Mountain High. Sunday River, Sugarloaf. Mount Snow. Bretton Woods. All have been purchased since June 2006 by a REIT. What makes these companies the latest craze in resort financing?

"We've always felt REITs were the proper financial vehicle for the ski industry," says Peak Resorts CEO Tim Boyd, "especially from the standpoint of operators who are not real estate developers. Ten to 15 years ago, we tried to start a ski area REIT. But we decided it was easier to work with one that already existed."

As have others. CNL Income Properties owns all those mentioned above (except Mount Snow), plus Cypress, B.C., Brighton, Utah, Northstar-at-Tahoe, Sierra-at-Tahoe, Snoqualmie, Wash., and Loon, N.H. Entertainment Properties Trust (EPT) owns several Peak Resorts properties-Mount Snow, Crotched, N.H., and Mad River, Ohio-and is buying other Peak properties.

THE PERFECT STORM

Is there a good reason for all this activity? No; there are several good reasons for it.

The basic mechanism is this: a REIT purchases the resort, then leases it back to the seller via a longterm management contract, frequently 20 years with the option for two 10-year extensions. According to the terms of the typical triple-net lease, the management group pays yearly rent and does the maintenance and upkeep on the property.

REITs offer several benefits. For one, they are a relatively low-cost and reliable source of financing. "A REIT gets money from public sector, and money is cheaper from the public market," says Boyd. "The problem with going public [as a ski resort] is that revenue numbers don't generate enough growth to keep pushing the stock price. Real estate is what keeps public companies going."

"We view ourselves as a hybrid of bank and equity partner," says Michael Birger, VP of investments for EPT. "But without covenances like a bank, or a dollar limit on ski industry exposure like some banks. But we ask for less return and interfere less than an equity partner."

Plus, REITs are hands-off owners (by law), and they generally have a much longer time horizon-decades, rather than quarters. "It's similar to a mall owner and Macy's," says Pat Corso, Bretton Woods Resort president. "We're Macy's. They provide the capital to improve the property; we pay a fee for the lease price. They are more involved than a bank would be, but we are the authors of the destiny we want to create."

"REITs are so much easier to work with than the banks," Boyd says. "With banks, even when you are paying them, they are not satisfied. They have so many more constraints and covenants."

And REITs enable resorts to capitalize on their real estate assets sooner rather than later. "We look at it as a way for us to take our equity out and maintain and start a management company," says Karl Kapuscinski, CEO of Mountain High, which did a sale/lease deal with CNL in July. "We hope to eventually expand and manage other properties."

"It's a choice. Do you want to build equity, or build cash flow?" Boyd asks. "We decided we were a cash flow company. You're still building value, but as an operating company, not an equity company. We were always more interested in being successful right now, not in 25 or 30 years. That's the real advantage that REITs offer."

REITs also have an incentive to continue investing in their properties. "Incremental investment is a way to protect that investment-if an area needs that investment to compete, the REIT wants to keep the management successful," Birger says. For example, at Mount Snow, EPT is supplying the capital for a water pipe to significantly improve snowmaking. "We have access to capital to make that possible," Birger says, "and that capability will increase the value of the whole property."

There's another advantage: the seller can get a higher price. "If you're expecting a resort to kick off $10 million a year for the rest of existence, as private equity, you might have to pay no more than $50 million for the resort, to get your 20 percent return," says Baxter Underwood, VP of investments for CNL Income Corp. "As a REIT, you can afford to pay a bit more-say $55 million-and still get the percentage return you want. That's one thing sellers have responded to."

From the REIT's perspective, resorts are attractive "because the operations are so capital-intensive, and not easy to replicate," Birger says. "There are not a lot of new resorts," so there's not likely to be a glut anytime soon.

Even so, resorts are a relatively new play for REITs. Traditionally, they have bought into commercial real estate. With resorts, they are relying in part of the management to derive the value from operations. And that makes them a bit more risky. For this reason, REITs prefer to work with management groups that have a solid track record.

EXPERIENCE TO DATE

It's not easy to find anyone who sees any downside to REIT ownership. "The only thing that changes is the network of support, it's larger," says John Rice, GM at Sierra-at-Tahoe, one of the Booth Creek-managed resorts in the CNL stable. "We're talking with Mountain High about the diversity market, since they have had so much experience with it."

"We're not just communicating with other area managers, but with those outside the ski business," he adds. CNL is in a lot of amusement parks; they may have ticketing or line control ideas, or vice versa. Who knows what we'll discover?

"I don't see any downsides at all. But ask me again in a couple of years."

THE ART OF THE DEAL

What does it take to do a deal? "We look at the worst case scenario," says Kapuscinski. "Even in our worst year in the last 10, we would have had enough cash flow for capital expenditures. We're looking at $1.1 million to $1.5 million clear in an average year. That's a decent payday. We'd like to add two or three more resorts to the company, then maybe we're clearing $4 million to $5 million."

Doing the math is not rocket science, says Stephen Kircher, Boyne's eastern president; Boyne has done deals on four resorts this year. "Some of what we do is proprietary; but it's based on a traditional review of cash flows. You figure out what you can pay based off of that. The multiples aren't any different."

"The goal is to monetize investments in real estate and put it back into the business," says Ken Baer, CFO for Bretton Woods. "In risk analysis, you look for a spreading of the risk. In this case, having a full resort, with ski area, hotel, golf course, beautiful location, real estate, we have multiple legs, that spreads the risk. The driving force on this was the iconic elements, the hotel (the Mt. Washington) and the view. You can't duplicate those.

"The other key is battle testing your economics, testing your pro forma."

Boyd looks for resort EBITDA that's twice the amount of the lease payment. "That takes some constraint on both our parts," he says. "But you have to be able to cap ex properly, or else you wind up like ASC [American Skiing Company].

"REITs force you to make sure the ROI is there. If it isn't, you shouldn't take the money."

Buyout Candidates

What types of areas are REITs looking for? Those with good cash flow and the potential to increase it. "Even day areas have their appeal, but pressures are on to mitigate the risks," says Birger. "We write to site-specific locations, where the demographics support our goal." EPT focuses on areas with affluent populations within easy driving distance.

Good managers are key. "Since we're long-term investors, it's nice to have a dependable partner. We don't want them to get distracted; we want them to focus on their immediate issues," he adds.

"If areas want to sell out but not manage, someone like Mountain High could move in as manager," says Kapuscinski. But, he adds, "there are only so many areas that can exclude real estate and work from an operations standpoint."

That's why REITs are very involved in the initial planning. "The REIT wants to make sure that your planning will work," says Corso. "The game plan is laid out before you do the deal. You are going to be their partner, so you're involved all the way through with them. The strength of the relationship is based on the preliminaries, up to the closing."

"We plan those future investments as part of the initial purchase," echoes Underwood. "We ask, 'what can we bring that will make this asset perform better?' For example, there are capital leases out there, say in the snowcat world, that are more expensive than our money. So we can buy it with equity at a lower interest rate. That's also true for lifts and snowmaking and other capital equipment."

Can REITs or their investments fail? Of course. Success depends on paying a fair, not inflated, price for the resort, and making sure that the EBITDA covers the lease, cap ex, and other costs of management. But REITs seem to stack the deck in favor of success.



What is a REIT?

REITs are tax-advantaged investment companies that extend the benefits of real estate ownership to everyone, especially small investors. That source of equity is less expensive than private equity. One benefit for investors is that, as a specialized tax corporation, REITs pay no tax, but must pay out 90 percent of their revenue each year. Also, REITs invest in tangible assets, which reduces risk, and profits are taxed as capital gains. So investors are satisfied with 5 percent to 9 percent annual returns. Finally, these are public companies, and investors can also gain from stock price appreciation. (Some REITs are publicly traded on the stock market, some not.)

Since REITs get their cash from retail investors, they have low leverage-typically, 30 percent or less. They are not directly affected by things like the recent credit crunch. With the global economy awash in dollars-thanks to Americans' enormous appetite for foreign goods-there's plenty of cash chasing a return. REITs are one of the safest vehicles for that pursuit.



Boyne USA, the New Mega-Manager

Boyne currently owns or manages 10 winter resorts plus two non-sliding resorts (Gatlinburg, which it purchased in 1952, and Bay Harbor). This makes the company one of the largest winter resort operators in the country, a position it has been aiming at for years. But it would not be there without the support of CNL, owns six of the 10 areas.

"We're not necessarily looking to get bigger, but we would, if the right opportunities came along," says Boyne East president Stephen Kircher. "We've been preparing for four years for what we've done to date, and we're preparing for more. We're working hard to build on our 60 years of experience in managing remote geographical locations."

Adding four areas in the past year is, Kircher admits, "a bit of a throttle up." But Boyne has had its eye on New England for more than a decade. "We have been expanding geographically and wanted to get there," says Kircher. "The combination of Loon plus the Maine resorts was a significant move, they make a serious foothold. We didn't want to be there in a small role. CNL capital enabled us to be involved in a bigger way than we historically would have been." But not as big as Boyne USA may eventually become.