Sunstone Hotel Investors Inc (SHO) 2009 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Sunstone Hotel Investors Inc. third quarter earnings call. At this time, all participants are in a listen-only mode. Following today's prepared remarks, instructions will be given for the question-and-answer session. (Operator Instructions). As a reminder, this conference is being recorded today, Wednesday, November 4. I would now like to turn the conference over to Mr. Bryan Giglia, Vice President of Corporate Finance of Sunstone Hotel Investors. Please go ahead sir.

Thank you, Brittany. Good afternoon everyone and thank you for joining us today. By now, you should have all received a copy of our earnings release. which was released this afternoon. If you do not yet have a copy, you can access on the Investor Relations section of our website at www.sunstonehotels.com. Before we begin this conference, I'd like to remind everyone that this call contains forward-looking statements that are subject to risks and uncertainties, including those described in our prospectuses, 10Qs, 10Ks, and other filings with the SEC which could cause actual results to differ materially from those projected. We caution you to consider those factors in evaluating our forward-looking statements. We also note that this call may contain non-GAAP financial information, including EBITDA, adjusted EBITDA, FFO, adjusted FFO and hotel EBITDA margins. We are providing that information as a supplement to information prepared in accordance with Generally Accepted Accounting Principles. With us today are Art Buser, President and Chief Executive Officer, and Ken Cruse, Chief Financial Officer. Mark Hoffman, Senior Vice President and Head of Asset Management, will also be available to answer questions during the Q-and-A portion of this call. To begin our discussion today, I'd like to turn the call over to Art. Art, please go ahead.

Thanks, Bryan. Good afternoon everybody, and thank you for joining us today. It's only been a few weeks since our last call, but at Sunstone it seems like we have news to report every couple of weeks, good news that is. During today's call I'm going to address three topics. First our third quarter results, then an update on demand trends, including preliminary October RevPAR, and finally an update on our acquisitions program. Ken is going to update you on our recent equity offering and our secured finance initiative. And then finally, I'm going to wrap up with observations on the emerging cyclical opportunities. Starting off with our current operations update, consistent with our pre-announcement for the third quarter, our total portfolio RevPAR was down [20.2%] to prior year. Occupancy was down 4.9 points. and rate made up the majority of the variance, down 14.9%. We realized a 570 basis point margin decline in Q3, which translates into a 48% save-through, meaning we met every dollar of revenue decline with $0.48 of expense savings during the quarter. As we discussed on our prior business updates, with RevPAR declines being driven predominantly by rate, we expected our margins to be pressured during the quarter. That our Q3 margin decline was better than anticipated and better than our Q2 margin decline is a credit to the efforts of our asset management team and our operators. So Mark, thanks again to you and your team for that.

Adjusted EBITDA was $40.1 million and adjusted FFO per share was $0.14, both of which are generally in line with [street] consensus. In terms of regional performance, for the third quarter our California properties were down 20.9% in RevPAR. LA-Orange County hotels were down 22.5%, while our San Diego down 18.4%. That's a huge improvement from the down 30% earlier this year. Our Southern region experienced a 19.8% RevPAR decline, which is a reflection of continued softness in both Orlando and Atlanta. RevPAR in our Other West region was down 22.5%. Our Midwest region was down just 16.9% to last year, driven in large part by the continued strength of our Rochester portfolio which was down just 7.5%. The Rochester market continues to out-perform, primarily due to our strong relationship with the Mayo Clinic. Finally, our Middle Atlantic region was down 20.2% for the third quarter. We continued to see relatively strong demand in Washington, DC, where RevPAR was down 7.6%. Baltimore was down about 19.1%, which is a slight improvement to the prior quarter. Our Boston properties were down just 16%. On the other end of the spectrum, New York City continued to show a high [data] where RevPAR was down 30.1%.

On our previous update call, we pointed out an increase in sellout nights in New York City and Boston. For example, we had 15 days at the Hilton Times Square in October where occupancy was between 98% and 100%. And that's compared to nine days in 2008. Rate was still lower for the same time period but we did have one day at a higher rate in 2008 and three days with higher RevPAR. Portfolio-wide, Q3 marked the first time this year where nine of our hotels had increases in occupancy over the prior year. We continue to see an increase in positive data points into the fourth quarter. Through October, 19 of our hotels had increases in occupancy from 2008. Although we continue to see deterioration in rate, positive occupancy growth is a critical step towards restoring pricing power. Total portfolio RevPAR for October was down 15%, of which approximately 13% was driven by rate.

Now looking ahead, while group pace for the remainder of 2009 remains down roughly 20%, consisting of approximately a 15% decline in occupancy and 5% in rate, we are continuing to see quality booking trends at our properties. 2010 pace is down approximately 24%, consisting of approximately a 21% decline in occupancy and 3% in rate. While we believe that the booking quality is superior to the bookings made last year at this time, we are still down a sizable percentage and expect rate to become a larger contributor to the decline as we book additional groups. [Last call] (tape skips here) we commented on the street's estimates and that in our opinion, they were overly [optimistic].Our estimates reflect a fourth quarter RevPAR decline between 9% and 16%, averaging about a 11%, 12% decline. Now our portfolio was down 15% in October, which would require a meaningful RevPAR improvement in November and December to hit the midpoint of that -- of the street's estimates. We believe now more than ever that the continuation of increasingly positive signs in terms of improving business and consumer sentiment point to an impending economic recovery, setting the stage for a prolonged period of positive fundamentals in the lodging industry.

So let me finish up by talking about the acquisitions environment. We continue to see a meaningful increase in both marketed deals as well as off-market conversations we're having with a variety of parties. In the last two weeks, we've delivered four expressions of interest for hotel acquisitions. As we evaluate and negotiate potential deals, we continue to be methodical and disciplined in our underwriting and return criteria, and we are unwilling to compromise either for the mere sake of deploying cash on our balance sheet. We're actively analyzing a variety of deals focused on the following criteria -- valuation, value-add, synergies, outperforming markets, and potential pipelines.

Let me explain that a little bit. In terms of valuation, acquisitions -- in terms of valuation, we're looking at acquisitions that are going to trade at a discount relative to the Company's enterprise value per [key] or EBITDA multiple. In terms of value-add acquisitions, as the cost of construction, renovations, labor, and materials have declined from the peak as some say as much as 35%, acquisitions where selective renovations and repositioning work really add value. In synergies, we look for -- such as economies of scale, ownership efficiencies, improved pricing power, staff sharing, might be realized by owning multiple hotels within the same market. In terms of outperforming markets, acquisitions in the strong markets within MSAs that are expected to outperform the US average in most cases, or even those that are going to out-perform the top 20 markets. And finally pipeline, we're looking for relationships with current owners of hotel real estate who may look to divest of such real estate in the future in the larger scale.

So in summary, we're looking at acquisitions that are additive, simply where one plus one is more than two. We're assuming that the market will not experience immediate and significant increases in RevPAR, but that our strategy for and asset management of the property will create value. I'm spending about a third of my time now on acquisitions. We have built a track record executing on our cycle of appropriate strategy and creating shareholder value and intend to build upon that as we enter into an acquisition environment. With tha,t let me turn the call over to Ken to discuss our recent finance initiatives. Ken, please go ahead.

Thanks a lot, Art. Good afternoon everyone, and thank you for joining us today. Today I'll briefly discuss our finance initiatives. Over the past year, we've capitalized on market conditions and executed on a well-timed finance plan designed to improve our credit profile, enhance our corporate liquidity, and increase our financial flexibility. Consistent with this plan, following our last business update call a few weeks ago, we raised additional capital from through an overnight common equity offering. The offering was very well subscribed both by existing stockholders and by new investors. This positive response enabled us to increase the size of the offering from an initially planned $100 million up to a full $158.6 million. This offering represents an important milestone for the Company, marking a shift in our business strategy from defense to cautious offense. We now have the offensive capacity to take advantage of market opportunities to selectively acquire hotel properties at discount valuations.

We're also focused on mitigating risk. To this end, another facet of our finance plan entails the selective restructuring of certain of our non-recourse mortgage loans, where we believe the intrinsic value of the collateral no longer exceeds the principle amount of the associated mortgage, and where hotel cash flows no longer support debt service under the existing debt terms. As we've said before, these conditions have not been met nor do we expect they will be met for the majority of our portfolio. To date, five of our loans have met the criteria for renegotiation. In these cases, where the lender is unwilling to amend the loan terms, a deed-back of the collateral and satisfaction of the debt may be warranted. Let me run down the five loans in our restructuring program. First, as previously discussed, the lenders representative for the W San Diego was unwilling to amend the loan, and consequently, we agreed to transfer the asset to a receiver, which led to our de-consolidation of the hotel from our financials in the third quarter.

Second, with respect to the Marriott Ontario, the lender's representative has been similarly unwilling to amend the loan and we expect to complete the appointment of a receiver at some point in the fourth quarter, at which time we will treat Ontario similarly to the W San Diego for accounting purposes. Third, we're finishing up an amendment of the $105 million mortgage on our Baltimore Renaissance. The mortgage is being converted to an interest-only loan for a period of up to 30 months which will eliminate cash outflows associated with the loan of approximately $6 million over the two-and-a-half-year amendment period. Fourth, we're working on the renegotiation of the $29 million loan secured by our Westchester Renaissance. We're still in the early phases of this negotiation and we'll keep you apprised of our progress.

Fifth and finally, we continue to work with Mass Mutual, the administrative agent for the $246 million mortgage loan which matures in 2011 and which is secured by 11 hotels. We're working to restructure this loan in a way that would either reduce the principal balance or eliminate the amortization and extend out the maturity. At this point, Mass Mutual is analyzing the collateral portfolio, and we expect them to come back to us with a response to our proposals in the upcoming weeks. As Mass Mutual had not responded to our proposals in advance of our November 1 debt service payment date, we elected not to subsidize this payment, which we expect will result in a default under the loan while negotiations are pending. Moreover, if we are unsuccessful in negotiating acceptable restructuring terms, we may elect to deed back the 11 hotels securing this loan in satisfaction of the debt.

We've included certain operating statistics with this portfolio in today's release to assist you in modeling the effect of a potential deed-back. Some of the key points you should note, the deed-back of this portfolio would eliminate a significant 2011 debt maturity, in which we have approximately $100 million of cash we have earmarked to pre-fund the expected re-financing shortfall on this loan. Second, as a result of the transformation of the Company's core portfolio over the last several years, most of the assets comprising the Mass Mutual portfolio lack strategic fit [with ] the Company's assets. Specifically, six of the collateral hotels are limited service and quality, the average collateral hotel is approximately 30% smaller than the average hotel comprising the balance of the Company's portfolio. [The average] RevPAR of the Mass Mutual pool is approximately 15% below that, of the balance of the Company's portfolio. And the collateral pool generally consists of older assets located in some of the more challenged markets in the US, both in terms of new supply and declining demand, including San Diego, Atlanta, and Long Island.

Given the average age of the collateral and the introduction of new market supply, we project this portfolio will need meaningful capital investments over the next five years to remain competitive. Finally, the current debt per [key] associated with this portfolio, is just under $100, 000, which we believe represents an attractive valuation for this portfolio in today's market, considering the items I just mentioned. As a final point on our secured debt restructuring program, I'd like to reiterate that our non-recourse secured debt provides a contractual backstop to corporate risk. Where value and cash flow deficits exist, restructuring the debt is not an option. It's an obligation. Importantly, we don't see our secured debt restructuring program as having a negative impact on our business plan going forward. The commercial mortgage market is undergoing sweeping and fundamental changes. These changes will impact underwriting and lending standards for all commercial mortgage borrowers going forward. And consequently, we expect the commercial mortgage markets will generally be unattractive as a source of capital for the next several years. As capital markets are efficient, when one form of capital becomes unattractive it is typically replaced by another form of capital. Today, the high yield and convertible debt markets both represent very attractive alternatives to the property level mortgage market. To the extent that we would look to source new debt capital in the future, we would like to return to these markets first.

To finish up my comments, we're focused on continuing to strengthen our balance sheet, improve our liquidity and deliver superior returns to our stockholders. Over the past year, we've executed on our well-conceived and well-timed plan, and we look forward to continuing to build on this track record going forward. As the broader economy improves, so will demand for lodging. And we believe we have positioned Sunstone well to capitalize on the positive trends and market opportunities ahead. Thank you. I'll now turn the call back over to Art to wrap up.

Great. Thanks, Ken. We are looking forward to the next phase of the cycle. As I mentioned, we're now seeing early signs of firming demand even as private asset values remain low, primarily as a consequence of the ongoing dysfunction of property level mortgage markets, as Ken alluded to. As a result we believe we're moving into a phase of the cycle where well-capitalized, proactive public companies may have opportunities to create significant value through acquisitions. We believe the backgrounds and skill sets of the Sunstone team make us well-qualified to capitalize on these emerging opportunities. Let me reiterate that we continue to run our business with a single focus. We exist to outperform. It has been our strategy to create long-term value by capitalizing on cyclical appropriate and market inefficiencies. As a result, we've made decisions which may have at the time appeared contrarian, but which have proven to be correct.

Before we turn the call over to Q-and-A. I'd like to share with you a general comment from our 60-plus investor meetings we've had over the past few months. What I'm about to say is exactly what I said on the last call, but it is really worth restating. The investment community in increasing numbers tells us that while they appreciate our tactics and strategy, they wonder if others, particularly those new or returning to the space, might not fully understand them. So with that comment taken to heart and seeing the number of new investors dialed in again today, I believe it's important to restate today and again in the future, how we would like you to think about our Company. Number one, we are leveraged to outperform. Outperform in the impending recovery. [Now that's been ahead of fixed cost] and has rightly been viewed as a negative for the majority of this year as we experience bottoming in the cycle and look towards recovery, our 5.6% weighted average debt with an average term of over six years. And no one is going to get those terms any time soon.

Our structure should provide outsize performance in the recovery even if we do not grow our portfolio. We are comfortable with our current level of debt and expect to see the Company naturally deleverage through acquisitions, secured debt negotiations, the future refinancings of existing debt at lower [LTDs]. Number two, our track record has really been exemplary. Our tactics have been well-timed and nimble. And while at times controversial, have been consistently aimed. at creating shareholder value, whether it was reducing our corporate staff from 40%, instituting significant property level efficiencies, deeding back hotels, buying back our convertible bonds this year for under $0.47 on the dollar, we are adding value. That said, going forward, we intend to do just as we have done. Rather than making promises we intend to demonstrate through results, our Company is worthy of your interest. And with that, I'd like to open the call up to questions. Operator -- Brittany, please go ahead.

Thank you, sir. (Operator Instructions). Our first question comes from the line of David Loeb with Robert W. Baird & Company. Please go ahead.

Hi, Art. Good afternoon. I have some interest in a couple of things if you don't mind going a little bit deeper. The Mass Mutual portfolio, you said in the press release that you-- the present value of the hotels' securing loan is currently less than the outstanding principal amount. I wonder if you could expand a little on that. How important is the CapEx requirement relative to the value? Looking at the numbers, it looks like on NOI, it's providing about an 8.4% yield, which does not look terrible in this environment.

Yes, David. That's right. And it's good that you pick up on it. There's really two points there. One, the CapEx for those hotels could be $60,000 to $70,000 a key over the next five years. So that number is significant. And secondly, the trailing number EBITDA and the forward-looking number are probably fairly different as well. Because you're right, on a trailing basis, it is a decent yield.

And going back to the acquisition opportunities, how would you gauge the probability of closing one or more acquisitions in the next two quarters, four quarters? And how will you -- do you plan on any external financing on those or will those likely be all cash?

Likely to be all cash. As I said, we're comfortable with our amount of debt, but we expect really to naturally de-lever over time. Can I go back to your first question? Because I think I told you CapEx is $60,000 to $70,000 a key and I think that number is more like [$25,000] a key. Sorry about that.

Okay. So probability of closings in the next two quarters or four quarters?

It always -- acquisitions always involve the other party being as engaged and focused as you are. It is interesting to observe that when you advertise you have$400 million in the bank, that prices go up. So difficult to say. As we noted, we're continuing to send out letters of intent or verbal expressions. And so it could be soon or it may not be at all, again depending on what the other party does as we negotiate with them.

I guess where I'm going with this is, you're comfortable with your leverage. You raised a big slug of equity. How comfortable are you that you'll be able to invest that equity?

Very comfortable. That's the reason that we went forward with it. Reason for the equity raise was were seeing an increasing number of deals we thought would be additive. And the one thing we knew for sure is, he who shows up with cash has a higher probability of getting that deal than not. In particular on the off-market deals, where we approach somebody and attempt to induce them to sell. If that inducement includes a-wait-until-I-go-to-the-market-and-get-money-and-I'll-be-back or here's-the-cash-and-you-get-the-deal-done. The latter is much more persuasive.

Can you give us a little color on the kinds of sellers? Are these distressed sellers? Are they brand companies with assets that they want to lighten up on? What's the mix of who you'e talking to?

Just about everybody -- onshore, offshore. And it's really less distressed. We don't believe people waiting around with catcher's mitts may get all the deals t hey think. Maybe that happens next year, and if it does, it's a great thing for the market. But as opposed to focusing on distressed sellers who like us, are looking to a trough and impending recovery and are really not focused on selling at a discount, we're really selecting assets we think we can create value after the current owner cannot. So it's more outreaching to hotels we think we can create value than those that are distressed.

Great. One final topic. Your Chairman has been a bit of a seller of your shares. And you comment about that and about where you see his head relative to your Board?

Sure. Meaning that the last part of the question, where his head is relative to the Board?

Yes. In other words, is Bob planning on -- does Bob have a long-term commitment to Sunstone, or should we read his share sale as his moving away from active involvement?

His share sale is fairly consistent with what he did when Steve had the job prior to me, when he was a seller of shares. I would say it's the exact same thing that was contemplated at that time.

Do you want to expand on that a little bit?

I don't want to speak for Bob because I'm not Bob. But when he hired -- .

That is apparent.

For those on the phone that can't the difference. When he hired Steve and hired me, the idea was that Bob was going to was going to be a net seller of shares as he was no longer the CEO and moved on -- onto the Board. As to what his future plans are, I can't speak to it.

Okay. That's great. Thank you for your candor.

Thanks again.

Thank you and our next question is from the line of Josh Attie with Citigroup. Please go ahead.

Hi, guys, Thanks. I just wanted to clarify something on your acquisition criteria. You want to buy things that are at a discount to your trading multiple, but you also want to buy things that have renovation opportunities, which suggest that the properties may be underperforming and need capital to be turned around. When you say you want to buy things at a valuation discount, do you mean on current earnings with immediate accretion? Or after a period of renovation and disruption? Or are there two separate opportunities? Is there a bucket of things that you would buy that's upfront accretion and then another bucket that maybe is dilutive immediately if it needs a period of renovation in front of it?

The latter. Clearly, to get something that is accretive on a multiple basis [in a deep turn] is probably unlikely. So yes, those different criterion are probably mutually exclusive.

And of what you're looking at today, do more of the properties fall in one of those baskets or the other? Or do one of those type of acquisitions appeal to you more than the other based on what you are seeing today in the market?

No, there's not one that appeals more than the other in the end. I think the most important one is if it's in our wheelhouse, is it something that Sunstone has done well or can do well? And can we create value? That is really probably one of the moe important ones. But if that had occurred in Iowa City, probably less likely that we would buy it. So there again, the market is certainly important as well.

Thank you.

Thanks, Josh.

Thank you. And our next question is from the line of Chris Woronka with Deutsche Bank. Please go ahead.

Hi, guys. Good afternoon. Just to kind of continue that last conversation from a different point. If hypothetically maybe something happens with the Mass Mutual portfolio, you're all of a sudden 27 hotels. Maybe you buy a few, or more than a few. At what point -- do you then de-lever again? I'm trying to figure out what your longer term targets are going to be on on leverage, and how you're going to try to maybe tie those to the next cycle relative to how this panned out?

Hi, Chris, it's Art. I can't say we have a specific target in de-leveraging. I can say we're heading towards being less leveraged than we are now. And by the potential give-back of Mass Mutual, that's one step. Doing all equity acquisitions is another step. And I thin it will have a lot to do with pricing and availability of capital. You don't want to say -- if debt is always priced -- and again, I think we're seeing secured debt around 9%. You aer really loathe to get a lot of that debt, but then you see where corporate bonds come in or even where preferreds trade, you look at that as a different instrument. So difficult to say what the ideal capital structure is forever. But those two transactions, again the potential of what happened with Mass Mutual on acquisitions will de-lever us.

Okay, great. And I'll just ask my standard inflation question. What are you guys thinking next year at the property level in terms of -- maybe you can break it down to two buckets. Things you think you can control and things you might not be able to control. And how you see that maybe shaking out on a percentage basis as we look at your adjusted base of 2008 costs.

Sure, Chris. Mark is the expert at that. Mark, why don't you take a shot at that.

Chris, I think we're just in the middle now of talking to the brands about the budgets. And so I would tell you that we are hoping to keep things to a very minimal, but really not at a point now where we can look at that yet and give you any thoughts about it at this point. But we certainly hope to keep it down to a very small number.

Okay. Thanks, guys.

Thanks, Chris.

Thank you and our next question is from the line of Ryan Meliker with Morgan Stanley. Please go ahead.

Hi guys. Just a couple of quick questions here. First of all, when we talk about the Mass Mutual portfolio, I recall I think conversations I had with you offline and the conversations online, you guys had mentioned one of the mine criteria in your willingness to hand back properties -- we'e talking about the W in San Diego -- was the idea of not impacting your relationship with your relationship lender. Here we are looking at Mass Mutual, which I believe is one of your relationship lenders. I'm wondering how all this is going forward. And obviously, you are talking about all equity deals in the near term. But have you had conversations with either Mass Mutual and your relationship with them, or even other relationship lenders going forward? You might be able to get [equity] through other means. And the second question was really about the acquisitions. What types of properties you guys are looking at. Are the the typical full-service properties in the primary markets, or are you looking at things maybe in secondary and tertiary markets? It sounds like you shying away from limited service from what you indicated about the portfolio that you're looking at potentially handing back. Any color you would have on that would be great also. Thank you.

Sure. Ken, why don't you take the front end of that question.

I'll take the lender relationships question. Good question and that absolutely is a focus as we go through these renegotiations, conducting an above board, fair, equitable, amicable process wherever possible. And the good news here is our lenders are very sophisticated third parties. When we entered into these loan agreements, they knew exactly what we were entering into. These are non-recourse mortgages. The benefit of the bargain is that if things go south in an unanticipated way, which is exactly what we're seeing today, one of the points of the deal is that there is a potential for a deed-back of the assets and satisfaction of the debt. And while that is said, it would be naive for us to assume that our counter parties would not have some sort of an emotional reaction to these renegotiations. And to their credit, I think those emotional reactions have been kept to a minimum throughout this process. And then more importantly, as I said in my prepared comments, one way or the other, we don't see the commercial mortgage market as being an attractive vehicle for sourcing debt for the next several years. We do, as Art mentioned, some other avenues for sourcing debt to the extent that we are looking to bring on debt capital because the markets are efficient. And so we don't see the mortgage markets as being a direct source of debt capital for us. Art, why don't you take the first part -- or the second part of the question?

Sure. In terms of acquisitions -- in terms of markets, never say never, and the one thing I've observed in the business of transactions, when you make the box too small, sometimes you miss the opportunity make money. And in the end the real goal is to make a spread above what your cost of capita is. And so if there were limited service that were urban -- New York, Boston -- you could convert something to a Garden Inn or a Residence Inn, that is is certainly something we would look at. Or even an Embassy Suites. What we like about those sort of brand are, if you believe we're in a choppy or slow recovery, and we are stuck in a place where frugality wins out, those kind of brands people don't shy away from -- have great flow-through, and so provide a great hedge in a choppy market and also can get great upside in urban locations.

All right. Thank you, guys.

Thank you.

And our next question is from the line of Smedes Rose with KBW. Please go ahead.

Hi, it's Smedes. Hi, Smedes.

How are you? Art, I just wanted to go back to your opening remarks for a second. Because you talked about -- it sounded like you were sort of optimistic on the occupancy side, but then you mentioned that rates continue to deteriorate. Is it fair to say that occupancy is firming but is still lower portfolio-wide year-over-year and rates are still declining year-over-year? And on that is the pace of decline accelerating or is it just that they're down year-over-year, but the pace is slowing?

First part of your statement is spot on. You're correct. Second derivative of change is obviously slowing. We hit the bottom, minus [24] RevPAR in. April, May. Now being in the mid-teens. Clearly, [that] -- that has backed off.

Okay. So margin going into 2010 just has to really start to come under a lot of pressure right? Because if it's going to be rate driven going forward, and you start to anniversary, your cost-cutting initiatives -- and it sounds like even though everyone wants to keep their costs low, there has got to be pressure from a labor perspective after two years of basically no increases. Is that just a fair thing that we should be thinking about.? I mean it sounded like you were kind of saying fourth quarter estimates are too high. Can you talk about maybe the 2010 consensus outlook?

In terms of 2010, the reason we haven't given guidance is, for instance we had our monthly meetings and of the 19 hotels that higher occupancy than last year, only one or two of them budgeted 30 days out that that might happen. So given that people on the ground can't call the numbers a month out -- and what I would add anecdotally to that -- a year ago we sat in budget meetings and our roll up was 2009 down 6.7%, that was only 1,000 basis points off. So I can' think there is anything I can give you for 2010.

All right. Fair enough. And my last question is on -- In your markets, can your just talk a little bit about supply? Obviously, we see what it is on a nationwide basis, but is there -- relative to say the kind of 2% growth that I think people are looking for next year?

Sure. Smedes, let me go back -- I didn't answer the first part of your previous question. You were absolutely thinking about margins. Correct. If next year occupancy is flat or up and you have the same guests or more guests at a lower rate, that becomes very difficult to control expenses. And so I think we've always talked about a [on call a] RevPAR deflection of 1%, yet EBITDA down 2% to 3%. It's at the worst end of that range or even beyond that. So yes, you absolutely should think about the pressure on margins. And since Mark and team have been cutting out costs for 16 months, practically two years, that at some point there's less things to cut.

Okay. And on the supply side?

On the supply side, city by city, New York has been advertised as being 14%. But that's metro-wide. And there's a bit of it kind of south of Times Square. It will be interesting. And it's kind of almost a different market segment because it's a lower price. So it will be interesting to see how that impacts New York. Orlando has had -- a fair bid is a 6% increase. The new Waldorf. and the Hilton. The Hilton is --- yes, three hotels opening up there. So Orlando has been particularly hard-hit. Houston has a lot of announced projects. We don't know how much of that is in the ground. I think [Intercontinental] had announced in hotel businesses, they had 20 new projects being proposed there. So Houston has the possibility of getting a fair bit of supply. Miami is digesting its supply, but doesn't seem to have a lot more. Southern California has gotten its share, but there's probably not much coming after that. Boston and Chicago, except for the [Shrinkwrap], Shangri-La and some other hotels, not much coming there either

Okay. Thanks a lot.

Thank you.

Thank you. And our next question is from the line of Michael Salinsky with RBC Capital Markets. Please go ahead.

Good evening, guys.

Hi Michael. Good evening.

Art, in your comments, you mentioned the 15% decline in October. Can you give us the details as to what the break-out is, occupancy versus rate on that?

Sure. Almost 14% of the 15% was rate and only a point was [occupancy]. So it was really just about -- sorry, I'm getting corrected. 13%.

Okay. Second, a bookkeeping question here. The W San Diego. Even though that has been handed to the receiver, is that going to continue to run through discontinued ops then until the title is officially transferred?

Good question. That will run until [disco] ops until the title is transferred at which point the entire thing on the balance sheet will hit discontinued ops as as well -- it's currently on discontinued ops for the income statement. You will see it as current liabilities of discontinued operations.

Any [guesstimates] as to what timing that is going to be?

It's largely out of our control. We're certainly working with the special service and the receiver to affect the final deed-back of the title. It could be several months or longer.

Okay. Then just another bookkeeping question here with the Mass Mutual life insurance loan there. You mentioned that the value of the portfolio is less than the debt in place, but yet you're still showing a book value north of that. Why wasn't there an impairment of that at that point?

Good question. The impairment analysis is based on recoverability. And the recoverability tends [to look] at undiscounted cash flows over an expected hold period. And so when we look at that portfolio, we used a certain weighting that would anticipate the portfolio going back, the reversionary cash flow on a give back [of the cash on the] allocated loan amounts. Then there is also a certain probability weighting that we would continue to hold the assets and then monetize those assets at some time in the future. So when you run that sort of recoverability test there's no impairment. But you are exactly right that the book value is approximately $14 million above the debt value.

Okay. Then finally, I think you mentioned a couple of times you are in discussion right now looking looking out to 2010. And I'm not looking for guidance or anything like that, but I just kind of wondered what are the major topics right now that you're discussing with your operators and what are the areas of focus they are pushing back on for 2010?

The number one issue -- and this is Art -- is wages. Wages are 40% to 45% of revenues. That's the one thing clearly we control. Steve I think had asked the question -- and I don't think I fully answered it -- why people don't get raises after two years, what about that? So that's a consideration. But if next year's negative RevPAR , and therefore EBITDA, is down a multiple of that can you really increase people's wages in that environment? So I think as owners, we at Sunstone and Mark and team, especially, is going to be getting together and sit down with operators to say, "Listen, this is a very difficult thing to do in this environment." So that is the number one issue that will be front and center in the next 30 days. I think that's probably the biggest thing. Everybody wants to increase rate, and trying to get people to do that at the appropriate time is a challenge. But it's really wages is the most

Okay. What percentage do you guys have of union exposure?

Union exposure, we just have two hotels.

Yes, we don't really have any union exposure per se. It's just a couple of hotels. And the brands are asking currently in the range of a couple percent for wage increases, 2%, 2.5%. And that's what we're trying to discuss.

Okay. That's very helpful. Thanks, guys.

Thank you.

Thank you, and our next question is from the line of Joe Greff with JPMorgan Chase & Co. Please go ahead.

Good afternoon, guys.

Hi Joe.

Art, you mentioned earlier about the sellout rates in New York and I believe Boston in October.Is there any trend there? Is it largely weekend or midweek? Is it leisure? Is it business? Is there a trend there that you've noticed?

Sure. It's all been midweek, particularly in New York. The last weekend was that kind of fell into November, the Marathon as well as the World Series. But otherwise, it's kind of a [Tuesday through Thursday pattern] So the good new is, it's really the business travelers came back. Mark, in Boston is it the same thing?

Boston has been a little bit of both, both midweek and fall which is terrific too -- usually a very strong period in Boston. So both midweek and weekend in Boston as well.

Great. And when you think about 2010 and -- what type of occupancy increases would you need to see where you would start adding to headcount at the property level across your portfolio?

Difficult to say. It varies a lot. If a hotel is running at [65 and going to 67], it's different than if it's [72 going to 75]. So I mean, Mark, you were GM for a lot of years, Is it 300 basis points? Is it 500 basis points?

I can't imagine that even if occupancy went up 300 to 500 basis points, that we'd be adding much of any labor at the hotels right now. It's variable. And again, we've worked hard to create a new business model at most of our hotels that we expect will continue this current cycle.

Thank you.

Thank you.

Thank you. And our next question is from the line of Bill Crow with Raymond James. Please go ahead.

Good afternoon, guys.

Hi Bill.

Art, now that you've got the capital and you're out there beating the bushes for acquisitions, can you describe the landscape of competition that you're finding?

Bill, it's widely varied. We bid one one deal, broadly marketed, told there were 20 bidders, didn't make the second round. I don't know whether that's -- having been a broker I couldn't tell if that was broker talk or not. The off-marketed deals, clearly we're the only one out there. Don't know how many other of our REIT brethren are out there. The majority of it is private equity. The challenge for them is they can't get debt, and if they do, it's pretty expensive. So kind of deals that have a lower initial yield, we probably are in a unique position to get something done that they can't. Everybody has money or is raising money. Everybody wants to buy deals. Many are kind of waiting for the generational opportunities or, as I think you best coined, the best opportunity that never came. But today there's a lot of people looking, but not a lot of people acting.

Okay. That was it for me. Thanks, guys.

All right, Bill. Thanks.

Thank you, and our next question is from the line of Brian Marr with Colin Stewart. Please go ahead.

Hi guys.

Hi Brian.

Kind of a quick question. We're seeing recently in a number of the top 25 markets, fairly strong occupancy numbers, and you can run down the usual suspects, New York, Boston, and a couple of others. And yet we're still seeing rate down mid-to-high teens. What can your guys do if anything, to induce the operators to more closely match rate with the newfound occupancy in those markets?

Brian, it's difficult, particularly for brand managed hotels that we don't run, revenue management. But what we do -- let's say, for example, one of our hotels sold out, is looked to build up for that day, and say okay, you sold out on 15 days. Let's look at the buildup and how did you -- When the Yankees made the World Series, did you shut all your B buckets, C buckets and only sell A buckets? And when you put those -- when they present the facts and they look at them, it's pretty clear what they should have been doing. So it's more on that basis than asking them to get aggressive. We -- we have, and Mark working with the team, has also asked them about experimenting. Let's hold the rates, let's not be punitive to people for being experimental with the rates. And again, it's really street corner by street corner. It's middle of the week. What do I do with a Tuesday and a Wednesday, though I might discount on the weekend. But it's really going back and proving to them what are the data points they should have focused on that should have allowed them to close off lower rated buckets. Because every hotel needs some base business. But really getting them to see the mistakes of the past and apply them going forward. And since a lot of the hotels have incentive management fees, they do have some incentive to try to make more money.

Okay. Thanks.

All right.

Thank you. And our next question is from the line of David Katz with Oppenheimer & Co. Please go ahead.

Hi, good afternoon.

Hi David.

So the Mass Mutual portfolio -- is that an all or nothing deal? I mean, is it possible that some of those assets are conveyed while others stay with you? And then I have just one other question about that.

Good question, David. This is Ken We, as I said in my comments, are endeavoring to negotiate a restructuring of that loan, and that restructuring could take any number of different forms. Certainly could entail the release of certain of the collateral assets, a partial paydown of the loan and the extension of the term, what have you. As we've said to Mass Mutual, we're open to discussion points here. And we're perfectly willing to work with them on solutions that would work for both sides. So stay tuned. We do expect to have some news on that one for you all in the next few weeks.

kay. So anything is out there. And so if we look at some of the discussion of covenants in the release, it does make mention of, I think, a prior amendment you had made where if you were to default in indebtedness in excess of $300 million -- and I realize this Mass Mutual portfolio is a little bit less than tha -- but if that were to be considered [right] an acceleration, then it would trigger some other senior events. Right? II guess in short? Am I interpreting that correctly? I just want to be clear on whether or not a default of that Mass Mutual portfolio mortgage would then be considered potentially a trigger of some of these others. If it were in conjunction with something else that would exceed $300 million.

Good question, David. What you're referring to is our exchangeable senior notes, of which there is just 62.5 million remaining outstanding. Those notes contain a covenant that's a cross acceleration covenant. So if in excess of $300 million of our indebtedness is not only in default, but also is deemed due and payable in advance of its maturity date, and that condition is not addressed within a 30-day period, the trustee has the right to put the notes back to us at par. As I mentioned, there is only 62.5 million of those notes left. And in fact we have prefunded all of our expected obligations through 2014. So we've got cash in our balance sheet here that is earmarked to prefund that maturity when it occurs. So to us, it's almost a non-event, it's almost -- to the Company to have those notes accelerated today because we'll eliminate the indebtedness and address it now.

Fixed expense.

Yes, and the fixed expense associated with it.

Okay. So you're not expecting it to occur, but you're prepared for it in case it does.

Precisely.

Got it. Perfect. Thank you very much.

Thanks, David.

Ladies and gentlemen, that does conclude our question-and-answer session for today. I would like to turn the call back to Mr. Buser for any closing comments at this time.

Thanks, Brittany. We appreciate your time today as well as your continued interest in Sunstone, and we look forward to speaking with you on our inter-quarter update call or seeing you at [NAREAK]. Thanks again.

Thank you. Ladies and gentlemen, this concludes the Sunstone Hotel Investors third quarter earnings call. We thank you for your participation. You may now disconnect.