Hersha’s New York play

<i>Pennsylvania-based hotel REIT ramps up in city, while unloading projects elsewhere</i>

From left: 337-343 West 39th Street, 320 Pearl Street
“I guess you’re big boys now,” one Wall Street analyst quipped during a recent conference call with Hersha Hospitality Trust honchos Jay and Neil Shah.

Indeed, the brothers have become “big boys” on the country’s biggest stage as they’ve ramped up their company’s focus on New York City hotels.

After taking their family’s modest Harrisburg, Pa., business public in 1999 and expanding it under multiple monikers (Hiltons, Hamptons, Holiday Inns) throughout the Northeast suburbs, the Shah brothers are now betting most heavily on the Big Apple.

Following February’s $164.5 million purchase of three hotels from developer Sam Chang in Times Square, which Hersha financed through the sale of more than 51 million shares of stock, New York now accounts for 27 percent of the decade-old, Philadelphia-based real estate investment trust’s geographic footprint.

“With the completion of this acquisition, we now have 14 hotels in New York City — a distinct competitive advantage,” Hersha CEO Jay Shah, 40, boasted on the conference call, “since New York is once again leading the [revenue per room] recovery.”

At the same time, the REIT is continuing to dump hotels in other parts of the country, from Frederick, Md., to North Dartmouth, Mass. — and even in its home state, in Gettysburg.

According to Neil Shah — the company’s Wharton- and Harvard-educated chief operating officer and de facto point man for its New York business — between 2004 and 2008 Hersha financed hotel developers in return for the right of first refusal on the completed projects. During that time it acquired over 10 of those properties on the East Coast, including four in Manhattan and two in Queens near JFK Airport. He said those properties “remain our best performers to date.”

Hersha has become even more aggressive in New York City over the last two years — a move Wall Street is applauding.

“Hersha looks to have increased its presence in New York City at a very opportune time, as performance in that market appears to be ramping faster than most U.S. markets,” noted analyst William Crow of Raymond James & Associates.

Still, the laser-like focus on New York comes as the hotel market here is struggling. Both average daily rates and occupancy levels fell to five-year lows in the city last year. Meanwhile, the supply of new hotels keeps rising, with more than 5,000 rooms opening in 2009 and another 50 planned hotels still in the pipeline in the five boroughs, according to the city’s tourism office, NYC & Company.

“New supply clearly remains a concern,” said Neil Shah, 36. “In ’08 and ’09, there was a lot of midscale new supply that hit a couple of our clusters, particularly Chelsea and Herald Square. … That clearly did make increasing rates, or trying to stem the tide of lowering rates, much more difficult last year.”

The lodging landscape is set to get more crowded still for Hersha, with an estimated 500 additional rooms planned in Tribeca and about 1,000 in Times Square, he noted.

“On one hand, it’s fortunate that all the supply is coming to New York versus the other parts of our portfolio,” Shah said, “because New York does seem to have the demand to be able to take the supply.”

The Shahs are doing their part to keep the supply chain chugging along. The glassy blue façade rising at the corner of Lexington and 48th Street may be their most ambitious project yet, landing them smack in the middle of Midtown’s hotel row, between the Roger Smith and the Waldorf-Astoria. The expected level of service falls on about the same spectrum.

“48Lex service levels will be closer to the Waldorf, but in a small, intimate and private environment,” Shah told The Real Deal in an e-mail.

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The planned 24-story, 116-room inn, which is slated to open later this year, is financed in part by nearly $11.5 million from the REIT’s development loan program, according to filings with the SEC. (The property is one of two hotel ventures the Shahs own privately; the Independent in Philadelphia is the other.) Still, the REIT isn’t handing out mezzanine financing the way it used to — it had just $46 million in outstanding development loans on the books at the end of 2009, compared to $81.5 million a year earlier.

Shah explained that last year Hersha reviewed its development loan portfolio and decided to only support projects that had obtained construction financing and were on their way to completion within two years.

Permanently impaired loans to struggling hotel projects in Manhattan and Brooklyn are perhaps proving a lesson in hard knocks New York real estate. Hersha was forced to write off more than $21 million that had been invested into a planned Hyatt Place Hotel on Nevins Street in Brooklyn, according to SEC filings. The REIT wrote off an additional $21 million on loans to stalled projects on East 52nd Street and Greenwich Street being developed by Chang, who they’ve worked with more than any other developer in New York. The Shahs have since decided to ditch the development loan program altogether.

Chang, meanwhile, said he plans to move forward with two other previously stalled, Hersha-backed projects: one under construction at 13th Street and Fourth Avenue and the other at 32 Pearl Street. According to SEC filings, they account for $11.5 million and $8 million, respectively, in Hersha financing.

In some cases, the Shahs have been able to parlay the economic carnage to their advantage. Hersha fully acquired the Hilton Garden Inn on York Street in Tribeca last June in a complicated transaction that absolved Chang of nearly $20 million in development loans that he owed the company.

When asked about his relationship with Hersha, Chang said simply: “They know what they’re doing.”

And the Shahs are poised to gobble up even more New York territory. The brothers plan to sell off up to 20 of the REIT’s “non-core” properties around the region, providing plenty of seed money (upward of $125 million, according to company estimates) for potential future acquisitions. And, the REIT also has nearly $52 million remaining on a $135 million revolving credit line to tap into.

As for the “big boy” comment, Neil Shah seems to be taking it as a compliment.

“Across the last cycle, we were the smallest REIT in the industry, the first Asian-led, publicly traded lodging company in the country, and we had a clearly stated, if ambitious, growth plan to move our portfolio from rural Pennsylvania to cities like New York and Boston,” he explained.

“Now, we really have built a scale portfolio in lodging — close to a $1.5 billion portfolio — and our focus today is less on accumulating assets than it is on managing it to produce returns beyond.”

Yet for all their newfound city credibility, associates described the duo as quite frugal, despite some scintillating corporate mythology.

In a 2008 interview with The Real Deal, Chang suggested that executives at Hersha are willing to splurge at times.

“All the Hersha partners have this [same] ring [with a diamond, number of carats determined by number of years of service] and this Rolex watch [with diamonds],” Chang said, when asked about his jewelry.

But Neil Shah insisted the brothers aren’t big on the bling. “I only wear a wedding band — and I assure you no diamonds are on it!” Neil Shah said.

“[There’s] very little bling here. We like brushed aluminum, beaten copper and a value orientation.”