Pebblebrook Hotel Trust (PEB) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the Pebblebrook Hotel Trust second-quarter 2013 earnings call. Today's conference is being recorded.

At this time I would like to turn the conference over to Raymond Martz, Chief Financial Officer. You may begin, sir.

Thank you, Lisa. Good morning, everyone. Welcome to our second-quarter 2013 earnings call and webcast.

Joining me today is John 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 risks and uncertainties as described in our 10-K for 2012 and our other SEC filings and could cause future results to differ materially from those expressed in or implied by our comments.

Forward-looking statements that we make today are effective only as of today, July 26, 2013 and we undertake no duty to update them later. You can find our SEC reports in 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. We are very pleased with our second-quarter operating performance which slightly exceeded our expectations. Same-Property RevPAR for the total portfolio climbed 6% to $195. This was at the top end of our outlook for RevPAR growth of 5% to 6% primarily due to strong business and leisure transit demand and better than expected performance at many of our West Coast properties.

In addition, we continue to see steady inbound international demand, which benefits many of our hotels given our high concentration of high-quality hotels in many urban gateway locations. Our overall Same-Property RevPAR gains in the quarter came primarily from growth in rate. Our 6% RevPAR increase was driven by a 4.4% increase in ADR while occupancy increased 1.5% to 86%, demonstrating the pricing power in the portfolio and the very high occupancy levels we have already achieved with the majority of our markets above prior peak occupancy levels.

As a reminder, RevPAR and hotel EBITDA results are Same-Property beginning with our date of ownership and include all the hotels we owned as of June 30 whether we owned them or not in the prior year period. We don't exclude hotels under renovation from our RevPAR and hotel EBITDA results.

In addition, our results reflect 49% of the performance of the Manhattan Collection, mirroring our joint venture ownership percentage. For our portfolio on a monthly basis, the April RevPAR increased a very strong 12.5% benefiting from the holiday shift. May was up 5.1% and June, as expected, was weaker rising only 1.3% up against a very difficult comparison from last year.

Recall that June benefited last year with lots of business moving into the month from July due to July 4 falling on a Wednesday.

RevPAR growth in the quarter was led by Hotel Zetta increasing 92.5% as we have had a great response from the market to our very creative design and new high-quality product following our comprehensive renovation and repositioning that was completed this spring. Other RevPAR leaders in the quarter included Sir Francis Drake, Vintage Plaza Portland, Monaco Seattle, Palomar San Francisco, the Argonaut San Francisco and Intercontinental Buckhead.

At the Affinia 50, RevPAR declined by over 40% in the quarter from the comprehensive $18 million to $20 million renovation repositioning, which continues to be on budget with substantial completion expected as scheduled by the fourth quarter. The substantial RevPAR decline at Affinia 50 negatively impacted our Same-Property RevPAR growth for the portfolio by 130 basis points in the quarter.

Compared to last year, second-quarter Same-Property total revenues increased 5.6% and expense growth was limited to 4.2% resulting in a Same-Property EBITDA margin increase of 93 basis points. EBITDA margin growth was reduced by 41 basis points and would have risen 134 basis points without Affinia 50, which is more indicative of our overall success and continuing to drive margins upwards.

As a result of our solid RevPAR growth of 6%, and EBITDA margin growth of 93 basis points, our total portfolio generated $46.1 million of Same-Property Hotel EBITDA, an 8.8% increase over the second quarter of last year. This strong growth was achieved despite the negative impact experienced at several of our hotels undergoing renovation during the quarter, including the Affinia 50.

EBITDA at Affinia 50 declined 88% in the quarter which reduced our Same-Property EBITDA growth rate by 241 basis points. The hotel EBITDA percentage growth -- growth leaders in the second quarter were Hotel Zetta, Sir Francis Drake, Vintage Plaza Portland, Palomar San Francisco, Hotel Monaco Seattle, Sheraton Delfina, and Mondrian, L.A.

12 properties grew EBITDA more than 15% in the quarter compared to the same period last year.

As a result of the solid hotel operating performance during the quarter, as well as a greater number of properties this year versus last, we generated adjusted EBITDA of $42.8 million for the quarter, an increase of $9.9 million or 30% compared to last year's second-quarter results.

Our adjusted FFO climbed to $26.4 million or $0.43 per share compared with $20.1 million in the second quarter of 2012 or $0.37 per share, a 14.8% increase.

Year to date, Same-Property RevPAR increased 7.2%, Same-Property EBITDA has climbed 10.8%. EBITDA margin is up 121 basis points and adjusted EBITDA is up 38% or $18 million versus last year. Without Affinia 50, year to date RevPAR is up 8.2%, Same-Property EBITDA has increased 12.9% and EBITDA margin has risen 154 basis points.

Now let's shift our focus to our capital investment and capital market activities in the second quarter. During the second quarter, we invested $11.7 million into our hotels as part of our capital reinvestment program which included completing our renovations at Hotel Zetta, Sofitel Philadelphia and Affinia Manhattan as well as the ongoing renovation of Affinia 50. Year to date, we have invested over $28 million into our hotels as part of our capital reinvestment programs.

On the debt side, in early April, we successfully completed a five-year $50 million nonrecourse loan at a fixed interest rate of 3.14% secured by the Affinia Dumont in New York. The Dumont is part of the fixed property Manhattan Collection which we own a 49% interest in with our joint venture partner, the Denihan Hotel Group.

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On the equity side on April 11, we announced that our underwriters exercised a greenshoe for our Series C 6.5% preferred equity offering that we completed in late March. As a result, we raised a total of $100 million of preferred equity for the Series C offering.

In addition, during the quarter, we raised $4.7 million in net proceeds through our ATM program at an average share price of $28.09. As of June 30, we had cash, cash equivalents and restricted cash of $165.4 million plus another $12.6 million in unconsolidated cash, cash equivalents and restricted cash from our 49% pro rata interest in the Manhattan Collection.

I would now like to do the call over to Jon to provide a little color on the recently completed quarter as well as our outlook for the remainder of 2013. Jon?

Thanks, Ray. So as Ray said, the second quarter was another terrific quarter for Pebblebrook. We benefited from a solid quarter of industry fundamentals and an ability to drive outperformance through the high occupancy levels of our properties and our markets.

When we look at the second quarter's overall industry trends, performance continued to be driven by strength in transient travel, both business and leisure. Demand in the US rose a healthy 2.1% in the quarter, and with little supply growth at just 0.8% industry occupancy grew another 1.3%. This provided the foundation for ADR to grow a healthy 3.6% resulting in a RevPAR increase of 5%, the 13th straight quarterly increase in industry RevPAR of 5% or more.

At Pebblebrook, our West Coast property significantly outperformed our properties located along the East Coast. RevPAR at our hotels located in Seattle, Portland, San Francisco, West L.A., and San Diego grew 11% in the quarter with occupancy up 3.3% to 84.8% and ADR climbing a very strong 7.5%.

On the East Coast, excluding Affinia 50, our properties in Boston, New York City, Philadelphia, Washington, DC, Buckhead, and Miami grew RevPAR by 3.2% with occupancy up 1.3% to an even stronger 89%, yet ADR increased just 1.9%.

If we look a little more closely at the individual markets and their performance in the quarter, it highlights the ongoing fundamental strength and better psychology of the West Coast cities compared to the East Coast markets. On the West Coast, RevPAR in Seattle's CBD increased 10.6% in the second quarter. In San Francisco's urban market, RevPAR climbed 17.1%. Hollywood, Beverly Hills market, 6%. Santa Monica, 6.8%. And downtown Portland, 15.1%.

San Diego, the one weak market on the West Coast, was up just 1.1% struggling with a less attractive convention calendar in the year and a Mayor who has created a situation where millions of tourism marketing dollars which are already being collected are not currently being spent.

By comparison on the East Coast, downtown Miami RevPAR increased 4.3% so up a much stronger 12.4% year-to-date. Downtown Boston was flat in the quarter. Buckhead was our best market on the East Coast with RevPAR increasing 7.6%. Washington DC's CBD, struggling with government cutbacks, was up just 2.2%. Philadelphia's CBD 1% and Manhattan rose 3.4%.

And please keep in mind these statistics are for the urban markets described, not the metropolitan markets or our individual properties.

While transient business led the way in our portfolio, our group business performed well in the quarter. Group revenue rose 4.4% with ADR up 3.2%. Transit revenue grew 6.5% in the quarter with ADR increasing 4.7%. Group represented 25% of our room nights in the quarter, transient made up 75%.

Year to date, this breakdown is the same and we expect the 75/25 segmentation to remain roughly the same for the rest of 2013.

Now let me talk a little bit about EBITDA growth and margins. As we reported, Same-Property portfolio revenues grew 5.6%. Same-Property EBITDA grew 8.8% and Same-Property EBITDA margin rose 93 basis points. As Ray mentioned, without Affinia 50 and its significant impact from its renovation, Same-Property revenues grew 6.5%, Same-Property EBITDA grew 11.2% and EBITDA margin climbed 134 basis points or 41 basis points better without Affinia 50.

On a Same-Property basis, we limited the growth in operating costs to 4.2% even with the 1.5% increase in occupancy and a 14.7% increase in property taxes, which continue to be negative impacted for one year by the automatic reassessments of our recently acquired California hotels including W Westwood, Palomar San Francisco and Embassy Suites San Diego. Property taxes at these properties alone reduced our EBITDA margin growth by 20 basis points.

These results highlight the success we continue to have working closely with our operators, identifying and implementing our best practices. As of today, we have now identified over $16 million of cost savings and enhancements. We expect this process of identifying and then implementing and then annualizing these EBITDA and margin enhancements will continue for several years to come.

Our margins are far below stabilized margins for our portfolio. And in addition, as we acquire hotels with significant opportunities to improve subpar performance, we refill the pipeline of higher EBITDA and margin growth for future years.

So, let me provide a quick update on our property renovations. During the quarter, two properties were undergoing significant renovations that had a material negative impact on their performance. The largest of them all, the comprehensive renovation, reconfiguration and expansion of Affinia 50, began in January and as Ray mentioned continues to be on schedule and without any budget surprises.

We have now taken out of service all of the old rooms and we have completed the renovation and put back in service 166 of the 210 rooms we started with. We should be back up to the original room count by early September with a newly created additional 41 rooms coming back into inventory over the course of the remainder of the year as they are renovated and the new elevator is completed.

We continue to be in a heavy phase of customer disruption as the externally visible public areas, including the entrance, lobby, and second floor are being renovated with substantial completion expected by the beginning of the fourth quarter.

We are very pleased that the newly renovated rooms have been extremely well received by not only the property's existing customer base, but by many potential new clients that have toured the new room product. We continue to be optimistic about the hotel's performance next year as a fully renovated repositioned and expanded hotel.

The other major disruptive work in the quarter involved the completion of the last phase of the comprehensive renovation of the Affinia Manhattan. Specifically, the public areas were completed by early June and included the entrance, main lobby and meeting space. We held a grand reintroduction party in late June and the reception was extremely favorable.

We are very encouraged by the opportunity for this property to gain back significant RevPAR penetration over the next couple of years and significantly grow its group base.

And as we look out into 2014 as discussed last quarter, we don't see any major renovations within the existing portfolio that will be materially disruptive to the overall performance of the Company outside of the more minor impact of the comprehensive renovation at Vintage Park in Seattle, which is a small property and the lobby, restaurants and bars at W Westwood which will all be renovated and re-concepted.

Now let me turn to a quick update on our outlook for 2013. We continue to expect 2013 to be a great year for both the industry and Pebblebrook. For the industry we are maintaining our RevPAR growth range of 5% to 6.5%. For our portfolio, we are also making no change to our RevPAR growth range of 5.5% to 7%, with about 100 basis point negative impact from the renovation of Affinia 50 still being forecasted.

Given the better than forecasted performance in the second quarter, we are raising the lower end of our range for Same-Property EBITDA, adjusted EBITDA and FFO by $1 million, reflecting our better than expected performance in Q2.

The third quarter looks healthy, based on current trends and business on the books. So we are forecasting RevPAR to increase by 5% to 6% which reflects about a 100 basis point negative impact from Affinia 50's renovation. For Q3, we are also forecasting EBITDA margin to grow by 25 to 50 basis points.

Economic trends, travel trends and business on our books continue to support our forecast of healthy growth for 2013. As of the end of June, total group and transient revenues on the books for the last two quarters of this year was up 10% over same time last year.

Portfolio-wide for the remaining six months of 2013, group room nights were up 4.4% with group ADR up 1.3% for a total of 5.7%. Transient room nights on the books for the second half were higher by 5.6% with transient rate up 7.4% and total transient revenues on the books for the last six months higher by 13.5%.

To wrap up, we continue to expect 2013 to be another terrific year for the lodging industry and an even better year for Pebblebrook. Underlying fundamentals remain healthy. With the completion of all of our renovations we have got tremendous opportunity in the existing portfolio to recapture significant RevPAR loss in prior years and dramatically improve margins through the implementation of best practices and lots of focus on hard work by our operators and our team. And quarter after quarter, we expect to continue to be successful executing on both of these major opportunities.

So, that completes our prepared remarks. We would now be happy to answer whatever questions that you might have. Operator.

(Operator Instructions). Bill Crow, Raymond James.

Good morning. Jon, could you address this lull that we have seen over the last six, eight weeks and in particular maybe dive a little bit deeper into the group business and what you are seeing as the driver for some of the weakness that you may not necessarily be seeing, but we certainly are?

Sure. Well, I think the lull seems terribly familiar with the lull that we had experienced last year from July through maybe November. Whether it is based upon the political activities early in the year, the fiscal headwinds, it's -- in total, it is hard to say. But it just continues to reflect, I think, the bumpy recovery that we continue to experience in the economy, particularly as we have seen economic growth in the first half particularly here in the second quarter to be pretty weak.

I think it is being probably more impacted by group than it is by transient travel and I think the group, at least in our view, likely reflects three negative impacts this year. One of which is -- and I think we have spoken about it since late last year. We have a weaker overall convention calendar in the US in 2013 compared to 2012, particularly in a lot of the major markets. So I think that provides a certain difficulty from a comparison perspective.

The second negative impact is government. Government has instituted lots of new rules about how they have -- how they allow meetings, how meetings get approved and who has to approve them. And there's significant reductions in overall spending for meetings as a result of cutbacks in overall government spending across the board and as a result of sequestration.

So, we are seeing, we believe, likely a significant cut or reduction in government meetings in the DC market. We think anecdotally it is about 50% and probably a bit less than that on a national basis.

And the third negative impact on group is this lull in or slowdown in growth in both corporate profits in the first half of this year as well as the growth -- slowdown in the growth of corporate revenues. And so we think that's restraining some government -- some group spending on the part of corporations. And we continue to see restraint on the part of corporations as it relates to high spend incentive travel meetings and rah-rah culture meetings.

And as we've stated previously, we don't think that is really going to change until we see more competition for people in those key industries such as the financial industries.

And with all those headwinds I think you said second-half group bookings are up 5 plus percent in your portfolio, I think in your prepared remarks. What has that trend been doing? Have you seen more cancellations than additions or is that -- is there upside to that 5% number? Where do you think that goes?

My guess is it might go down some. We have seen probably slightly weaker shorter term bookings certainly in the second quarter we did than what we had seen previously, particularly beginning in May and June. So I think it might go down a little bit from the numbers that we are at, particularly on the occupancy side. And you can see by the strength in our transient numbers that that is clearly making up for the overall numbers. So we still feel pretty good about the second half of the year.

And I think perhaps others are -- others who have a broader reach in the industry can probably give you a little more guidance on the overall outlook. Because I think we have with such a small portfolio particularly small number of group-focused houses, I don't think we are particularly representative of the industry.

Fair enough. One final question for me. The 4.2% increase in operating expenses, you I think attributed 20 basis points to the rise in property taxes from California. Is that 4% number a good way to think about next year or are you starting to think about healthcare costs or other issues that might bump it up from there?

Yes. That is a good question. I think -- our view is, we think of core expense growth at around 3%. And that is probably higher, made up of a higher percentage in labor and benefits and a lower percentage in Other.

Now those expenses will go up or down based upon what happens with overall revenues, obviously, particularly growth in non-room revenues and of course growth in occupancies.

Now for us, outside of the renovated properties and probably Zetta in the portfolio, there's not a whole lot of occupancy growth that we are really driving towards in the rest of the portfolio. And you can see that with the 86% that we ran in the quarter for the overall portfolio. And I think we had 21 out of -- we are looking at 21 out of 26 properties in excess of 80% for the year.

So, I think most of the increase is going to come from rates and other revenues. But there's still lots of costs that come along with that. And so, we think flow is going to continue to be for those somewhere in the 60% to 70% for ADR and clearly for Food and Beverage and Other, the flow tends to be far less than that. Because food and beverage is often volume and not price increases.

Thanks for the color.

Ian Weissman, ISI Group.

Good morning. Just a quick question on deals. There has been a lot of concern in the marketplace, management teams have been getting questions about back-up in cap rates given what the tenure has done.

You guys are very active on the deal side. Maybe you could just talk a little bit about what you are seeing in cap rates and underwriting and whether or not investors are changing assumptions at this point.

Sure. I think what we are seeing in the market in general is the opposite of what perhaps the theory of higher interest rates would cause, or at least what you think it would cause. We have seen -- we are driven as much or more by the supply of capital in the industry than we are with interest rates. And, particularly, in a business and we are a business that has very strong fundamental growth inherent in it for at least the next few years. And so it is not a fixed income stream that folks are buying, which maybe interest rates would have a bigger impact on.

So we have actually seen an increase in the amount of competition for deals. We have seen greater aggressiveness in the gateway markets from both REITs and private equity. We are seeing even more aggressiveness in properties that have brand or management available as operators or brands hook up with private equity where there is more capital available, and where there is higher leverage available in the debt market even with what is a temporary shutdown or slowdown in the CMBS markets due to the Treasury volatility.

So we have seen cap rates in the gateway markets, particularly the West Coast markets, probably declined by upwards of 100 basis points in the last 90 days. And in many cases that is dropping cap rates below 6, well below 6. We have seen some deals go for sub 5 in some of those markets. And for us, it means that we are going to remain disciplined to achieve the returns that we feel comfortable with that adds value for the Firm and because we are ready have a particularly heavy representation on the West Coast, we don't feel any strategic need to add properties and EBITDA in markets that we might otherwise be underrepresented in.

So I think the overall markets -- and maybe in -- some of it is capital coming from other sectors, we have seen some interesting players in New York where I would describe them as core institutional investment funds or groups which don't historically invest in lodging, have come into lodging and made investments. And honestly that always scares me when we see more players come into the space because oftentimes they are late.

That's helpful. And finally, last question, you gave very good detail on specific markets comparing the East Coast and West Coast. I imagine the East Coast continues to suffer because in part supply issues, too. I imagine it's government-related. But if you think about without giving I guess guidance for next year, do you think that that trend can reverse itself next year? Or would you say that the West Coast will continue to outperform longer term because of maybe its supply is the bigger driver, but do you think that trend can continue next year?

I do. I think it will continue for next year. I think our view is that next year the economies will likely continue to be a little bit better on the West Coast than the East Coast. There's very little to no supply in the West Coast markets arriving next year or the year after. And I think we will continue to face supply issues in New York. And we have a supply issue in DC for next year with the new convention hotel opening in April or at least forecasted to open in April.

I think some of that will be offset by the fact that we have some better convention calendars on the East Coast in Boston, in particular in DC as well in Atlanta as well. So that will -- that headwind will be somewhat offset by a better group and convention market.

Just given that you mentioned before about the compression in cap rates in the lodging sector and given some of your concerns that you are addressing, could you see Pebblebrook selling assets over the next 12 months to reposition the portfolio?

Yes, I don't -- there's this -- we look at things in sort of a buy-hold-sell period and forecast out each year we go through an analysis and compare; and I guess I would describe it as a little like getting an offer you can't refuse to the extent it gets meaningfully out of whack compared to the growth rates and the opportunity, particularly for properties where we are fixing operations and physical attributes of the properties that will lead to much higher growth, which a buyer might not necessarily pay for.

I would say we are probably more likely in a hold period particularly for more of our perpetual markets. And we will look more closely next year at some of that non-perpetual market properties and we will be focused on both what values are and what cap rates are doing there and also what supply it looks like in the underlying economic environment in each of the individual markets. So we will take a case-by-case review of our assets and it is certainly possible that we might sell some -- particularly some of our non-perpetual assets next year.

Okay. Thanks so much.

Andrew Didora, Bank of America.

Good morning. Little bit of a follow-up to Ian's earlier question on the transaction market.

Jon, you are already -- in the past your comments seems like you have been a little bit, been factoring in a bit more risk in to some of your underwriting whether it is coming from increased supply in New York or maybe some weaker group compression. When you think about how your underwriting property is now, have you started to factor in any sort of recession in your five-year models yet and I guess have you changed your exit cap rate assumptions on your current underwriting much, given the future rate expectations?

So, two things. One is, we haven't changed the way we underwrite in general. We analyze the macro environment, the micro market and then the individual property, and base our underwriting based upon all of those factors.

Two, we have wanted to underwrite conservatively with cushion. And because we screw up from time to time, and things don't exactly turn out the way we think they are going to turn out, in any of those three pieces, the macro, the micro or the individual property, sometimes they take longer to achieve our objectives as well.

So, we haven't changed our desire to have a cushion. We have not built in a recession yet and as soon as we do, you can expect that that will price us out of the market immediately.

And then, as it relates to cap rates, we've been utilizing cap rates anywhere from 7% to 7.5% on the backend. And so I think just as we don't use marginal cost of capital to underwrite, we use long-term cost of capital. We also use what we believe would be more middle or late cycle cap rates, although I would tell you that at least in the last two cycles that I have experienced, we never did see cap rates rise later in the cycle as in theory they should as both growth rates decline and you are much closer to any cyclical downturn.

And two, interest rates typically go up. So, from our viewpoint we feel comfortable that what we were underwriting is still appropriate for what we are underwriting today. And that will lead to whether or not we win deals and can achieve the spread on our cost, our long-term cost of capital that will add value for the shareholders.

That's helpful. I guess it's why I asked the question. Because your deal activity has taken a bit of a pause lately, so I didn't know if you were underwriting any -- changed your underwriting assumptions at all relative to the next buyer out there.

But just in terms of the reason for the pause in your deal activity, is it because of the more competition that you were referring to earlier or are you just not seeing the types of assets in the markets that you are targeting like you have seen in the past?

No. I think the volume of opportunities in the market is similar to what it was in the second half of last year. So there is a reasonable number of properties we have an interest in, in the gateway markets. I would say our success rate has declined on particularly competitive transactions due to the competition and the way others are underwriting and, look, we don't -- the interesting thing about our space is what our view of the future is in a market or for an asset may be very different than somebody else.

And so, we may be wrong. They may very well be more accurate and it may turn out that we were too conservative. And maybe we should have been willing to pay more on transactions. Only time will tell.

The one thing we can look at with the way we underwrite compared to what is going on in the market is we can look at how are things occurring with the assets we have already bought compared to what we have underwritten. And while we have been exceeding what we have underwritten, it is not by a monstrous margin. And so as a result of that, we feel good that we are being appropriately conservative.

Our sense, at least by our underwriting and again similar approach, we think we have seen unlevered IRRs drop into the low 9's for Gateway properties. And given the environment and where we are in the cycle, and the fact that cost of capital is likely -- at least marginal cost of capital is likely to have risen for other folks -- we think that's pretty aggressive and generally unattractive from our viewpoint.

Thank you. That's helpful. One final one for me and changing gears a little bit.

On the Delfina asset, maybe give us a little bit of a background on how you came about to choose the Le Meridien brand over any other brand or even an independent brand? Did Starwood offer anything to you here in order to stay within their brand family?

Sure. So when we bought that asset, if you recall what we said was the franchise agreement was going to be up in the fall of 2013. So, later this fall. And we would analyze a multitude of scenarios from keeping it at Sheraton to rebranding it to making it independent. And what we told you is exactly the same conversation we had with Starwood.

And so as really over the last 12 months as we finish the renovation there, as we've been able to see how the property performs in the market, where it is successful, where there's opportunity, we really came down to two scenarios that we looked at that we analyzed in great detail and compared. And one of those was making it independent, which -- or small brand -- which obviously, we feel comfortable with.

And two, upbranding it with Starwood. I think we came to the conclusion that that property in that market as a Sheraton is just leaving too much on the table from an opportunity perspective and upside perspective.

And so, we ended up comparing Meridien, which we ultimately selected to independent. And I would tell you it was a very, very difficult decision. The numbers are very, very close. There are benefits of both, there are risks of both and where we ended up was with Meridian and we did not analyze other brands.

And in fact that was a discussion we had with Starwood that based upon the relationship we had, we really didn't want to pit them against other brands. We just feel like our relationship with our existing brands and operators in our existing situations is too important to us. And so, they were either going to win it as Meridian or they were going to lose it as an independent. And so we ended up with Meridien.

In terms of the arrangement that we negotiated, we had alternatives. So you can come to your own conclusions about what that means. But we feel very good about the overall transaction and the opportunity to really take advantage of what we think is a lot of upside in a very strong market where our rate is $80 to $100 lower than in properties a couple of blocks away. Obviously closer to the beach, which making it a Meridien doesn't get us any closer to the beach.

But I think it does provide in the market a view of an upper upscale brand versus the view of an upscale brand which Sheraton represents.

Okay. That's great. All for me. Thank you.

Jeff Donnelly, Wells Fargo Securities.

Good morning, guys.

Actually, Jon, if I could just stick on this Sheraton Delfina, I am just curious. Do you expect much disruption from back conversion? And I know oftentimes when we see an upbranding you see an increase in rate. What is that going to do to the expense load in margin by going more upscale with that hotel?

I think, our -- we are going to spend some dollars obviously to make a conversion. The good news is, it is not that much considering we just spent $9 million renovating the property with the idea that it would continue to be an upper upscale quality property with high design and high style, probably a bit inconsistent to some extent with what Sheraton represents as a brand.

And that is part of probably what was limiting some of our upside as a Sheraton. So, the cost will be slightly higher. Although, again, we have been running it as really a four diamond quality upper upscale hotel.

There really isn't a material change in cost base. And in fact in some cases, there are fewer services. We don't need to have a separate clubroom for Starwood guests and the costs that go along with that which were an obligation of the Sheraton brand, but not of the Meridien brand.

From a disruption perspective, Jeff, it should be fairly small as a result of any physical changes. What we are doing is primarily signage, artwork, a few changes from an FF&E perspective. And then probably the most significant work would relate to making improvements to the bar off of the lobby which is a separate space. And so I think the disruption would relate more to just the change of flag.

And the good news is it is in the Starwood system. We do do a lot of Starwood loyal guest business at the hotel. We do a lot of corporate, a lot of corporate accounts at the hotel in that Santa Monica market. And so we think that business is likely to stay.

We may lose some Sheraton core customers. But hopefully over time, we will replace that with much higher paying Meridien or upper upscale customers.

I think the other bigger benefit is we have this wonderful set of meeting space including a ballroom on the top of the hotel with terrific views of Santa Monica and the Pacific Ocean. And I think, unfortunately in the high-end Santa Monica and West End markets, Sheraton just isn't the brand of choice for weddings and bar mitzvahs and bat mitzvahs.

And so we think the change to Meridien along with the improvements we already made in terms of upgrading the quality of that space should help drive significantly more food and beverage into the hotel.

And you mentioned how the rate stacks up against some of the beachfront hotels. If my memory serves me correct, I think that was one of the only Starwood products pretty much west of the 5 over in Santa Monica. I think like the W Hollywood, I think, is one of the closest hotels. Do you think it is relevant in terms of how you price off with them? How do you think about where you can ultimately end up?

Yes, I think one of the considerations in staying in the Starwood system versus certainly versus any other system and/or make it independent is exactly what you describe is that they have little to no representation in that market. And obviously they were -- it was very important to them to maintain distribution in that marketplace.

So, it was certainly a big factor in the consideration and certainly some of the bigger pluses, particularly when you think about a brand like Meridien which doesn't yet have the recognition in the US perhaps that it certainly has abroad.

And maybe switching gears to build on the prior line of questioning. I think going back a few years maybe the summer of 2006 you had called for a peak in the lodging cycle that ultimately proved timely.

If you had to look into your crystal ball for this cycle, can you predict when you think you will make that same call again? When you are going to start underwriting recessions into your underwrite -- putting it into the underwriting performance?

It is much harder in this cycle so far. And our sense is this is going to be -- this will continue to be a slower recovery and the economy is likely to because of that probably see a longer recovery. And so the macro to us seems like it is more likely to be more similar to the two prior cycles before the prior -- the two we just experienced. So more likely the 80s and the 90s where we saw more like a nine-year economic cycle versus 2000 and into the 2010s where we saw more like the six-year economic cycles.

But that is the macro and obviously the one thing we learned with 9/11 or the financial crisis is there are events that could shorten that. And those are pretty impossible to predict.

The micro side, we have certainly bounced off the bottom of supply growth as an industry and it, obviously, varies by market. But in general we are seeing a slow growth in supply coming back into the market. We think it too will be stretched out for some period of time particularly since it really is not supported in a lot of markets yet by the underlying economics.

But we think we are likely to get to a point of neutrality between demand and supply by 2015. It is somewhere around 2%, supply growth, 2%, demand growth. If the economy is better, 2015 will end up being a continuing year of occupancy growth. But we certainly think 2014 is going to be strong. 2015 should be very healthy and 2016 and beyond really depend upon how the macro plays out and how the capital markets for new construction play out.

How do you think that leaves you to write your balance sheet from this point and run your acquisitions? Do you basically you step back from doing the acquisition redevelopment story so that you can allow some of the assets to season and allow your debt to EBITDA to naturally or organically be [left or] to that point?

Yes I think you are seeing that, Jeff, in that our acquisition volume has continued to come down from the early years of Pebblebrook and the earlier years in the cycle. We do tend to get more conservative with our growth outlook and when others don't, we tend to lose deals. And we are good with that. We would rather the general buyers in the early part of the cycle, in the first half of the cycle than the second half of the cycle.

And so, you are seeing the result effectively occur as a result of our view on risk and growth and where we are in the cycle. And I think from a balance sheet perspective, we will continue to run the business very conservatively from a debt level and we will add the extra juice for the large amount of growth we have already in the portfolio through 2015 with the perpetual preferreds that we have layered over top.

So, we have -- we are playing our approach to this strategically as -- look, we are buying properties that have a lot of growth. We are not paying for that growth. Assuming we can execute and fix and improve these properties and improve their performance, we are going to drive very significant growth in topline and bottomline. And that will lead to very significant growth in valuations due to the bottomline improvement. And we want to lever that more than the risk involved in debt through the addition of perpetual preferreds.

So when you look at us on the debt to EBITDA basis, we are at the low end of our peer group. When you look at us as debt and preferred, we are in the middle of the peer group, maybe at the upper end of the -- certainly the more conservative REITs. Because we have so much value creation in the opportunity, we want that to go to the existing shareholders. And we can do that through the extra leverage from the perpetuals.

One last question. You talked about group earlier in your comments and I think the folks at Starwood yesterday were saying that group -- or corporate demand seemed to be shifting towards smaller meetings away from the big corporate gatherings.

Is there an investment case to be made for small group hotels similar to those run by, say like, a Dolce? With your attitude towards acquiring hotels maybe you like those. Like the [Scaminis], or the deal you once did in a prior life at Santa Cruz.

I guess I would generally say that we view there to be more risk and properties that have more group. In the long term. And while I don't know that the trend that you just mentioned is a secular trend, it -- our view is consistent with our view that a lot of this group won't come back until later in the cycle and when there is a lot more competition for people, and companies need to put on those larger cultural meetings and the higher-paying incentive group travel.

Our view is more risk with the big hotels. They are more complicated. They have more food and beverage components particularly in the urban market.

While the food and beverage is interesting from a revenue perspective, based upon a lot of the union arrangements in those major markets, you really don't make any money. In fact, you can lose money. You can lose significant money on food and beverage even banquet business in the major markets.

And so, we feel like we are in the sweet spot.

There is a price will pay for those assets, but we haven't been successful. And the other view, at least on the big properties, is we have such great diversification within the portfolio we don't have any single asset that is going to dramatically swing or put at risk the performance of the portfolio.

And so, we've tended to for risk reasons shy away from some of the larger assets that have been on the market.

In terms of small, small properties with group, that is sort of where we are in our portfolio.

Thank you.

David Loeb, Baird.

Good morning. I wanted to ask a little bit about pricing power and confidence in ratesetting. What do you think changes that, particularly in the East Coast over the next year?

I think more economic activity and less fiscal noise.

So, do you think the government issue was a big part of that or do you think —?

Yes. I do. I think the noise out of DC, the continuing uncertainty while less, compared to what it was, there was a period in the first quarter running well into the second quarter where there was perhaps a lot of hope and excitement about tax reform as an example. And it seems pretty clear to us based upon the increasing partisanship that has gone on that the likelihood of anything happening in tax reform has probably declined dramatically in the last 90 days.

Just look at the inability to get something so helpful and so pragmatic done in terms of immigration. That is a nonpartisan issue in general. It is just amazing.

So our sense is that you have got this fiscal drag for this year and, certainly, you have some drag from the sequestration impact on the overall budget that will run through the first four months of next year. It seems to us that as that drag declines, economic activity is likely to pick up and that should lead to more corporate investments, more growth, and more certainty on the part of the corporate America.

And how do you see group broadly impacting pricing power?

It is interesting, David, because we really have -- we have properties, quite a few properties in the portfolio where because our transient rates are so much higher, because the markets are running at such high occupancy, that unless groups are willing to pay the rates that we are looking for that we can get from alternative demand, we are just not taking it.

And so, I think it really varies by market. Clearly to the extent we see growth in demand from group, I think that will have a material impact overall on pricing. And it will build a base for those who don't have it that right now are out there competing in the transient markets.

That's pretty helpful. One more. Miami. You said the CBD was up 4.3 in the quarter. That seems a little lighter than what it has been doing. Anything specific you see going on there?

There isn't anything specific. You have this bumpiness and economic growth in Latin America and particularly in Brazil where I think their forecast for economic growth have moderated. And I think all of that more modest economic growth in Latin America impacts travel, into Miami in particular.

So while there's still healthy growth, it has just moderated a little bit. And as we get into the second quarter and then into the third here, where we run generally lower occupancies than we do in the first quarter, you just don't have the same level of pricing power in that market that you had in the first quarter as an example.

Great. Thanks.

Wes Golladay, RBC Capital Markets.

Good morning. Looking at the acquisition market, we did notice that you guys had a $3 million deposit. And we are wondering what you are looking at. Would it be more of a core acquisition that you are seeing or a value add or maybe a full term such as a Zetta?

We are looking at a hotel.

Okay. I guess for modeling purposes, any ideas there?

We have always said just because of the relationship with sellers and the lack of 100% certainty on potential acquisitions, that in general, our view is we will let you know what it is when we buy it. And we will give you all the detail about it when we do buy it. But you should presume it continues to be in the markets that we've targeted, in the markets we have been buying. And we continue to look for properties that have upside.

That's helpful. Now you mentioned that you are turning away group in some markets. Has that expanded beyond San Francisco?

Yes. I would say and again it will depend on seasonality. So, in markets like Seattle or Portland where the transient rates in season can be significantly higher than group that we will be -- we are making decisions to trade-off group for transient and those markets in season. We have been doing it in L.A. particularly at the W in Westwood where we've cranked up our overall occupancies because of the strength of the market into the mid to upper 80s.

And, again, the groups are unwilling to pay what we can get from transient customers. So our group is off meaningfully at that property. Not that it is a huge piece to begin with, but it is probably off at least a third potentially a half this year and it is all conscious on our part.

It is just about taking business and revenue managing in a way that is going to give us the best performance.

And looking at -- you had hedged strong EBITDA growth across the portfolio. Are you starting to get near where you have to pay incentive fees for your hotels?

Not really. We have gotten into incentive fees at two properties. Actually one was just incentives from the day we bought it with an existing management arrangement. And we have only had one of the properties that we have acquired that have moved into an incentive fee-based incentives. It is because it is way, way far ahead of underwriting.

And Neil (inaudible) has one quick question for you guys.

Your Denihan investments have been pretty significant and as such has a big impact on EBITDA. Just a question, how do you look at booking or getting people to come to those hotels? I know it is New York and it is easy to get occupancy, but how do you get people to come or increase brand awareness to boost or get the RevPAR index to its highest level?

Yes. It really comes down to hiring the right people who understand how to get business. We have this funny thing in the business; we call these people salespeople. And for many of our branded properties they tend to be order takers as opposed to salespeople. So for our small brands, our independent properties, it is really about PR. It is really about direct-sales. It is about the Internet and getting exposure on the Internet which has really leveled the playing field versus the big brands.

The research that a customer can do today, the information they can get, not just from our websites but from Trip Advisor or from Yelp or from Expedia or any of the sites that people look for third-party reviews, customer reviews, customer photos, all of that tends to eliminate uncertainty on the part of the traveling customer and a willingness to maybe take a risk that is no longer a risk and go to a property that they are not familiar with, if it is not branded.

So what we find over time is particularly in the urban markets, people are already coming to those markets. You don't need the brand to attract people into the market. We just need to get the business that is coming to the market. And we feel we have been doing this now for 20 years on the independent side and the small brand side.

And what we find is that we can be as competitive or more competitive and we can do it at lower cost and that means we make more money per key which means we have more value per key. And we have full flexibility to spend our sales and marketing and PR dollars as we wish. We are not stuck in corporate programs. We are not stuck in things that won't help us. We don't have to do things physically that we don't think is in the best interest of our property or our customers which would otherwise need to fit and be consistent across the brand.

So we feel very comfortable with both. And I think the decision we made in Santa Monica is a good example where we could have gone either way. It was pretty much a wash. We think a little better opportunity with Meridien in the market than independent, but we were very comfortable going as an independent property.

And the other -- whether it is a branded property or a nonbranded property it is ultimately really critical that you have the right management team in place at the property. And that is what we have always focused on, and particularly with the Manhattan Collection. Half of the general managers within the six hotels are new general managers that have done a -- we have brought in some good teams and made some improvements there. So we are going through lots of changes and we are very encouraged with the direction.

But this is across all of our hotels. That is one of the things we always spend a lot of time focused on the management team at the property level.

Okay, thanks.

Lukas Hartwich, Green Street Advisors.

Jon, Pebblebrook has been around for about four years now and I am curious how things have played out versus your expectations. Is there anything that surprised you along the way?

Yes. A couple of things. One is I think we were able to accumulate a larger number of assets of higher quality in overall better locations in major gateway markets than what we thought and what we told people when we went on our roadshow for the IPO back in December of 2009. So clearly, we are much more excited about the quality of the portfolio.

Second, I think we were able to find properties with even more opportunity than what we thought, both off market and on market and with more upside that we could execute on. And so that the kind of value creation opportunity is greater than what we thought it would be.

And then, finally, not -- something that has played out differently is while we underwrite on an unlevered basis, and we had a certain view of the debt and preferred capital markets when we went public, those markets have turned out to be much more attractive than what we thought when we went public. And therefore, we have been achieving the unlabored returns that we talked about on the roadshow or better, but our levered returns are better than that. And better than what we thought they would be.

So we are really excited about the way it has played out and we think there's just great opportunity within the portfolio for several more years.

Great. Thank you.

There are no further questions. I would like to turn the conference back over to our speakers for any additional or closing remarks.

Thanks, operator, and thank you all for participating. And as our song says we are here for you if you have questions and so please feel free to give us a call if you have further information you are looking for. Otherwise we look forward to talking with you and reporting next quarter.

That concludes today's presentation. Thank you for your participation.