CEO Jon Bortz has a long history in the lodging business. Prior to taking Pebblebrook Hotel Trust (NYSE:PEB) public in December 2009, Bortz was the CEO and founder of LaSalle Hotel Properties (NYSE:LHO). Pebblebrook's initial public offering (IPO) at $20 a share raised $402.5 million, all of which would go to acquiring "upper upscale" hotels. It would do another three offerings in 2010 and 2011 raising an additional $626 million, most of which would also be used to purchase hotels. Two-and-a-half years removed from its IPO, its stock sits less than a dollar above its IPO price. While some might see danger, I see an incredible opportunity. Read on and I'll explain why.

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Hotel Properties

When I first discovered Pebblebrook in June 2010, it had just purchased the Sir Francis Drake Hotel for $90 million along with another hotel in Bethesda, Maryland, with contracts to purchase three others in the works. Today, it owns 14 hotels with 3,812 guest rooms along with a 49% joint venture interest in another six hotels and 1,730 guest rooms. Pebblebrook paid $152 million for its share of the joint venture along with the assumption of $294 million in debt. The six hotels are all in New York City and the purchase price pegs the value per room at $526,000, approximately $80,000 a room higher than the average price paid in the second quarter of 2011. The New York City hotel market is likely the most lucrative in the United States so I'm confident Bortz knew the upside outweighed the initial cost. Long-term you can't serve the upper end of the market and not be in New York City.

When Bortz started his buying spree in 2010, Pebblebrook research indicated that there were 1,100 hotels in the U.S. in financial distress worth approximately $29 billion. Hotels in distress obviously will require capital reinvestment to bring them back to their former glory. Those costs have been a drag on profitability in the short term, but long term will pay big dividends in terms of revenue per available room. In the first quarter it spent $17.4 million on capital improvements including $5.5 million at the Westin Gaslamp Quarter in San Diego. The three-year renovation at the Westin is in its final stages. According to Bortz, "Early guest reviews and results at all of the [renovated] properties have been very encouraging." Its most recent acquisition is the Hotel Milano in San Francisco, where it paid $29.8 million to acquire the hotel and intends to invest an additional $8 million to $10 million to completely renovate it with completion in the second quarter of 2013. RevPAR at the Milano will increase significantly once the renovation is completed. Investors who are patient will be rewarded.

SEE: 5 Ways To Invest In Travel And Tourism

Profitability

The first thing most investors will look at in its first-quarter report is the 14 cents loss per diluted share. But that's to be expected given the capital improvements underway. In addition, a majority of its increase in hotel operating expenses in the quarter came from its five newly acquired hotels. Some of the key metrics improving in the quarter include an 8.4% increase year-over-year in RevPAR to $142.34, a pro forma EBITDA margin increase of 314 basis points to 18.4% and an increase in adjusted funds from operations of 37.5% to 11 cents per diluted share. Pebblebrook was very happy with the performance of its properties and investors should take note.

Where's the Opportunity?

To date, Pebblebrook has acquired 4,769 upscale rooms in 12 major markets at a 37% discount-to-replacement cost. Most of these hotels were seriously underperforming when they were acquired, which presented the company with serious margin expansion opportunities through higher average daily rates. In 2011, its hotel EBITDA margin was 25%; lower than LaSalle, Diamondrock Hospitality (NYSE:DRH), Sunstone Hotel Investors (NYSE:SHO) and Ashford Hospitality Trust (NYSE:AHT). Having formerly run LaSalle, whose margin is 600 basis points higher than Pebblebrook, you can bet Bortz is aiming to meet and exceed LaSalle's level of profitability.

SEE: A Clear Look At EBITDA

The Bottom Line

Pebblebrook expects hotel EBITDA margin growth of at least 250 basis points in 2012, RevPAR growth of at least 800 basis points and adjusted FFO growth of at least 18%. The real estate investment trust is like night and day from its IPO in late 2009. Yet its stock trades at the same price it did nearly three years ago. If that's not an opportunity, I don't know what is.

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At the time of writing, Will Ashworth did not own shares in any of the companies mentioned in this article.

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