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Edited Transcript of HOT.UN.TO earnings conference call or presentation 8-May-19 9:30pm GMT

Q1 2019 American Hotel Income Properties REIT LP Earnings Call

Vancouver Jul 1, 2019 (Thomson StreetEvents) -- Edited Transcript of American Hotel Income Properties REIT LP earnings conference call or presentation Wednesday, May 8, 2019 at 9:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Azim Lalani

American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc.

* Bruce Pittet

American Hotel Income Properties REIT LP - Senior VP of Asset Management & COO

* Jamie Kokoska

* John Christopher O'Neill

American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc.

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Conference Call Participants

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* Bradley Sturges

Industrial Alliance Securities Inc., Research Division - Equity Research Analyst

* Colin Healey

Haywood Securities Inc., Research Division - Research Analyst of Mining

* Lorne Kalmar

TD Securities Equity Research - Associate

* Mario Saric

Scotiabank Global Banking and Markets, Research Division - Analyst

* Matt Logan

RBC Capital Markets, LLC, Research Division - Senior Associate

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Presentation

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Operator [1]

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Good afternoon, and welcome to American Hotel Income Properties REIT LP's First Quarter 2019 Results Conference Call. (Operator Instructions)

At this time, I'll turn the call over to Jamie Kokoska, Director of Investor Relations. You may begin your call.

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Jamie Kokoska, [2]

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Thank you, Rob. Good afternoon, everyone, and thanks for joining us for our first quarter 2019 results conference call. Discussing AHIP's performance today are John O'Neill, Chief Executive Officer; Bruce Pittet, Chief Operating Officer; and Azim Lalani, Chief Financial Officer.

The following discussion will include forward-looking statements as required by securities regulators in Canada. Comments that are not a statement of fact, including projections of future earnings, revenue, income, FFO, FFO payout ratios and AFFO payout ratios are considered forward-looking and involve risks and uncertainties. The risks and uncertainties that could cause our actual financial and operating results to differ significantly from our forward-looking statements are detailed in our MD&A for the 3 months ended March 31, 2019, and our other Canadian securities filings available on SEDAR and our website at ahipreit.com. AHIP does not undertake to update or revise any forward-looking statements to reflect new events or circumstances except as required by law. Listeners are urged to review the full discussion of risk factors on AHIP's Annual Information Form dated March 22, 2019, which has been filed on SEDAR at sedar.com.

Our first quarter results were made available earlier this afternoon after market close. We encourage you to review our earnings release, MD&A and financial statements, which are available on our website as well as SEDAR.

On this call, we will discuss certain non-IFRS financial measures including FFO and AFFO. For the identification of these non-IFRS financial measures, the most directly comparable IFRS financial measure and a reconciliation between the two, please see our MD&A. All figures discussed on today's call are in U.S. dollars unless otherwise indicated.

I would like to remind everyone that this call is being recorded today, May 8, 2019. A replay of this call will be available on our website.

John will begin today's call with an overview and update regarding portfolio, strategy and performance, Bruce will provide a brief update on hotel renovations and operations, and Azim will provide a summary of our financial results.

I'll now turn the call over to John O'Neill, Chief Executive Officer.

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [3]

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Thank you, Jamie, and thank you, everyone, for joining us today. Overall, we're pleased with how our hotels performed during the first quarter and especially with strong contributions from our recently renovated hotels and also strong results across our entire economy lodging portfolio. In particular, our 3 recently renovated Embassy Suites hotels in Dallas, Columbus and Cincinnati achieved net income growth of approximately $600,000 this quarter, the first quarter that these properties had after renovations, an increase of 33% compared to Q1 2018. The $10 million spent to renovate and reposition these large and significant hotel assets is already paying off.

Average daily rates increased 1.9% overall versus first quarter last year to $97.32. This was supported by a 3% average increase in rate from the 6 hotels that underwent renovations in 2018. We would expect to see ongoing improvement from these properties during 2019 particularly as they start lapping the second to fourth quarters of 2018 when many of them were undergoing renovation.

Our strong rate growth of 1.9% was higher than the benchmark ADR increase of the broader U.S. hotel industry and was supported by a very meaningful increase in average rate across our economy lodging portfolio. This increase was due to higher commercial guest traffic, which often generates a higher room rate, and a reduction of 186 rooms from 3 economy lodging hotels we sold in the last 9 months.

This strong rate performance was partially offset by canceled guestroom bookings related to the U.S. government shutdown during January and reduced occupancy rates that resulted from hotels that were under renovation. On average, at the 4 hotels that had significant renovation activity during the quarter, the Fairfield Inn & Suites Jacksonville, the Staybridge Suites Tampa, the Residence Inn Baltimore White Marsh and the Residence Inn Chattanooga, occupancy declined 10% at these 4 hotels. This is largely attributable to the number of guestrooms taken out of inventory as rooms are being updated and was in line with our expectations for guestroom displacement at these hotels. It should also be noted that the average daily rate at hotels under renovation was actually up, indicating strong hotel demand despite renovations occurring.

The U.S. government shutdown did have an unfortunate impact on our performance and more specifically on occupancy during the quarter. Approximately 8,300 room nights were canceled by government agencies during the shutdown, representing over $1 million of lost revenues. Overall, total occupancy -- portfolio occupancy declined by 1.1 percentage points. However, with our strong average daily rate performance, our overall RevPAR grew 0.3% during the quarter.

We are pleased to report that overall in the first quarter, our net operating income margin grew by 50 basis points from the same period last year to 32.1%, with net operating income growing 0.7% in the quarter to $25.8 million. Similarly, FFO grew by 0.4% to $11.4 million or $0.15 per diluted unit, and AFFO grew by 0.5% to $9.9 million or $0.13 per diluted unit.

As I mentioned earlier, the government shutdown did have an impact on our first quarter results, as did some onetime expenses related to management changes. Removing the impact of these 2 factors, FFO and AFFO would have been approximately $0.015 higher on a normalized basis.

In the last several months we've welcomed 2 important new leaders to our company. In February we welcomed Chris Cameron as Chief Investment Officer, and he has been very busy working on options for our capital recycling strategy in the year ahead. We are currently evaluating some very compelling opportunities at the moment related to selling assets we no longer see as the best fit for our long-term strategy and redeploying that capital to activities or new assets that we believe will be more efficient -- will more efficiently support our cash flow growth.

And just last week we announced the addition of Bruce Pittet to our team as our new Senior Vice President of Asset Management and Chief Operating Officer. Bruce brings decades of hotel experience, operations experience and management experience and, perhaps more importantly, brings intimate knowledge of our hotel portfolio, processes and systems, having recently been a Senior Vice President overseeing AHIP's hotels at Aimbridge Hospitality, our independent hotel manager. Given his 6 years of experience with our markets and properties, Bruce has had a running start here at AHIP and joins us on our call today.

Bruce is now responsible for driving our hotel performance by working closely with Aimbridge to ensure all revenue and cost-saving opportunities are pursued. In addition, he will be overseeing the capital renovation program to ensure projects are completed effectively with minimal displacement.

So with that introduction, I'll now turn the call over to Bruce for a more detailed update on our renovations program and hotel operations. Bruce?

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Bruce Pittet, American Hotel Income Properties REIT LP - Senior VP of Asset Management & COO [4]

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Thank you, John, and good afternoon, everyone. It's a pleasure to be on the call with you this afternoon. Renovation activity at 5 hotels occurred during the first quarter, with upgrades at 3 hotels completed by February. The updates to the Embassy Suites Columbus, the Staybridge Suites Tampa East and the Residence Inn Baltimore White Marsh are already generating strong results, as John mentioned, contributed in the back half of the quarter to ADR growth. We are pleased with the quality of these renovations and that these projects were accomplished on time and on budget. The Fairfield Inn and Suites in Jacksonville and the Residence Inn Chattanooga both began renovations in the first quarter and are expected to be complete by the end of Q2.

So far during the second quarter, we have started renovation projects at 3 larger Homewood Suites hotels, those in Allentown and Bethlehem, Pennsylvania, and Dover, New Jersey. We also expect to begin renovations at our last 2 Embassy Suites hotels before the end of June, the 224-room Embassy Suites Tempe in Phoenix and the 271-room Embassy Suites Cleveland.

As a reminder, we do not expect a significant amount of disruption for the Embassy Suites Tempe property, as the summer months are typically seasonally very slow in Phoenix, and the layout of this specific hotel is campus style, which will allow us to minimize hotel guest disruption, as rooms can be isolated to specific buildings during renovations and not impact other areas of the hotel. The Embassy Suites Cleveland property will see some displacement, given its open atrium layout.

AHIP'S asset management team and Aimbridge are working diligently to schedule and plan these renovations in a manner that minimizes the impact to our guests and hotel performance. We will continue to update you as each hotel renovation project is completed.

As for our portfolio's performance during the first quarter, we did experience a meaningful RevPAR improvement across the hotels that were recently renovated, with the newly updated hotels averaging 3% growth in ADR and 3.8% growth in RevPAR. It's important to note that it's still very early in seeing the full post-renovation results from 3 of these 6 properties, as renovations at these hotels weren't completed until partway through the first quarter. There is typically a ramp-up period post-renovation as the hotel is reestablished in the markets. The best post-renovation performance was seen at our Embassy Suites Cincinnati in Covington, Kentucky, where RevPAR jumped more than 29% from the first quarter last year, with increases in both occupancy and ADR.

We also saw some meaningful RevPAR growth from select regions as well. Namely, our premium branded hotels in Arizona, Georgia and Iowa all generated RevPAR growth above 12%, and the 5 hotels we own in North Carolina saw an average RevPAR growth of nearly 8%, driven by strong transient guest demand.

Conversely, there were some pockets of regional weakness. New supply was the cause of a 7.5% decrease in RevPAR in Virginia, specifically within the Harrisonburg area.

As mentioned earlier, the government shutdown in January caused some guestroom cancellations from agencies and government-related industries through the quarter. This impact was particularly evident in our portfolio of hotels in Oklahoma, New Jersey and Florida, where group and government-related transient bookings were canceled.

I'm pleased to say that overall, our premium branded portfolio is performing above its designated peer group. The STR RevPAR Index, which compares the performance of AHIP-owned hotels to their competitive set in each region, indicated AHIP's premium branded hotels had an average index rating of 129, with 100 representing a fair share of the market.

Within the economy lodging segment of our business, RevPAR grew by 6.7% as a result of both higher occupancy and a 4.3% increase in ADR. Occupancy grew primarily as a result of increased Wyndham-generated transient guests who were able to book a larger number of available rooms as rail crews were unable to utilize some hotels due to inclement weather in Nebraska and Iowa. Despite this, economy lodging hotels still benefited from guaranteed revenue from railway customers even though some rooms were not used by their crews, which contributed to the 4.3% increase in ADR.

Finally, I wanted to mention that in Q1, all AHIP properties have completed migrating onto the Aimbridge systems platform. This migration and integration of reporting, accounting, payroll and procurement will provide AHIP properties greater and expanded visibility of property operating metrics as well as enhanced forecasting and reporting capabilities.

And with that update on our renovation program and hotel performance, I'll now turn the call to Azim to discuss financial and capital metrics. Azim?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [5]

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Thank you, Bruce. Good afternoon, everyone. As John discussed at the start of today's call, we were pleased with the growth we saw in ADR and RevPAR this quarter. It speaks to the strong operating position our hotels have in their respective markets.

First quarter revenue was $80.5 million, about $535,000 lower than the first quarter of last year as a result of displacement from hotels under renovation and impacts from the U.S. government shutdown. NOI margins improved as a result of higher daily rates. Strong asset management also helped in controlling expenses and reducing property taxes during the quarter, primarily at some of our Baltimore and Ohio hotels.

It's also worth noting that the first quarter was negatively impacted by nonrecurring expenses associated with management changes during the quarter. This was offset by lower professional fees and other head office expenses.

Our NOI margin grew by 50 basis points compared to the first quarter last year, resulting in NOI increasing to $25.8 million. Similarly, EBITDA margin improved 40 basis points with EBITDA for the quarter growing 1.1% to $20.9 million.

Net income during the first quarter was negatively impacted by a $700,000 unrealized fair value loss on interest rate swap contracts for 3 of our variable rate economy lodging term loans. This compares to a $1.4 million unrealized gain recorded in the same period last year. The fair values of the interest rate swap contracts fluctuate based on the movements and interest rates during the respective periods.

As at March 31, 2019, AHIP had recorded on its balance sheet a cumulative unrealized fair value gain of approximately $800,000. As a result of these fair value changes, AHIP's net loss for the quarter was $456,000. This compares to net income of $1.4 million last year.

More importantly, FFO increased 0.4% to $11.4 million or $0.15 per diluted unit, unchanged from last year. Likewise, AFFO grew 0.5% to $9.9 million or $0.13 per diluted unit, also unchanged from last year.

As mentioned in our quarterly materials this afternoon, we are aligning our same-property definition with our publicly traded U.S. hotel REIT peers. This means that only hotels owned and operated for the entire year in both reporting periods will be included in same-property results. Therefore, hotels acquired or sold will be excluded from same-property results.

As our portfolio of premium branded hotels is unchanged from last year, no same-property metrics have been presented this quarter for this segment.

Within the economy lodging segment, 3 smaller hotel properties totaling 185 guestrooms were sold during the last 12 months. These hotels had no meaningful impact on the REIT's total results. As a result of excluding these hotels, same-property RevPAR at economy lodging hotels grew 3.5% to $41.56, revenue grew 2.2% to $17 million and net operating income grew 2.4% to $4.8 million compared to the first quarter of last year.

Our business is seasonal in nature, with the first and fourth quarters seasonally weaker and the second and third quarters seasonally stronger. As we pay a consistent monthly cash distribution, we review our payout ratio on a trailing 12-month or rolling 4-quarter basis. For the first quarter of 2019, our trailing 12-month FFO payout ratio was 90.7% and our trailing 12-month AFFO payout ratio was 98.7%. We continue to pay a U.S. dollar-denominated monthly distribution of $0.054, which is equivalent to $0.648 per unit on an annual basis, a level that we have maintained since April 2016. Based on today's closing Canadian dollar unit price, this provides a yield in excess of 12%.

Turning to capital metrics. As at March 31, 2019, AHIP had an unrestricted cash balance of $12.3 million and approximately $22 million available through revolving credit facilities. We also had a restricted cash balance of $33.4 million, which includes $16.7 million on deposit for upcoming property improvement plans.

At the end of March, we had a weighted average remaining term on our debt of 6.2 years and a weighted average interest rate of 4.64%. Approximately 97% of AHIP's term loans have fixed interest rates, and we don't have any significant debt maturities until June 2022.

With that financial discussion, I'll turn the call back to John for some closing remarks. John?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [6]

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Thank you, Azim. A key component of our strategy for the remainder of 2019 is focused on improving hotel performance through ongoing renovations and active asset management. The early signs of this were already evident in the first quarter with improved margins and overall hotel profitability.

Importantly, our strategy is also focused on capital recycling, which will become more evident in the second half of the year. We're confident there are opportunities to enhance the quality of our earnings by selling certain assets that we no longer believe are core to our long-term strategy and reinvesting that capital into activities or assets we think can drive higher, more sustainable returns. I look forward to updating you on capital recycling initiatives as they evolve.

Our 2 new recently appointed executives, Chris Cameron as Chief Investment Officer and Bruce Pittet as Senior VP Asset Management and Chief Operating Officer, are playing roles in helping us finalize our plans to best position our business in the long term. We are very fortunate to have 2 such trusted and experienced industry veterans join our team.

As we actively pursue activities to enhance the value of our business, which we hope will be reflected in our unit price, we continue to offer our investors one of the highest yields in the REIT sector. This yield, and therefore overall return for our Canadian unit holders, continues to be bolstered by the strength of the U.S. dollar. In fact, since this date last year, the U.S.-Canadian exchange rate has added over 4% to the value of our U.S. dollar distributions once converted into Canadian currency.

In addition, as we estimate only 60% of our monthly distributions will be considered taxable U.S.-sourced income for Canadian investors in 2019, this further enhances their net return. I continue to see great value in our unit price and plan to continue purchasing our units once our capital recycling strategies are announced and insiders are permitted to make purchases again.

With that overview of our first quarter performance, we'll now open the call to questions from analysts.

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Questions and Answers

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Operator [1]

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[Operator Instructions.] And your first question comes from the line of Lorne Kalmar from TD Securities.

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Lorne Kalmar, TD Securities Equity Research - Associate [2]

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Just on capital recycling, I know, I guess, still early days. But is there any target markets you're looking to get out of?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [3]

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I don't know that it's early days. We're well advanced on some initiatives. But in terms of naming specific markets, of course, I can't really do that at this time. But I think suffice it to say that we are looking to improve the quality of our earnings and improve the kinds of markets in terms of size and stability that we're in and have higher quality hotels in terms of larger and larger markets, larger properties. So that's probably about as specific as I can give you at this time.

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Lorne Kalmar, TD Securities Equity Research - Associate [4]

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Okay. And just on the G&A, was there any onetime items in there?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [5]

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Yes, the onetime item was just with respect to the management changes that increased G&A. But on a year-over-year basis, we had a reduction in professional fees and some other head office costs like travel, and so that actually offset a lot of those costs.

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Lorne Kalmar, TD Securities Equity Research - Associate [6]

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Okay. And then I noticed you guys didn't mention anything about the Pittsburgh market. Any update there in terms of new supply or the absorption of the new supply?

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Bruce Pittet, American Hotel Income Properties REIT LP - Senior VP of Asset Management & COO [7]

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My comment on Pittsburgh would be that I think in general we're starting to see it level off. As you know, there has been a tremendous amount of new supply come into the market, and a couple of the submarkets that we're in -- the airport and Cranberry, especially around the Residence Inn -- I think I would say are stabilizing and even maybe even seeing some slight improvement.

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Lorne Kalmar, TD Securities Equity Research - Associate [8]

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Okay. And then just lastly, I guess for Bruce, are there any -- now that you're coming over from Aimbridge, do you see any other cost-saving or material cost-saving opportunities going forward here?

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Bruce Pittet, American Hotel Income Properties REIT LP - Senior VP of Asset Management & COO [9]

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Cost-saving opportunities was the question, right?

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Lorne Kalmar, TD Securities Equity Research - Associate [10]

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Yes.

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Bruce Pittet, American Hotel Income Properties REIT LP - Senior VP of Asset Management & COO [11]

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Aimbridge is very involved in labor management and has instituted a couple of programs, especially around housekeeping. But they've got some further initiatives that they're focused on that would encompass really all labor in hotels. So I do think there's opportunities on the labor side to see some improvement going forward, as an example.

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Operator [12]

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And your next question comes from the line of Colin Healey from Haywood Securities.

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Colin Healey, Haywood Securities Inc., Research Division - Research Analyst of Mining [13]

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I have some questions on capital recycling as well. How quickly do you expect to replace that revenue base when you're disposing of properties to ensure that you're not putting the dividend at risk or eroding some of the cash generated from the disposal?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [14]

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That's a very good question and high on our priority list not to effectively sell an asset and let the money sit in the bank for too long, which becomes dilutive, of course. So it's our goal, essentially, if and when we are to announce any sale of assets, is to effectively put that money to work by the end of the year so that there's really not much significant time in between the loss of the income and a replacement of the new income. So we're really going to manage the dilution as best and as fast as we can. So I think the general answer is any sales that do occur, we replace that income by the end of the year.

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Colin Healey, Haywood Securities Inc., Research Division - Research Analyst of Mining [15]

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Okay. Great. That's what I wanted to hear. Obviously, it's complicated to do multiple deals with multiple different parties all at the same time, but minimizing that dilution is key. Without naming properties or specific markets, can you talk about the property disposals that are under consideration, how much they're kind of contributing to the top line? And are you looking at kind of full replacement with better-margin properties and higher ADRs? Can you talk...

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [16]

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I can't really tell you specifically that the revenues and the income that would be part of the hotels that are for sale. But I think consistent with what we've been stating in terms of a higher quality of income, higher quality of earnings in better markets, clearly higher average rate would be a function of the new assets or replacement assets. But I think beyond that, Colin, I probably would get too specific in terms of any kind of specific detail, and I think we kind of have to wait until we're firm on some of those transactions to give you any more specifics.

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Colin Healey, Haywood Securities Inc., Research Division - Research Analyst of Mining [17]

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Yes, I kind of expected that, but I had to try. On the Embassy Suites Cleveland, you mentioned that you'll see some financial impact due to the renos that you're planning to kick off. What can we expect in terms of reduced contribution to the top line there? And how have you seen the margins impacted at properties that are similar during the reno periods?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [18]

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Yes, we've actually been fairly clear about sort of the impact of renovations in terms of the general levels of displacement. Cleveland specifically, we think that probably is going to impact income by about $1.5 million during its renovation period, which is sort of Q3 and beginning of Q4. But that's still down from 2018. Our total displacement expected for 2019 for all of our renovations, about half of the displacement that we saw in 2018. Cleveland's our only major displacement renovation in 2019.

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Operator [19]

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And your next question comes from the line of Matt Logan from RBC Capital Markets.

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Matt Logan, RBC Capital Markets, LLC, Research Division - Senior Associate [20]

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Just following up on, I guess, the G&A, you guys have been investing in some new IT systems, adding to the team. How should we think about the run rate for the G&A in 2019?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [21]

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Matt, this is Azim. So from a systems perspective, a lot of those systems are being done by Aimbridge, so not necessarily a REIT expense. Some of those, for example, by the transition from one lodging to Aimbridge, there was no additional incremental cost on the accounting software because that's something that they provide for all of their other clients, so no real change from a systems perspective.

I think on a run rate basis for G&A, we're probably running about $2 million a quarter, which is pretty much where we were for this quarter and last year, so that's probably a good run rate. As we've added people, we've also had other people leave. So from that perspective, that's how I would look at it.

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Matt Logan, RBC Capital Markets, LLC, Research Division - Senior Associate [22]

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Okay, and in terms of some of those systems, can you talk about any of the impact or ability to maybe manage your margins or improve your margins in 2019?

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Bruce Pittet, American Hotel Income Properties REIT LP - Senior VP of Asset Management & COO [23]

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Some of the systems -- a couple of examples, if I could; this is Bruce -- new payroll system, actually, that's been installed across the platform will actually allow us to manage our payroll more precisely. And instead of having, say, a person clock in 10 minutes before their start and being paid for those 10 minutes, now it's down to a minute before they start. So there would be some savings in that way as well as stronger reporting that allows the hotels to manage overtime more effectively as well, and I could have brought this up earlier as it pertains to cost containment. The procurement system that Aimbridge has is robust, and the properties not only take advantage of the system, but they take advantage of the entire buying opportunity that Aimbridge has. So we get really preferred pricing, and we'll continue to see benefits of that as we continue on through this year.

And these systems, I should also lastly mention, are fully integrated. So from a reporting perspective, it gives a lot of transparency to the management of the hotels to make really better and faster decisions to adjust their business.

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Matt Logan, RBC Capital Markets, LLC, Research Division - Senior Associate [24]

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That's good color. And I guess in terms of the overall impact on how we should think about margins, would it be fair to say that in 2019, the overall change might actually be a little bit positive, similar to the current quarter?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [25]

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If you looked across the whole U.S. industry, there is certainly some margin pressure. A lot of our U.S. peers, wage rates increasing and labor costs increasing. But we've managed to manage that well in our first quarter and expect to continue to do so. So I think the answer is yes, we expect to see and continue to see some slight margin improvement.

And one of the evidences of that is as we have more hotels essentially completing their renovations -- you saw it in Q1 -- our average rate grows as opposed to occupancy. And average rate growth is what we have been focused on for quite some time, that that's our opportunity with this portfolio of hotels. We run a fairly high occupancy already across the whole company, about 74% to 75% occupancy. But our room for growth is average daily rate. And we have started to grow nicely on average daily rate.

Our active asset management both corporately of AHIP is assisting with that. But average rate flows better from a margin perspective. Increased occupancy comes with increased costs; average rate, not so much. So assuming we continue to see those average rate improvements, and we expect to see so as a result of the hotels coming out of renovations, we also expect to see continued margin improvement as well.

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Matt Logan, RBC Capital Markets, LLC, Research Division - Senior Associate [26]

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I appreciate the color. And maybe just one last housekeeping item from me. I didn't see the same-property RevPAR figures for the overall portfolio. Would it be possible to get those numbers for this quarter and Q1 '18?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [27]

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Yes, we're just gathering that, so we'll send that out to all the analysts at the same time.

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Operator [28]

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[Operator Instructions.] Your next question comes from the line of Brad Sturges from Industrial Alliance Securities.

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Bradley Sturges, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [29]

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On the lines of the rate and margin discussion, I guess what I'm trying to reconcile there is with the rate growth and yes, the occupancy was down a bit with some of the items you talked about, but with rate growth, why didn’t -- why wasn't there more margin growth than what you actually achieved? I mean margins were fairly flat, so what would have been, besides occupancy, which comes with higher costs, why didn't that rate growth translate into a little bit better margin?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [30]

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Well, a couple of points. Good question, Brad. Two things, and I'll let -- if Bruce has anything else to add. But first would be for us, increased food and beverage revenues. Three of our large Embassy Suites, as we've talked about earlier, essentially have come out of renovations, and those are our largest essentially convention and meetings hotels. So we had nice increase in our food and beverage revenues in those properties, and food and beverage margins just as a whole are much lower margin business than rooms business. So it would impact our overall margin as we have more food and beverage to rooms revenue overall. So that's actually expected. Not a bad thing. We can't always be absolutely focused on our margin. If we have increased food and beverage revenues that drive increased profitability, we're happy with that, but it will affect the statistics a little bit because we had essentially quite diminished food and beverage revenues with those 3 properties in renovations at the end of last year.

And the other is what I just talked about, which is still -- yes, we've managed our labor costs well in an increasing rate environment, low unemployment across the U.S., so that does increase -- it puts pressure on wage rates and some minimum wage increases in a number of states. So we still had wage increase, net -- yes, well, in the 3% -- not wage increase, but labor cost increases about the 3% range. So there's a lot of levers to pull on even maintaining a flat margin or slightly up.

So average rate growth was one of the very positives on helping the margins. But actually, increased food and beverage revenues, as I said, was one of the levers that actually decreased our overall margin. So a couple of answers to the margin question, I think, but we're happy where the trend is going and where we ended up in Q1.

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Bradley Sturges, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [31]

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Okay. And as with the capital recycling program, obviously, you're still working on it, so there's only limited details of what you could provide. But I guess I'm also trying to reconcile there in terms of the idea of selling, I guess, inherently some of your lower-quality or the ability to try and high-grade the earnings. Inherently, if you're selling some lower-quality assets that could be higher-yielding and how you would manage that in terms of redeploying into a higher-quality earnings stream which inherently you would be buying at a lower yield. And without causing more erosion, I guess, from the AFFO per unit, how would you -- I guess from a (inaudible) perspective, try to thicken all that?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [32]

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That's a good question, and exactly right. A lower quality of asset might theoretically trade at a higher cap rate. So to replace it with a higher-quality asset, might trade on a lower cap rate. So our goal is clearly to ensure that we don't have dilution and -- in terms of our recycling strategy. And there's a lot of assets available for sale across the U.S. right now. I don't know that I would say it's a buyer's market, but there's a lot of product available for sale.

Pricing hasn't necessarily come down and matched the volume of new assets that are -- or asset that are available, but particular buyers can do quite well in terms of a cap rate buy. So without giving you specific examples, Brad, we are keenly aware that a transaction for us needs to be very compelling for us to do it or else we won't trade just for the sake of trading. So -- and keenly aware of any income dilution in achieving those results. So it's doable and it's our goal and stay tuned. How's that?

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Bradley Sturges, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [33]

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Again, I guess lastly, would like to go back to the AFFO calculation and just understand it once more. So when you're calculating or tackling your FF&E reserve, I assume you're following what's required for your lenders, so typically in the 3% to 4% range. When that happens, are you actually moving the cash in the restricted cash as per the franchise agreements and the lending agreements?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [34]

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So the franchise agreements don't have that requirement. The lending agreements do. So we do actually fund with our borrowers -- or with our lenders, sorry -- the full reserve that's required. And then as we spend the money, we draw from those accounts.

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Bradley Sturges, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [35]

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Right, so you're setting aside the cash even if it's not an actual spend in any particular month or quarter?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [36]

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Correct.

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Bradley Sturges, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [37]

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So why not follow that practice in terms of your AFFO calculation rather than the actual spend, which is right now running less? Wouldn't that -- wouldn't the reverse be the more conservative approach to your AFFO calculation?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [38]

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That's certainly one approach, and as we actually spend the CapEx dollars, not all of it is maintenance. Some of it is value generation and ROI creation. And so that's the assessment that we're making. So even though we are pre-funding the reserve, some of that is used for non-maintenance purposes. And so I don't think it's appropriate to be deducting ROI-generating capital out of a maintenance reserve.

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Operator [39]

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And your next question comes from the line of Mario Saric from Scotiabank.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [40]

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A couple of questions, one on the reno program, one on the capital recycling initiative. Maybe I'll start there. I don't know if I've missed it, but is it too early to provide a quantum in terms of the total planned dispositions in terms of dollars?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [41]

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Yes, it's too early to provide that kind of guidance, I think, but we'll basically just wait until the announcement, until we're in a position to actually announce. So we're not giving guidance in terms of quantum of dollar value.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [42]

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Okay. And then related to the previous question, like when you're looking at buying and selling, how do you think about the required kind of incremental long-term NOI growth from the acquired asset relative to the disposed asset? So you're in a scenario where you're selling higher cap rate asset to buy a lower cap rate, better quality income asset, but that asset may show meaningfully better NOI growth over time. So how do you think about what the required spread between those long-term growth rates is?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [43]

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Well, I think the other -- good question. I think the other component of that is what kind of renovation capital is required and when may it be required? So in other words, what income are you starting off at, and what do you think the growth trajectory of that income is in that new asset? And is that sort of a one way, meaning it's just going to continue to grow, or will you have a major displacement while you're kind of renovating and repositioning? Does it need renovating or repositioning? Not every new acquisition, of course, will need that, right?

So it's about 4 dimensions of decision-making when you look at a new asset like that. If it's perfectly new, perfectly renovated, then yes, it will probably trade at a lower cap rate, but its trajectory should be stable and constant and reliable, whereas perhaps if an older asset that needs a little renovation is going to -- you can buy it at a better cap rate, but it's going to dip as you're renovating and require some additional capital and then start growing again.

So I don't know if I'm answering your question specifically, Mario, but there's no one answer as to what's the spread between the selling cap rate and the buying cap rate. It depends. Our preference would always be higher quality of asset and without any sort of looming disruption of renovations. We want to avoid the dilution and continue to improve our FFO and AFFO. So maybe that's the answer that you're looking for. That's how we're guiding ourselves.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [44]

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That makes sense. Okay, so maybe just shifting to the renovations. In terms of the total expected spend, is the $16.7 million that's on reserve, does that take us through 2020 in terms of the total CapEx spend required?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [45]

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Hey, Mario, this is Azim. Yes, that's both for '19 and '20, so that covers both periods.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [46]

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Got it. So that would cover all of the hotels that are listed in terms of undergoing programs?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [47]

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That's right. For certainly the ones we've disclosed in '19, that would cover all those and then some that will happen early in 2020 as well.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [48]

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Got it. Okay. And then on that chart or that slide, I noted that it looks like you've given yourself a bit more buffer in terms of timing for some of these renovation programs, traversing over 2 quarters as opposed to 1. Is that simply just flexibility in terms of start and end dates, or are you seeing delays because of labor shortages and what-not in terms of executing on programs?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [49]

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We're not actually seeing many delays, Mario. We're actually on time, on budget, and some of them do indeed span over 2 quarters. We've really just been scheduling those based on levels of business, and so we're not seeing either overruns or time issues in terms of the completion of our renovations. So right now we're right on time.

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Jamie Kokoska, [50]

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Yes, I would actually just add to that. In terms of the chart there, some of the renovations were scheduled to end either right near the end of the quarter or right at the beginning. It kind of straddled that, so just to provide you guys with a realistic outlook of what quarters could be impacted, we have expanded 1 or 2 of those.

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [51]

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Great. Thanks, Jamie, yes.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [52]

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Okay. That makes sense. And then maybe a bigger question on the renos. We see large year-over-year declines in terms of NOI when a hotel is under renovation or [ceased generating], and then we see a substantial uptick in terms of the rate growth upon completion. When we look out over the next 3 or 4 years and kind of smooth out that process, like what -- it may be a difficult question to answer -- but what type of returns are you typically underwriting or targeting in terms of the CapEx spend, and how would you characterize the spend today versus, let's say, a year ago or 2 years ago in terms of being offensive versus defensive?

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Azim Lalani, American Hotel Income Properties REIT LP - CFO & Corporate Secretary of American Hotel Income Properties REIT (GP) Inc. [53]

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This is Azim. So from a return perspective, we typically look at it as generating an 8% or 8.5% cap rate because a lot of those renovations are change of control ownership related, and we do that as part of our underwriting. That's how we look at renovations, certainly from that perspective.

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [54]

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And it's John. From an offensive versus defensive position, every renovation and repositioning and improvement that we do is a little bit different. Clearly, the 3 Embassy Suites that have just finished and come out of renovations was an offensive renovation, meaning we expect and have seen improvement since coming out of renovations.

Some clearly are defensive in some markets that also have seen some increases in supply, like the Baltimore market and the Pittsburgh market, for example, where you're -- and these aren't as nearly as major renovations, but there are times where you have to do essentially a defensive renovation to maintain your market share. And we as a company have actually done very well overall with our market penetration.

So we clearly like an offensive renovation much, much better. It gets you, in many cases, a better than 8% ROI. But some, admittedly, are defensive in nature or just clearly an updating to a new brand standard, which has longer-term benefits as well. So a bit of both.

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Mario Saric, Scotiabank Global Banking and Markets, Research Division - Analyst [55]

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My last question is more of a broader question. I noted in the outlook part of the MD&A with respect to the STR 2019 outlook, it looks like the RevPAR growth expectations for several of the operating segments that you're in came down a bit quarter-over-quarter for the 2019 outlook. And the U.S. economy is doing fairly well as highlighted by the strong U.S. dollar appreciation that you referenced earlier on the call. What are you seeing on the ground in terms of broad-based demand/supply? Does it feel like maybe the demand's getting stronger? What's maybe driving that slight deceleration in outlook for STR quarter-over-quarter?

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [56]

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I mean -- while new supply is moderating, it's still significant, 1.5% to 2%, with RevPARs generally looking to grow 2% or 2.5%. The Smith Travel, the STRs and the CBRE have a snapshot on the whole industry have -- are calling for a little more moderate RevPAR, as you've noted. But there are issues like the government shutdown in Q1 that had some spillover effect, and not just -- even though the shutdown was primarily in January, it had spillover effect for the rest of the quarter and maybe even a little bit into Q2.

So I don't think there's any one thing that's called for the little pullback of the RevPAR increases for the industry. I don't really have any more specifics than that, that I think the experts are looking at sort of Q4 results and Q1 and sort of trending that out for the balance of the year. Still seeing growth and still seeing rate growth and have just moderated their expectations just ever so slightly, but with no one thing causing it.

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Operator [57]

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There are no further questions at this time. I'll turn the call back over to our presenters for any further closing remarks.

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John Christopher O'Neill, American Hotel Income Properties REIT LP - CEO of American Hotel Income Properties REIT GP Inc. [58]

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I appreciate everyone listening and the questions, and we're feeling very positive about our results from Q1 and look forward to talking with you again in 3 months or sooner. Thank you.

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Operator [59]

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This concludes today's conference call. You may now disconnect.