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Bethesda-based real estate investment trust (REIT), DiamondRock Hospitality Company (DRH - Snapshot Report), recently announced the acquisition of Hotel Rex in San Francisco for $29.5 million. This major acquisition marks the entry of DiamondRock in San Francisco.

The 94-room Hotel Rex was opened in 1996 and is managed by Joie de Vivre Hospitality, Inc. The hotel is situated in the heart of San Francisco city  in close proximity to city landmarks such as Union Square, Moscone Convention Center, Yerba Buena Gardens and the Museum of Modern Art.

Hotel Rex is a well-equipped boutique hotel, which caters to both leisure and business travelers, and enjoys current occupancy rate of over 85%. DiamondRock intends to invest in further renovation and development of the property to hike Average Daily Rate (ADR) and also avail leased space opportunities for retailers.

DiamondRock anticipates that the hotel will generate revenue per available room (RevPAR) of over $150 in 2012, which represents a year-over-year increase of 20%. RevPAR is expected to increase over 10% in 2013 backed by strong demand for all guest types in San Francisco.

The acquisition is in line with the company’s ongoing portfolio restructuring activity. The company is actively selling off the non-core properties and using the proceeds to purchase assets in fast growing regional markets in the U.S. In October 2012, DiamondRock sold a Starwood Hotels and Resorts Worldwide Inc. (HOT - Analyst Report) property - Westin Atlanta Perimeter North - for $39.6 million. The hotel was sold to a joint venture among Carey Watermark Investors Inc., The Arden Group Inc. and Marcus Hotels & Resorts of The Marcus Corporation (MCS - Snapshot Report).

San Francisco, the leading financial and cultural center of Northern California and the San Francisco Bay Area, is one of the top tourist destinations in the world. Year-to-date through October 2012, the city recorded strong performance with RevPAR growth of approximately 14.0%. The city’s lodging industry mainly benefits from high demand and lack of new hotel supply.

Moreover, the advent of highly profitable events in the city going forward will likely boost the operating performance of the lodging market in coming years. These growth factors have caught the attention of DiamondRock. However, DiamondRock should be wary of its competitors. Its top peers, Strategic Hotels & Resorts, Inc. (BEE - Snapshot Report) and FelCor Lodging Trust Incorporated (FCH - Snapshot Report), already have a strong presence in the city.

DiamondRock owns, acquires, and invests in upscale hotels under the Hilton, Marriott and Westin brands across the U.S. The company reported adjusted FFO (funds from operations) of 18 cents in the third quarter of 2012, missing the Zacks Consensus Estimate by a penny. Its current property portfolio includes 27 hotels with over 11,600 rooms.

We have a long-term Underperform recommendation on DiamondRock. Also, it carries a short-term Zacks #4 Rank (Sell).

Note: FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.

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