Host Hotels & Resorts Inc (HST) 2010 Q3 法說會逐字稿

Good day and welcome to the Host Hotels & Resorts, Inc. third quarter earnings conference call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to Executive Vice President, Mr. Greg Larson. Please go ahead, sir.

Thank you. Welcome to the Host Hotels & Resorts third quarter earnings call. Before we begin, I'd like to remind everyone that many of the comments made today are considered to be forward-looking statements under federal securities laws. These statements are subject to numerous risks and uncertainties that could cause future results to differ from those expressed, and we are not obligated to publicly update or revise these forward-looking statements. Additionally, on today's call we will discuss certain non-GAAP financial information, such as FFO, adjusted EBITDA, and comparable hotel results. You can find this information together with reconciliations to the most directly comparable GAAP information in today's earnings press release and our 8-K filed with the SEC, and on our website at HostHotels.com.

This morning, Ed Walter, our President and Chief Executive Officer, will provide a brief overview of our third quarter results and then we'll describe the current operating environment as well as the Company's outlook for the remainder of 2010. Larry Harvey, our Chief Financial Officer, will then provide greater detail on our third quarter results, including regional and market performance. Following their remarks, we will be available to respond to your questions.

And now here's Ed.

Thanks, Greg. Good morning, everyone. We are pleased to report another strong quarter with solid REVPAR growth driven for the first time in a while by improvements in average rates, and continued transaction activity as we completed great acquisitions in several key target markets. First let's talk about our third quarter results. Our comparable hotel REVPAR for the third quarter increased 8.8% driven by an increase in our average rate of 4.5% and an increase in occupancy of 2.9 percentage points. Our average rate was $162, and our average occupancy for the quarter was 73.3%. Our properties benefited from strong group demand which drove a 6.2% increase in comparable food and beverage revenues. Ancillary revenues net of cancellation fees increased by just 1.6%. Comparable hotel revenue growth of 6.9%, combined with an increase in comparable hotel adjusted operating profit margin of 150 basis points, resulted in adjusted EBITDA of $163 million for the third quarter which represented an increase of $24 million from the prior year.

FFO per diluted share after a reduction of $0.02 related to debt repayment and acquisition costs was $0.11 for the quarter. On a year-to-date basis, comparable hotel REVPAR increased 5.6% and comparable F&B revenues grew just 4.3%. Total year to date revenue growth of 3.7% combined with comparable hotel adjusted operating profit margins that declined 20 basis points resulted in a year to date adjusted EBITDA of $539 million and year to date FFO per diluted share of $0.42.

REVPAR growth in our portfolio has been consistently strong since April of this year. As we have transitioned more fully into a recovery, the composition of that REVPAR growth has turned more favorable as the improvement has been increasingly driven by increases in average rate. We are also continuing to benefit from a shift in business mix towards higher rated segments. These improving demand trends allow us to be less reliant on just booking discounted business.

While these trends were apparent in both our group and transient businesses during the third quarter, the actual beneficial impact differed. On the transient front, our 8.6% revenue improvement was primarily driven by an increase in transient rate of nearly 7% led by an 11% average rate increase in our premium corporate business. Our overall transient demand growth of nearly 2% was generated primarily by an increase of 34% in special corporate business which more than offset a 7% reduction in discount room nights. We would expect to see additional strengthening on the rate side as our business mix continues to shift more towards the higher rated segments and as the impact of last year's special corporate rates, which were determined during a weak environment, diminished and are replaced by higher priced contracts.

On the group side, the strengthening demand trends we have been enjoying all year carried into the third quarter as group revenues improved by more than 9%. The bulk of this improvement was caused by an almost 8% increase in room nights, although we still benefited from a 1.3% increase in average rate, which was our first average rate increase in the group sector since the fourth quarter of 2008. The demand growth was led by association business which grew by more than 11% and our luxury corporate segment which increased by 27%.

While we benefited from demand growth in all segments, the lowest increase was in the discount segment. Consistent with the pattern we have been experiencing this year, our booking cycle continues to be very short-term. Bookings in the quarter, for the quarter exceeded last year's strong pace, and were well above levels we experienced in 2007. Group booking activity for the fourth quarter is up nearly 6% compared to 2009 with the improvement occurring over the last 90 days as our fourth quarter room night pace was negative at the start of the third quarter. As we look out to 2011, our booking pace for the combined first three quarters is up slightly, and we would expect that surplus to strengthen as we progress into the year.

On the investment front, we completed several transactions over the last few months, some of which we discussed with you during our call in July. In addition to the purchase of the Westin Chicago River North, which was announced on our last call, we closed on the acquisitions of the W New York Union Square and the Le Meridien Piccadilly which is located in the Mayfair district of London. These three acquisitions represent a solid cross-section of the types of transactions we are seeking to complete -- superb assets located in major urban gateway markets that can appeal to both business and leisure travelers. We are confident that these assets will outperform the industry over the course of the cycle.

In today's earnings release we announced a fourth acquisition that matches that profile. The 245-room JW Marriott Hotel Rio de Janeiro, our first hotel in Brazil. This high-end property is in a prime location across from the Copacabana beach and close to the city's central business district. The hotel is approximately 7,300 square feet of meeting space. It includes a 2,300-square-foot ballroom. It also has a rooftop pool with spectacular views of the city and the coastline. This hotel represents our fourth investment in Latin America, and we are hopeful that it will facilitate further investment in the dynamic Brazilian market.

These four hotels were purchased for a combined price of $478 million and reflect a 2010 EBITDA multiple of slightly less than 14 times. Collectively we project our acquisition prices represent more than a 25% discount to replacement cost. This is a unique period of time in the acquisition market as the spread between unlevered returns and our cost of capital has rarely been higher, and the discount to replacement cost on acquisitions has seldom been more attractive. We will continue to look for additional acquisition opportunities that meet our investment criteria. And while we continue to have a solid pipeline, our guidance for the remainder of the year does not include any additional deals beyond what we have announced today. Additionally, we have not included any further dispositions in our guidance for the remainder of the year.

Turning to our capital investment program, expenditures for the third quarter totaled approximately $49 million, and are $149 million year to date, including $17 million of return on investment projects for the quarter. For the full year, our expected capital expenditure estimate is $300 million to $320 million.

Now let me spend some time on our outlook for the remainder of the year. Overall, our strong performance in the third quarter and the solid booking activity for the fourth quarter suggests that REVPAR should increase between 5.5% and 6.5% for the year, which reflects an increase over our prior guidance. However, this improvement is slightly offset by a more cautious outlook with respect to food and beverage and ancillary revenue. The revenue guidance, combined with a comparable adjusted margin change of flat to up 15 basis points, results in full-year adjusted EBITDA of approximately $815 million to $830 million, and FFO per diluted share of $0.67 to $0.69, which has been reduced by $0.04 to $0.05 per diluted share for debt repayment and acquisition costs.

Given that we are in the very early stages of our budgeting process, we are not providing 2011 guidance at this point. However, as we look to next year, we believe that the positive trends we are seeing now will continue, resulting in improvements in REVPAR margins and EBITDA. We will give detailed 2011 guidance on our next call in February.

In closing, we are pleased with our performance this year, and certainly this quarter, and are optimistic about the trends we are seeing in our industry and look forward to carrying the momentum into 2011. We remain focused on pricing strategies that are assets for continued improvement on the rate side. On the investment front we are excited about the transactions we have completed over the last several months and are continuing to aggressively look for investment opportunities, both domestically and internationally. Thank you.

And now I will turn the call over to Larry Harvey, our Chief Financial Officer who will discuss our operating and financial performance in more detail.

Thank you, Ed. Let me start by giving you some detail on our comparable hotel REVPAR results. When looking at our portfolio based on property types, all of them performed very well for the quarter. Our urban hotels performed the best with a REVPAR increase of 9%. REVPAR for our resort conference hotels increased 8.7%. While REVPAR at our suburban and airport hotels increased 8.6% and 7.8%, respectively.

The two best performing markets for the quarter were New Orleans and Orlando where we have one large hotel in each market. The New Orleans property had a REVPAR increase of 28.3%. Occupancy increased over 12 percentage points and ADR increased 8.3%. The hotel benefited from a significant increase in group room nights and contract business related to the Gulf oil spill cleanup. For the fourth quarter, we expect the property to underperform the rest of the portfolio due to less city-wide business.

REVPAR for our Orlando property increased 26.7% due to an occupancy increase of 14 percentage points and a slight decrease in ADR. Group demand, particularly association business, increased significantly. We expect the hotel to underperform the portfolio in the fourth quarter due to lower levels of group business and the start of a rooms renovation at the hotel.

The Chicago market continued to outperform the portfolio with a 14.2% improvement in REVPAR. Although there were two fewer city-wide events in the quarter, occupancy increased three percentage points, and ADR improved 9.4% as our hotels benefited from higher levels of in-house group business. A positive shift in the mix of transient business as well as actual rate increases drove the ADR growth. We expect our Chicago hotels to perform in line with the portfolio in the fourth quarter.

Our Boston hotels with a REVPAR increase of 14.5%, continued to perform exceptionally well. Occupancy increased 5.8 percentage points, and ADR grew 6.9%. The outperformance was driven by nearly a 30% improvement in group and city-wide room nights. Our five hotels in the market averaged nearly 87% occupancy for the quarter. However, we expect the Boston market to underperform the portfolio in the fourth quarter due to fewer city-wide room nights and the ballroom renovation at the Sheraton Boston.

Our New York hotels had another great quarter with a REVPAR increase of 12.9% as rate increased 12.4% and occupancy increased slightly. For the quarter our New York hotels had nearly 91% occupancy. At these levels we have been limiting the number of groups and driving transient business and rates. As a result, transient ADR increased 15.4%. We expect New York City to have a very good fourth quarter, even with rooms renovations at the New York Marriott Marquis and the Sheraton New York Hotel and Towers.

As we discussed on the second quarter call, we expected our Hawaiian hotels to finally turn the corner in the third quarter and they did. REVPAR increased 11.8%. Occupancy improved 8.3 percentage points due primarily to a significant improvement in group demand. The increase in airline capacity helped results for the quarter. While both of our hotels will have some of their rooms out of service due to renovations, we still expect them to continue to outperform the portfolio in the fourth quarter.

The Denver market continued to perform well with a REVPAR improvement of 11.8%. A significant increase in group and transient demand drove occupancy up 7.2 percentage points. For the fourth quarter, we expect Denver to continue to outperform the portfolio as we expect both group and transient demand to remain strong. REVPAR for our San Francisco hotels increased 11% due to higher levels of transient demand. Occupancy was up 5.3 percentage points and ADR improved 3.9%. Improvement in special corporate and corporate demand led to a transient ADR increase of 6.5%. We expect our San Francisco hotels to perform in line with the portfolio in the fourth quarter.

REVPAR for our San Antonio hotels fell 7% as occupancy dropped 6.6 percentage points and rate increased 2.3%. The poor performance was due to lower transient and group demand. We expect our San Antonio hotels to rebound in the fourth quarter and outperform the portfolio due to a substantial increase in group and city-wide demand.

As expected, our Phoenix hotels struggled in the third quarter due to the renovation of a significant amount of meeting space at two of our hotels and the construction of a new ballroom at the Westin Kierland. REVPAR declined 9.8% as occupancy fell 4.3 percentage points and ADR decreased 1.8%. We expect our Phoenix hotels to continue to underperform the portfolio as the renovation and construction projects at the Westin Kierland continue in the fourth quarter.

Year to date New Orleans has been our top performing market with a REVPAR increase of 16.9%, followed by Boston with an increase of 16.8%, New York with an increase 12.6%, and Miami-Ft. Lauderdale with a REVPAR increase of 10.1%. Our worst performing market was San Diego with a REVPAR decrease of 5.8%. However, our San Diego hotels started to rebound in the third quarter and we expect them to significantly outperform the portfolio in the fourth quarter.

For our European joint venture, REVPAR calculated in constant Euros increased 10.3% for the quarter due to an eight percentage improvement in occupancy, and a slight decline in ADR. The Crowne Plaza Amsterdam and the Westin Palace Madrid outperformed the rest of the portfolio while the Renaissance Brussels was the poorest performer primarily due to a rooms renovation. On a year-to-date basis REVPAR calculated in constant Euros increased 6.1%.

For the quarter, adjusted operating profit margins for our comparable hotels increased 150 basis points, our best performance of the year. This occurred despite the significant reduction in the level of cancellation and attrition fees and the meaningful increase in bonus expense in 2010, which when combined, resulted in a 100-basis-point reduction in margins. Rooms flow through was excellent for the quarter at 80.1% as flow-through benefited from the ADR increase and productivity improvements that led to flat wages and benefits on a per occupied room basis.

Food and beverage flow-through was lower than expected as groups remain cautious with ancillary spending, preferring to purchase lower margin items. Unallocated costs increased 7% for the quarter. This increase was primarily driven by expenses that are variable with revenues including credit card commissions, reward programs, and cluster and shared service allocations. Utility costs increased 6.2%, primarily due to higher electricity usage, particularly the Northeast, where some of our major markets such as Boston, New York, and Washington, DC, had a substantial increase in the number of 90 degree plus days.

Property taxes declined 1% while property insurance decreased approximately 20%. Looking out to the full year, we expect comparable hotel adjusted operating profit margins to be up 15 basis points at the high end of the REVPAR range and flat at the low end of the range. These amounts have been reduced by 70 basis points for the year-over-year difference in cancellation and attrition fees and 30 basis points for incremental property level bonus expense.

We currently own a leasehold interest in 53 Courtyards and 18 Residence Inns which were sold to Hospitality Properties Trust and leased back in 1995 and 1996. In 1998, we subleased these 71 properties to a third party with initial lease terms expiring in 2010 and 2012. In the third quarter, the subtenants failed a network covenant and we terminated the sublease in order to not trigger a default under our lease. Accordingly, we now act as owner under management agreement, and we started to record property level revenues and expenses from the date of the sublease termination instead of rental income and rental expense.

While the sublease terminations affected revenues and expenses, there was no effect on the quarter's operating profit or net income from the termination. We have recourse against the parent of the subtenants and the subtenants and expect them to continue to fund the majority of the deficit.

We gave notice that we will terminate the lease on the 18 Residence Inn properties effective December 31, 2010, at which time we expect that our $17 million of deferred proceeds plus some cash collateral will be returned by HPT. In 2010 we also intend to give notice that we will terminate the lease on the 53 Courtyards effective December 31, 2012, at which time our $50 million of deferred proceeds, plus some cash collateral, will also be returned.

During the quarter, we redeemed $225 million of our 7-1/8 Series K senior notes for $230 million. We finished the quarter with over $838 million of cash and cash equivalents and over $540 million of capacity on our line of credit. After taking into consideration the acquisition of the JW Marriott Rio de Janeiro, subsequent to the end of the third quarter and pending defeasance of the $115 million mortgage on the W Union Square later this month, we would have approximately $670 million in cash and cash equivalents.

This completes our prepared remarks. We are now interested in answering any questions you may have.

Thank you. (Operator Instructions). And our first question will come from Felicia Hendrix with Barclays Capital.

The first question is, Marriott, on their conference call, recently made some comments regarding the ramp of their incentive fees which apparently was lower than many people had been expecting. Just wondering from your perspective, as owners of hotels, as owners of Marriott branded hotels, if you could share with us what percentage of your portfolio is still under the owner's priority returns and when do you expect those properties to start paying incentive fees?

Sure. At this point I think we're, as we look out towards the end of the year, we're expecting that roughly a third of our hotels will be paying incentive management fees, and then logically as we continue to move upwards in terms of EBITDA that number will increase.

If you have to think about -- and I know projections are hard, but if you have to think about through 2011, do you think by the end of 2011 you are two-thirds of the way there?

No. It would be very difficult to speculate on the fly on that particular point, because it's so unique to each individual asset. But just remembering back to the pace at which we recovered in 2004, 2005, and 2006, it was a far more moderate transition than that.

Okay, thanks, that's really helpful. And just getting to your special corporate business, which is clearly ramping, I'm wondering if you could -- and I know we're still in the process, in the RFP process, but if you could give us some thoughts about where you think rates might come out for 2011?

I don't know that I could add much more than what Arnie would have speculated on the call last week. You can rest assured that we are wholeheartedly supporting the efforts of our operators to obtain meaningful increases from our special corporate customers. I think we're probably still a little early in those negotiations to have a clear read. Certainly some of the contracts that have been negotiated are coming in at the high single digits, sometimes better, but I think it's still up in the air to see how strong they ultimately end up. One thing for sure, though, is where that has been a drag on our numbers this year, it should certainly start to contribute to average rate increases next year.

Right. Okay, and final question. On your last call you were indicating you would start looking at dispositions probably more likely next year or the year after. I'm just wondering, are there any particular geographic regions or brands that no longer fit with your overall strategy?

Certainly there would be no particular brands that we would be trying to sell from. I think we're very comfortable with all of the brand partners that we have. In terms of regions, broadly speaking we're probably more focused on the coast with the exception of Chicago, and less focused on the interior of the country. So some of those will be the source of locations that we would be more likely to sell.

But having said that, I think what you are going to find is that next year we'll have some level of acquisitions, we hope. A lot of that is going to be dependent upon both the performance of the assets that we're looking to sell, meaning have they started to come back closer to their peak operating level, so that we'll feel comfortable that we're getting good pricing. We don't need to sell assets right now from a liquidity perspective. Selling assets is more about reaping value where we think we've created as much as we can, and then it's also part of just over time repositioning the portfolio so that the bulk of the portfolio is located in higher growth markets.

Great. Very helpful. Thank you. Appreciate it.

And our next question will come from Joe Greff with JPMorgan.

Good morning, everyone. Ed, you had talked about caution with respect to food and beverage and catering revenues associated with the group stuff. Is that specific to just a handful of markets? I know Marriott referenced that last week, as well. And then when you look at your 2011 group pace, first three quarters of next year, that data point that you referenced, are you seeing any improvement on the non-room revenue side? Thanks.

With respect to which markets we're seeing the greater effect, the sense that we had in looking through our numbers is that it wasn't a marked difference. I think what you are just seeing is customers being -- the good news is that customers are meeting again. Groups are coming back to properties, and the events are happening. I think what we found over the course of the summer, and as we looked out into the fourth quarter, is that they were probably being a bit more cautious about what they spent on food and beverage, specifically on breaks. That seemed to be the area as we talked to the operators where we were feeling the most impact. It's just coffee and water and soda instead of more elaborate food displays.

And so the net effect is that group spending per customer is down just a little bit. I wouldn't want to describe this as any kind of a sea change from our perspective, but we were expecting a little bit more in the third quarter, and as we looked out to the fourth quarter we realized that we should probably moderate our expectations a bit.

The other thing that's happened on that side, that I referred to in my comments, that I think is a little tied into the ancillary revenue issue is that on the ancillary revenue side we're not seeing quite as much spending in spas and golf as we might have anticipated. With the strong increase in occupancy that we've had, we would have normally expected those revenues to trend up a little bit more aggressively. If you look at where we ended up, I think we're probably up probably about 4% increase in occupancy, yet our ancillary revenues were only up about 1%. Again, I don't think it's a major issue. It's just we were hoping that we were going to see a little bit more growth on that side. I think what you're finding is consistent with the fact that groups are spending a little bit less on some food items, they're also spending a little bit less on some of the activities that are happening around events.

As we look in the next year, I don't know that we have enough data yet to necessarily draw a firm conclusion. I would expect that if you -- rather than thinking about what happened in prior recoveries, typically what happens is that first groups have to start to meet, then the next year you start to see folks be willing to spend a little bit more on the event in order to make the event a little bit more special, and we tend to start to benefit from that, of course.

The other thing that will hopefully start to happen, and so far we've only seen this happen in a couple of markets, is at some point the dynamic around the competition for meeting space in hotels at certain high targeted times will begin to allow us to again to charge meeting room rental. And that, of course, is a great -- there's a flow-through on that particular revenue item is excellent. We have been able to charge it in some markets this year, this last quarter, but not very many. As occupancies continue to improve I think there's a greater likelihood we'll start to see that next year, and that will factor into this equation, too.

Great, thank you.

Next we'll hear from Smedes Rose with KBW.

When you are looking at your acquisitions, is there more opportunity on the domestic side or the international side? I've been a little surprised at the amount of international you're looking at. And on that, I think Marriott was the owner of the Rio hotel. I'm just curious, had you looked at that property before, and things just came together to make a purchase opportunity now versus in past years?

With respect to the JW and Rio de Janeiro, we had looked at that asset over the last couple of years. There were some title challenges with that asset that needed to be resolved before Marriott could execute a sale transaction. And so once those were resolved, it was possible for the two of us to negotiate. But it was something that we had been interested in, really, as far back as two years ago.

I think it's somewhat coincident or opportunistic in terms of the timing that we've had, that of the first four properties we've bought, two of them have been located outside the US and two are located inside the US. I still suspect that in general the majority of the acquisitions that we complete will be domestic. It's just that we have been active in these other markets. We've been looking in these other places for a while. We felt comfortable with the opportunities when they presented themselves and so we acted on them. But by and large I would say our pipeline still has more assets that we're looking at that are domestic in nature than those that are international.

Okay, thanks. And then can you just comment on, is the cost pressure building for next year for the employees at the property level? Do you have a sense of how much that needs to go up next year?

I think the operators are still sorting that issue out, but I don't believe that we're necessarily looking at anything that would be beyond what you would -- usually the employment cost index has a tendency to trend a half or so points above the CPI. I would suspect that as you look into 2011, you will probably find that wage increases will trend slightly above inflation, consistent with the long-term average. We're not getting the sense that there's going to be any major movement to -- which I think is where your question is ultimately focused is, is there going to be a movement to try to catch up on some of the lower wage increases that might have happened over the last couple of years. And so far we're not hearing that.

As we've talked a little bit, one of the things that might help offset some of those changes over the course of the year, which as Larry has talked about several times in his comments, we've had some pressure in the broad salary and wage area because of the bonus expense coming back into our P&L as the properties perform much better than anticipated, and certainly much better than last year. We'll still have bonus expense for next year, but as you think about year-over-year changes that bonus expense should not be as significant in a year-over-year context as it was in 2010.

That's great. Thank you.

Next we'll hear from Ryan Meliker with Morgan Stanley.

Good morning, guys. I just had two quick questions. First one on your 2010 RevPAR guidance and the implied guidance for 4Q, it looks like it's at about a 5.5% to 9% range for 4Q, coming in at 8.8% in 3Q. Is there anything you are seeing that leads you to believe that RevPAR growth might moderate with the renovations you're working on? Is there something going on that would lead us to believe that things are getting worse in 4Q as opposed to getting better?

No, I wouldn't read into our number any sense that things are getting weaker. The comp gets slightly more difficult in Q4. But I think that the one thing we did comment on, as Larry went through the different markets, is that we do have some renovations happening at some of our larger hotels that are going to hit in November and December of this year. Now, the reason those renovations are targeted for that time of year is traditionally business demand levels and volume levels are lower. So we hope that there will be less disruption. But in terms of thinking through what was going to likely happen in the quarter, we were thinking that we should at least provide for some room for conservatism in case the impact turned out to be greater than we expected.

Clearly, we've had a lot of questions in meetings and I think there is in the industry, about the potential impact of some of the slowing that we saw in the economy during the really late spring and during the early summer, and whether that is going to have any impact on our operations. And clearly that's something that we've been focused on.

The short answer on that is that we've continued to see very good demand. September, based on preliminary results, was up 9.5%. So September for us, meaning September for our monthly hotels, and period 10 for our Marriott International hotels. So that's favorable compared to where we are for the third quarter. Booking pace continues to follow the same pattern of being about in line a quarter out, and then getting very strong during that quarter preceding the actual quarter that happens, and then bookings in the quarter continue to be good.

We're also comforted by the fact that as demand has continued to improve, we're finding better and better ability to both stop or limit providing discounts to customers to solicit business, and at the same time to begin to move rates. Of course, the broader economic, or the broader fundamental in all of this is that supply is moderating consistently through the year and will be even lower as we work our way into next year.

So the net of it is that it is something we've been watching carefully. We've been looking carefully at every monthly report we get to try to see if there is anything that's suggesting that there's weakness. And I think really what's happening, at least as it relates to our portfolio, which, of course is very focused on urban markets and has always benefited a lot from corporate travel is despite the fact that GDP growth has not been as strong as people might have hoped, or certainly might have predicted early in the year, we're continuing to see that corporate investment and corporate profitability are very strong, and frankly are coming in better than where people thought in the beginning of the year and even better than where people thought at the beginning of the third quarter.

We benefit from that trend because whenever investment is up, corporate travel seems to be up. At least, that's what history suggests. So I think that's why you are seeing the results that we're having. The good news for us as we look a little bit further forward is that the outlook at this point for corporate investment for next year is to be even stronger than what we're seeing this year.

That's helpful. Thanks. And then one other question on rooms operating margins. Obviously you guys did a great job this quarter with 80% flow-through in the rooms department. I think last quarter you mentioned that typically towards the peak of the disparity between rate growth and occupancy growth you get to plus or minus 80% flow through, yet you were able to do that at only about 50% split between rate growth and occupancy growth. If I were going to assume maybe rate growth is up 80% of RevPAR growth in 2011, is it realistic to believe we could exceed that 80% flow-through, or do you think 80% is still a peak that costs will start to go up a little bit more?

I think you could assume that certainly within individual quarters you could do better than the 80%, but a little bit more is probably in the context of a full year. I don't know that I would be more aggressive than that.

Thanks a lot. That's very helpful.

Next we'll hear from Jeff Donnelly with Wells Fargo.

Good morning, guys. Ed, if I could just build on Smedes' earlier question about the valuation proposition between domestic and foreign properties, just given the debate about the long-term health of the US economy and what might be entailed to get us back on the upward trend, do you think you might be better served placing more dollars outside the US in future years?

Jeff, that's a really good question. It's one of the things that we have thought a lot about as we've gone through our different strategic planning exercises. Certainly as you look around the world, and focus on markets like Brazil, India, China, you certainly see a lot better economic growth than what we're projecting to see in the US. And we know that economic growth ultimately translates into hotel demand growth. And that's the most fundamental reason why we have felt it was important to explore opportunities internationally.

Today international probably, when you total up the amount of investment that we have in our portfolio in international markets, it's roughly in the 7% to 8%. That's counting in Europe just our share of the JV and not the total magnitude of the assets that are there. But as we look into the future, if we continue to feel that we can invest successfully in those markets, and every country is a little bit different, and every market is a little bit different, so as we continue to prove to ourselves that we can successfully invest outside of the US, I think for the very reason you suggest, we would feel comfortable in having that percentage increase in an effort to try to give us broader exposure to markets that are going to grow better than where the US is going to grow.

Just looking here at the US, I'm curious, how concerned are you that maybe some of the current prices that we see on transactions are being somewhat influenced by the low rate environment that exists out there and that may be a rising rate environment in future years? Can you have some appreciation potential because certainly most asset prices aren't off as much as the cash flow certainly would bear out?

I think right now, I would feel comfortable that given the reduction in profitability, that at least the markets that we're looking and experienced, I would feel pretty comfortable that even when we ultimately come back to a rising rate environment -- frankly, I hope that we do because it would suggest a healthier economy, I would feel comfortable that the increases in EBITDA that we would expect to benefit from would certainly keep asset pricing well above where it is today.

At the end of the day, pricing should, in most markets, move much closer to replacement costs. And as I mentioned in our comments, we think we're buying at a meaningful discount to replacement cost. The increasing interest rate, or the low levels of interest rates have had some effect certainly on the ability of people to pay some of the prices that they've paid. This is not quite as debt driven an acquisition environment right now as what we saw in the '05, '06, and '07 time frame. Leverage plays a role in deals, but it's not the driver behind deals right now, because you just can't get leverage at the same levels that you could get before.

So net of it is that you will probably see cap rates go up over the next two or three years, but I think some of that is going to be reflective, it will be a little bit because rates are a little bit higher, and it will be because, as we start to progress through the growth phase that we all expect to see in these assets in '11, '12, and '13, there's usually a little bit of moderation that comes as the anticipated growth rate moderates too.

And just since you brought it up about replacement costs, I'm curious what your thoughts are on the prospects for development. And I don't mean just full service in the urban markets, but maybe more broadly in the industry. I know that the conventional wisdom is development is off the table for an extended period of time. But the transaction pricing we're seeing in the market today on a key basis is pretty close to where it was in 2004 and 2005 when many folks were actually starting construction last cycle.

And I think if Marriott is correct on their 2011 outlook, the industry is going to be getting pretty close to being within striking distance, say, by 2012, of peak revenues or nearing on peak profitability that we saw last time, and construction costs are arguably lower. I'm curious, I know it's not today, but do you think in the next 12 months we could hear increasing signs of construction activity, or do you think that that's still going to be off the table as we look forward?

Certainly from the standpoint of full service development, I think I would be surprised if we saw real progress towards a lot of new development in the next 12 to 24 months. I still tend to look towards the levels of supply growth that we saw in '03, '04, '05, and '06 as being indicative of what's likely to happen in at least '11, '12, and '13.

When I compare the two periods, even assuming we have the same rate of recovery that we had last time, which I think is feasible, the reality is we started a little bit lower so that the gap between value and replacement cost is certainly as great, if not greater. The availability of financing in today's environment for new construction is weaker than what we experienced in the early part of the last decade. So while financing conditions are trending in the right direction, I don't see a lot of lenders racing to provide loans for new hotels. And that will be necessary in order for construction to really increase.

So I think you are right from the standpoint that values have recovered, maybe a bit more quickly than people were projecting. The bulk of the reasons behind that is that cash flows are recovering more quickly than people had projected. That will ultimately support new construction, but I think we've got a fair amount of time before that's going to happen.

Now, having said that, that's a full-service discussion. I think it's even tougher in the luxury market. Luxury sells more, and luxury the last time was subsidized by a lot of condominium construction where the hotel was an amenity to a condo project. That's only going to make sense in markets that have a vibrant condo market, and I don't see that happening in the near term in most of the major markets across the country.

We probably will see some limited service construction sooner than we'll see full service construction. Those properties are smaller, they're easier to finance. The numbers have always tended to work sooner with that type of a product. And so I suspect that when we do start to see supply numbers begin to trend upward instead of continuing to trend downward, it will be because of additional supply in that segment.

Just one quick final question, if I could. I know you haven't given 2011 guidance, but as you think about that next year, what do you think will be the bigger driver of your RevPAR outlook? Is it just incremental demand overall, higher rates, or more of a mix shift just between existing rate categories?

Certainly it will be all of the above. We are encouraged. We are encouraged by the fact that, one, the occupancy rebound this year has been as strong as it has been. But at the same time, we're encouraged this last quarter by how strong the rate contribution was. We're probably, if you look at how we've done, we're still not quite 50% back -- if you look at the drop that we had from 73%, 74% in occupancy in '07, down to 66% last year, we're working our way back but we're probably at best about halfway back on that recovery.

So I would still be expecting next year that we would continue to progress back towards our prior peak occupancy levels. But certainly as you work your way through the year next year, rate will play an increasing role.

What's interesting is that as you look at what's happened to us this past quarter is that change in business mix has been helpful, but we've also been able to get absolute changes in rate within particular segments. And I don't see any reason why that trend won't continue into next year.

So to sum that up, my guess is by the time we get to the end of next year, we probably would find that rate was a bigger contributor to RevPAR growth than occupancy, but both will contribute.

Thanks.

And that does conclude the question-and-answer session. At this time I would like to turn the conference over to Mr. Walter for any closing remarks.

Great. Well, thank you for joining us on the call today. We appreciate the opportunity to discuss our third quarter results and our outlook with you. And we look forward to talking with you following the close of 2010 with more detailed insights into 2011. Have a good remainder of the week.

And that does conclude today's conference. Thank you for your participation.