A Publication of Paramount Capital Corporation. Strategy and Insight for the Commercial Real Estate Industry

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1 Volume III Issue 10 A Publication of Paramount Capital Corporation Nov 15, 2011 Strategy and Insight for the Commercial Real Estate Industry AN UPDATE ON MORTGAGE LOANS HELD BY BANKS AND THE CMBS INDUSTRY AND REIT FOCUS ON ASHFORD HOSPITALITY TRUST, INC. For this issue of VOM, we will discuss the state of the industry, update and analyze the latest data on the balance of mortgage loans held by FDIC insured banks and the CMBS industry and REIT focus which will be on a large lodging company, Ashford Hospitality Trust, Inc. Industry Update It appears the CRE industry is slowly starting to come back to life. There are many positive signs including, increased job placements on job sites such as Selecteleaders.com and others, robust activity in the sale and finance of apartment properties, expanded lending activity in all property types except land and an overall increase in the volume of transactions. This burst of activity doesn t mean that the industry is ready for the next boom, but these are positive signs of recovery from a brutal downturn that is closing in on its fifth year. The volume of activity is still somewhat concentrated in the core markets of New York, Boston, Los Angeles, San Francisco and Seattle and in leased class A type properties. Activity outside of core markets and core properties is picking up but still very subdued. Of the four property types of office, retail, industrial and apartment, the greatest activity is in apartments. Leased up Class A apartments are in great demand and are trading for 4%-5.5% cap rates. There are also approximately 75,000 new units to be developed in 2012 and shown below in Table I. Most of the new development is being done by the public apartment REITs as they have easier access to debt and equity capital. For example, Avalon Communities, one of the largest apartment REITs has approximately $1 billion in apartment development projects in the pipeline. The least favorable asset is land, which is still being sold at discounts of 40% to 90% depending on the location and entitlements. It is also very difficult to finance land and

2 future development opportunities are limited. We here at VOM have looked at recapitalizing a well located 68 acre commercially zoned land parcel with all entitlements in a Northern CA city just off a major east/west freeway. The land has $14.6 million of bank debt and $3.4 million of equity. The land is worth in a cash sale approximately $3-$5 million, so as stated above, there is a big discount for land. Table I Bank and CMBS Loans We last looked at the amount of bank and CMBS loans in the September 15, 2010 issue of VOM. Table III below updates this data and shows the total CRE loans held by the 7,830 FDIC insured banks as of the second quarter of 2010, 7,513 banks as of the second quarter of 2011 and the CMBS industry as of September As we have discussed here numerous times, the average value reduction of CRE pricing from its peak in October 2007 was approximately 45% per the Moodys/Real Commercial Property Price Index, as shown in Table II, and is currently down 37%. Therefore, we will use 37% to estimate the current value of the real estate assets and potential value write-down from these mortgage assets. In addition we will assume that the average loan to value ratio of the loans was 75% when the loans were originated.

3 Table II Table III FDIC Bank CRE Loans: 6/30/10 6/30/11 Construction and Land Development $383,000,000 $275,000,000 Commercial Real Estate $1,081,000,000 $1,059,000,000 Multifamily Residential $215,000,000 $216,000,000 Farmland $67,000,000 $68,000,000 Total $1,746,000,000 $1,618,000,000 CMBS Loans (9/10 & 9/11) $707,000,000 $680,000,000 Total CRE Loans at Banks and CMBS $2,453,000,000 $2,298,000,000 Estimated Original LTV Ratio 75% 75% Estimated Original Value of Properties $3,271,000,000 $3,064,000,000 Average Value Reduction Per Moodys/REAL 55% 63% 9/10 & 9/11) Estimated Current Value of Properties $1,799,000,000 $1,930,000,000 Balance of Loans Per Above $2,453,000,000 $2,298,000,000 Estimated Value Write-Down ($654,000,000) ($368,000,000)

4 As shown in the table above, the value of commercial real estate loans held by banks and the CMBS market are underwater by approximately $368 billion. This is down from the $654 billion projected in September The decrease is due to a reduction in the amount of loans outstanding and the lower estimated price reduction from 45% to 37%. Although the amount of problem loans in the system is declining, $368 billion is still a large amount of loans to be restructured, foreclosed and refinanced. Assuming the average loan balance is $10 million, there are 36,800 properties to restructure, a huge and daunting task. As the economy and CRE industry improve, this amount may decline further. However, the lenders have already restructured the easiest and most attractive loans and the remaining properties securing these loans may never recover to their 2007 value. REIT FOCUS This month s REIT Focus is on Ashford Hospitality Trust, Inc. ( AHT ). AHT is a selfadministered and self managed Maryland equity real estate investment trust that invests in the hospitality industry across all segments including direct real estate, secrutities, equity and debt. AHT owns its lodging investments and conducts its operations in an UpReit structure through Ashford Hospitality Limited Partnership. A wholly owned subsidiary of AHT is the general partner of the UpReit limited partnership. AHT directly owns 91 hotel properties and 5 hotel properties through majority owned joint ventures which represent 20,656 rooms all of which are located in the U.S. AHT owns a number of different hotel franchises including, Embassy Suites, Hilton, Hampton, Marriott Courtyard, Sheraton and others. AHT commenced operations in 2003 and is headquartered in Dallas, TX. For the nine months ended 9/30/11, the RevPAR, average occupancy and average daily rate were $95.30, 73.62% and $ respectively. As of 11/14/11, AHT had 68 million shares outstanding, a stock price of $7.45/sh and a market capitalization of approximately $507 million. Select financial data for AHT as of the 9/30/11 10Q for the period 1/1-9/30/11 are as follows:

5 Real Estate Assets $3,537,000,000 Total Assets $3,628,000,000 Mortgages and Other Debt $2,391,000,000 Shareholders Equity $992,000,000 Revenue $656,000,000 Net Loss ($26,000,000) Earnings Per Share ($.44) Cash Flow from Operations $64,000,000 Senior Credit Facility $150,000,000 Market Capitalization $507,000,000 Debt to: Market Capitalization 471% Assets 66% Real Estate Assets Per Room $171,000 Dividend Yield ($.40/sh) 5.20% NOI and Value Calculation: Revenues Per above Annualized $875,301,000 Rental, G&A & Other Expenses ($623,143,000) Projected NOI $252,158,000 Projected Cap Rate 9.5% Projected Value of Portfolio $2,654,000,000 Less: Total Debt ($2,391,000,000) Value of Company Equity $263,000,000 Shares Outstanding 68,000,000 Projected Value Per Share $3.86 Market Price Per Share (11/14/11) $7.45 As shown above, our value for AHT is $3.86 per share versus a market price of $7.45 per share. The value difference can be attributed to the use of a higher cap rate of 9.5%, which is the average cap rate for full service lodging properties across the US per the August 2011, CBRE Cap Rate Survey. Some of the value difference may also be due to annualizing the September 30 th income and expenses and no incremental value given for goodwill and management. The market however, is valuing the company at a cap rate of approximately 8.6%, which we believe is too low of a return, given the risks inherent in lodging investments. Lodging properties are 60% business investments and 40% real estate investments. This is due to the fact that lodging properties have more operating business than real estate characteristics like large staffs, 24/7 operations, ancillary services like shops and restaurants, one night leases and are very sensitive to economic activity. With more business characteristics, lodging properties are subject to more business and financial risk and

6 therefore should be valued at higher cap rates as compared to traditional commercial real estate assets. The other issue with AHT is its high level of debt at 471% of its market cap and 67% of the cost of its properties. In reviewing the third quarter 10Q, we noticed that AHT created and invested $20 million in a subsidiary that invests in public securities including taking long and short positions in stocks, bonds and options. AHT also purchased a credit default swap derivative for a notional amount of $100 million and a premium of $8.2 million. It appears that AHT is speculating in the stock, option and credit default swap markets and this seems very strange for a hotel investment and management company. There is no fundamental business reason for AHT to acquire a credit default swap or stock/bond investments, other than for speculative investment purposes. It should raise shareholder concerns as to why a hotel REIT, that must distribute 90% of its taxable income as dividends, is using company cash funds to speculate in the stock market. I guess no one remembers the $157 million that Proctor and Gamble and the $19.7 million that Gibson Greeting Cards lost in ill conceived derivative investments in the 1990 s. We here at VOM believe that companies should stick to the core business and invest capital in that business to increase the value of their stock and company. AHT has an attractive dividend at 5.20% but we would not recommend purchasing the stock due to its high price, high level of mortgage debt and stock and derivative speculation activities in the market. REIT Focus reviews in prior issues of VOM are as follows: 1. BRE Properties, Inc., June 15, Boston Properties, Inc., July 15, Simon Properties Group, Inc., August 15, First Industrial Realty Trust, September 15, Public Storage, October 15, 2011 THE VIEW OF THE MARKET NEWSLETTER ARCHIVES Copyright Paramount Capital Corporation 2011 Disclaimer: The information, strategies and material presented in the newsletter are for information purposes only and not to be considered as an offer or a solicitation to sell or an offer or solicitation to buy or subscribe for securities, investment products or other financial instruments. This newsletter is available only by paid subscription and should not be reproduced, copied, ed or disseminated in whole or in part without the express written consent of Paramount Capital Corporation.