

Company officials note that its remaining portfolio consists of bigger-sized hotels: they average 530 rooms in size. Sunstone now has five hotels in California, with the rest of the portfolio spread out across eight states.

Notable properties it owns include Maui’s Wailea Beach Resort, the Hilton Times Square in New York, the JW Marriott in New Orleans and Florida’s Renaissance Orlando at SeaWorld.

Seven of the firm’s 20 hotels are valued at more than $300 million, said Arabia, who noted the firm could continue selling if the price is right.

The company has not been mentioned as an outright acquisition candidate in any reports of late.

“I think we’re very well positioned if the economy reaccelerates. We’ll have some excess cash that we’ll need to make decisions on. But if the economy turns sour or materially declines, we’re incredibly well positioned.”

“I think Sunstone is now well prepared to play offense during the next cyclical downturn,” Cruse said.

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