REIT Rankings: Hotels
This is an abridged version of the full report published on Hoya Capital Income Builder Marketplace on July 6th.
Despite recession-like levels of consumer confidence and surging transportation costs, the U.S. hotel industry is enjoying record-high revenues in recent months as the ‘Summer of Revenge Travel’ has helped to offset mounting economic headwinds. Skepticism over the sustainability of this momentum, however, has dragged on the hotel REIT sector over the past month after being the top-performing property sector for much of 2022. Within the Hoya Capital Hotel REIT Index, we track the sixteen largest hotel REITs, which account for roughly $35 billion in market value.
Dubbed the ‘Summer of Revenge Travel’, Americans are traveling this summer at rates approaching pre-pandemic levels as several years of COVID-delayed demand has finally been unleashed. According to recent data from STR, U.S. hotel revenue per available room (“RevPAR”) climbed to an all-time high in late June as surging room rates from “price-agnostic” leisure travelers have more-than-offset the lag in occupancy rates relative to pre-pandemic levels. In the most recent week of data, average hotel occupancy was still about 4% below 2019-levels but Average Daily Rates (“ADR”) were remarkably more than 17% higher than 2019, resulting in an average Revenue Per Available Room (“RevPAR”) that was 12.3% above pre-pandemic levels.
For the leisure industry, “two weeks to slow the spread” became two long years of operational struggles, and just as COVID headwinds faded, soaring energy prices and slowing global economic growth have become new risk factors. While the ‘Revenge Travel’ momentum should be enough to drive strong hotel performance throughout the summer, concerns over a “demand bubble” appear warranted given the complexion of the recent boom, driven almost entirely by domestic leisure travel and surging urban room rates while business and international travel remain severely depressed. Recent TSA Checkpoint data has shown a stalling-out in the travel recovery with June recording the lowest level of throughout since March as a percent of pre-pandemic levels, trends that continued into the July Fourth weekend.
STR – the leading hotel industry research firm – provided a mixed updated outlook in their U.S. hotel forecast in early June, raising caution about the impact of slowing economic growth, ongoing labor shortages, and unevenness across markets. STR now believes that nominal RevPAR will surpass 2019 levels this year – ahead of the prior forecast of 2023 – but delayed its forecast for the recovery in real RevPAR to 2024. STR noted that “Demand and occupancy have trended in line with our recent forecasts, but pricing continues to exceed expectations due to the influence of inflation.” While STR commented that “the outlook for hotel performance remains positive,” it noted that hotels in some major markets are still well behind in the recovery timeline and will likely not see a full recovery in real RevPAR until after 2024.
CBRE provided a relatively more upbeat outlook on the hotel sector in their latest report in late May, expecting a full demand recovery next year, but reiterated that there are “winners and laggards” across hotel markets and segments. CBRE noted that “hotel-specific leading indicators show no signs of deterioration, but macroeconomic leading indicators suggest there could be challenges ahead.” Lower-priced hotels continue to significantly outperform on an inflation-adjusted basis, reaching 2019 RevPAR levels in 2021 and seeing a full occupancy recovery this year, but a recent surge in room rates in the luxury segment this summer has offset the RevPAR differential. While urban markets have closed the gap in recent months, the Top-10 performing markets in 2022 are all in the Southeast or Southwest regions led by Miami, St. Petersburg, Savannah, and Virginia Beach while the Bottom-10 markets are in Northeast or Northwest urban destinations with San Jose, San Francisco, Oakland, Seattle, D.C. and New York still 25-50% below pre-pandemic levels.
As discussed in our REIT Earnings Recap, these trends were on full display across hotel REIT earnings results as the mid-scale segment remains far further along in the occupancy recovery than REITs focused on the upscale and luxury segments. Notably, Southerly Hotels (SOHO) and Apple Hospitality (APLE) – reported a full recovery in occupancy levels by early Q2 in recent business updates over the past several weeks. Upscale hotel REITs with a business-heavy mix – notably Park Hotels (PK), Pebblebrook (PEB), Sunstone (SHO), and Host Hotels (HST) reported occupancy levels that were still more than 20% below 2019-levels in Q1, but have offset some of those declines with the recent surge in urban room rates, which are 20-30% higher, on average, across the upscale and resort segments due in large part to higher labor costs and staffing shortages that have forced some hotels to limit available room nights or reduce services.
Hotel REIT Stock Performance
Hotel REITs – along with the global leisure and tourism industry – were decimated in the early stages of the coronavirus pandemic, plunging by more than 65% between late February and early April 2020. The vaccine rollout in late 2020 and into early 2021 sparked a “reopening rotation” into many of the beaten-down COVID-sensitive sectors, but hotel REITs were unable to hold onto that outperformance throughout the year, ultimately ending 2021 with total returns of 19% compared to the 41% returns on the Equity REIT Index – marking their fourth-straight year of underperformance.
Hotel REITs were the top-performing REIT sector for much of 2022, buoyed by the growth-to-value rotation across the global equity market and optimism around the post-COVID recovery. Skepticism over the sustainability of the travel recovery momentum, however, has dragged hotel REITs lower by nearly 20% over the past month. The Hoya Capital Hotel REIT Index – a market-cap weighted performance index – is lower by roughly 14% so far in 2022, slightly outperforming the -19.7% decline from the Vanguard Real Estate ETF (VNQ) and the -18.3% decline from the S&P 500 ETF (SPY).
Within the sector, we’ve seen a clear “flight to quality” pattern and outperformance from hotel REITs focused on the midscale segment, notably Southerly Hotels and Apple Hospitality. The lone hotel REIT in positive territory this year is Hersha Hospitality (HT), which announced last quarter that it will sell seven properties for gross proceeds of $505M or ~$360K/key and use the proceeds to “significantly” reduce its debt. Several hotel REITs have created significant shareholder value by selling assets into the private markets at premium valuations including CorePoint Lodging which surged more than 125% last year after it agreed to be acquired by a group led by Cerberus Capital. Condor Hospitality meanwhile, also soared more than 100% last year after selling its entire portfolio to Blackstone (BX) in a $305M deal that closed in January.
Hotel REIT balance sheets have – as a whole – improved considerably over the past several quarters, but several REITs are still far from out-of-the-woods. The roller-coaster ride for Ashford Hospitality (AHT) – one of the worst-performing REITs of the past decade – has continued this year with the stock underperforming yet again amid a continued wave of dilutive share issuances. AHT, along with a handful of other small-cap hotel REITs including Service Properties (SVC) and Braemar Hotels (BHR) that operate with elevated levels of leverage, has seen their balance sheet issues worsen during the pandemic and simply cannot afford any further setbacks in the recovery.
Deeper Dive: Hotel REIT Economics
Hotel ownership is a tough, capital-intensive business even in the best of times. Generally, the companies that are ubiquitous with the hotel business Marriott (MAR), Hilton (HLT), Hyatt (H), Choice Hotels (CHH), and Extended Stay (STAY) – don’t actually own hotels but instead simply manage the hotel for the property owners. These hotel operators are typically structured as C-corporations and tend to operate with an “asset-light” operating model with higher margins and lower leverage. While REITs are effectively partnering with these hotel operators, the relationship with another emerging player – Airbnb (ABNB) – isn’t quite as friendly.
In recent years, hotel operators have been negatively impacted by a growing “shadow supply” of transient rooms offered through short-term home rental firms such as Airbnb. While we’re skeptical of Airbnb’s valuation – 2x the market capitalization of the entire hotel REIT sector combined – we are believers in the growing utilization of short-term home rentals. While short-term rentals represent less than 10% of available room nights on an average night, supply growth tends to swell considerably in response to high demand. Studies from STR and the BLS have found that short-term home rentals affect urban hotels most acutely, representing a source of “liquid supply” that compromises pricing power on critical compression nights.
In contrast to these hotel operators, hotel REITs operate under a relatively asset-heavy model and operate at considerably lower margins. We estimate that during “normal” times, hotel REITs operate at adjusted NOI margins of just 10-20%, the lowest in the REIT sector. Because of this operating profile, they assume a high degree of operating leverage and are highly sensitive to marginal changes in supply and demand conditions. Hotel REITs tend to be less nimble and have slower growth rates than C-corp hotel operators, but have historically paid a sizable dividend yield to investors.
Perhaps the only silver lining of the pandemic, the hotel development pipeline is finally showing signs of cooling after a half-decade of above-trend growth, and if the past recession is any indication, developers will be slow to resume activity even after the dust settles. Over the past several years, supply growth was most acute in the middle- and upper-quality segments, the segments most commonly owned by hotel REITs. On the other hand, supply growth has been nearly non-existent in the limited-service and economy segments, which have been two of the outperforming categories over the past several years.
Hotel REIT Dividend Yields
It’s tough to pay dividends if hotels are sitting half-empty. Generally speaking, 40-50% occupancy is needed to “keep the lights on” for hotel REITs. Once one of the highest-yielding REIT sectors, all 18 hotel REITs slashed their dividends in 2020 – accounting for a sizable percentage of the total REIT dividend cuts during the pandemic – and despite the first wave of dividend resumptions this year, hotel REITs remain in the basement of the dividend yield tables. Hotel REITs pay an average dividend yield of just 1.0%, far below the 3.4% yield on the market-cap-weighted average and significantly below the 7.5% yield on the tier-weighted Hoya Capital High Dividend Yield Index.
While hotel REITs have generally been among the last REITs to restore and/or raise their dividends, as anticipated earlier this year, Apple Hospitality was indeed the first hotel REIT to materially restore its dividend, reinstating its monthly cash distribution of $0.05/share, representing a healthy dividend yield of 4.02%. Host Hotels is likely next on the list after APLE, having doubled its dividend rate in early May, the only other hotel REIT with a dividend yield above 1%. Two other hotel REITs also reinstated their dividends, but at nominal levels – Braemar Hotels reinstated its quarterly dividend at $0.01/share while Park Hotels also reinstated its dividend at $0.01/share.
Takeaway: More Cautious Outlook, But See Select Value
Dubbed the ‘Summer of Revenge Travel’, several years of pent-up demand from COVID delays have helped to offset mounting economic headwinds, powering hotel industry revenues to all-time highs in recent weeks. Concerns over a “demand bubble” appear warranted given the complexion of the recent boom, driven almost entirely by domestic leisure travel and surging urban room rates while business and international travel remain severely depressed. Given looming questions over the ultimate recovery in business and international travel – combined with shaky balance sheets and non-existent dividend yields – we remain cautious on full-service coastal hotel REITs, but see long-term value in select limited-service hotel REITs.
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