Sales market should remain strong in 2005.

Not long ago, we saw a mile-long gap between what sellers were willing to sell their assets for and what buyers were willing to pay. This "big disconnect" led to a record low number of transactions in 2002 and the beginning of 2003; there was as much as a 4% difference in the capitalization rate between sellers' and buyers' expectations. As we come to the end of 2004, things have changed dramatically, leading to a record increase in sale transaction activity. We have identified five key factors for this increase:

A strong economy set the scene--the lodging industry is heavily dependent on the performance of the overall economy. As the economy came out of recession in early 2003, businesses started to ease up on travel restrictions and people started to take vacations.

The Trailing 12 continues to rise--hotels are typically sold based on historical performance of the prior twelve-month period (referred to in the industry as the "Trailing 12"). As each successive month in 2004 came along, it replaced a less profitable month in 2003. This allowed the sellers to create the "dream" in the buyers' mind that monthly performance would continue to increase, thus leaving some upside for the new owner.

Interest Rates are at historic lows--as of press date, the interest rate index most commonly used for hotel loans, the 10-year treasury, is hovering around 4%. The index, combined with a credit spread of 175 basis points, has allowed owners to lock in long term fixed rates at approximately 5.75% for periods of five to 15 years. This historically cheap source of capital allows even marginal deals to work and leaves a lot of room for price flexibility on the buyer's part.

Trading up--hotel owners often start out with smaller, limited service properties. As they become proficient in the financial and operational issues of a hotel, they often look for the next challenge to trade up to larger and eventually full-service properties.

Because of the depressed market for sales during the recessionary years, many of these owners did not want to sell and have held their properties

longer then their original business plan called for. These owners are now eager to sell their properties and move on to larger more complicated properties.

The final item creating such an active sales climate is the plentiful amount of mezzanine financing. Mezzanine financing fills the gap in the capital structure between the first mortgage (usually up to 70%) and the equity that the owner has to invest in the project. The AFC Hotel Finance Group routinely works with many mezzanine lenders who provide up to 85% financing for both new construction and existing assets. The pricing for this type of capital ranges from 9% to 12%. When the mezzanine pricing is blended with the first mortgage, it results in an "all-in-rate" of somewhere in the low- to mid-7% range. This low pricing and availability of mezzanine financing is the fuel helping buyers reach for larger transactions.

This year, my crystal ball is telling me that the hotel sector will continue to be strong in 2005. Many of the reasons that led to such a robust 2004 are still strong as we go into 2005.

The economy continues to improve with each quarter. Unemployment is on the decline and GDP is again growing at a normalized rate. Recessions tend to run in seven to 10-year cycles. With the last recession over in early 2003, we should have at least another five years of normal economic growth and activity.

Eventually the Trailing 12 will stop showing year over year increases. However, through effective management, technology and implementing aggressive yield maintenance programs, the better owners will still be able to increase their cash flows.

Although interest rates are forecast to rise from their current historically low levels, the increase is expected to be modest. There is still plenty of demand from smaller owners to trade up to larger full service properties. The lack of supply and bidding wars in 2004 have left behind many unsuccessful bidders.

They will become more aggressive in 2005. There are new firms entering the mezzanine market on almost a daily basis. With interest rates still low, the mezzanine market allows capital providers to achieve higher returns on their money for providing higher leveraged capital.