Hotel REITs: Both sides now

NATIONAL REPORT—Anyone on the lodging-conference circuit knows that lobby chatter is at least 90% about deals: who did one, who’s doing one, and who’s looking at doing more. At one point, hotel REITs were the hottest topic out there along those lines, their acquisition activity so robust, competitors considered them the Goliaths of the transactions sphere and very hard to come up against in a deal. While that eminence is in retrograde, hotel REITs, nonetheless, still are in focus, thanks in no small part to those wanting to be a part of that investor mix, such as Hilton’s spinoff Park Hotels & Resorts and REIT-in-waiting CorePoint Lodging Inc., hoping to be spun out of La Quinta Holdings Inc.

With Q4 2017 on the horizon, Hotel Business decided to take a sample look at how hotel REITs are perceived at this point, from both “inside”—REIT executives—and “outside”—expert observers—perspectives.

The “outsiders” who offered their viewpoints are John B. (Jack) Corgel, professor of real estate at the Cornell School of Hotel Administration and senior advisor CBRE Hotels’ Americas Research, and economist Calvin Schnure, SVP of research and economic analysis, NAREIT (National Association of Real Estate Investment Trusts). The “insiders” are Dennis Craven, COO, Chatham Lodging Trust; Justin Knight, president/CEO, Apple Hospitality REIT; and Robert O’Neill, CEO, American Hotel Income Properties REIT LP (AHIP).

How would you characterize lodging REITs right now in terms of performance?Schnure: The hotel and lodging REIT sector has enjoyed good operating performance recently, with rising funds from operations (FFO) and net operating income (NOI) over the past several years. For example, NOI of the hotel and lodging REIT sector was $2.15 billion in Q2 2017, an 81% increase compared to Q4 2012. FFO of the sector was $1.55 billion, more than triple the Q4 2012 level. While some of this increase is due to new hotel REITs in the FTSE-NAREIT All Equity REITs index, over two-thirds of the increase is due to higher NOI and FFO of REITs that have been in the index this entire period.
Corgel: Hotel REITs face the same slow growth as other owners and managers in the industry. This does not mean they are losing money…just that incomes are not growing. Margins have held up due to expense control.

Are they overall active or conservative in terms of buying, selling?
Corgel: Hotel REIT portfolio expansion and shrinkage depends on their stock prices and relation to NAV (net asset value). Most trade at a single-digit discount, and prices have been flat during 2017. This means that the economics of buying are not present and the incentives for selling are not great. Hence, portfolio pruning and selective portfolio balancing will continue.
Schnure: REITs have been conservative in their acquisitions since 2015

Lodging REITs in the recent past were considered aggressive hotel buyers. What happened?
Schnure: REIT acquisition activity has slowed sharply. The hotel REIT sector overall were net sellers in 2016, and net acquisitions in first-half 2017 averaged $240 million per quarter. This compares with an average net acquisitions of $800 million per quarter from 2010 through 2015. The cost of capital for hotel and lodging REITs has been less favorable in recent quarters. Executives also have been conservative in their acquisitions.
Corgel: The prospects for property price appreciation are not favorable.

Might lodging REITs be building so-called “war chests,” hedging their bets in anticipation of a downturn?
Corgel: I don’t think many REIT managers place a high probability on a near-term downturn. It is not a time to buy and sell. It is a time to hold. At these low inflation rates, holding cash isn’t preferred but also is not illogical.
Schnure: Growing supply presents a challenge to property owners in hotel and lodging. Also, slack growth of corporate business travel has limited the growth of demand.

REITs in the lodging and resort sector have managed these concerns and have posted significant increases in FFO and NOI. 

Where do you see lodging REITs heading in 2018?
Schnure: With corporate profitability on the upswing, business travel (and hence demand for hotel rooms) is likely to benefit from strengthening fundamentals. Leisure travel, which accounts for a smaller slice of REITs’ demand, has outpaced business demand of late and remains solid. New supply appears to be leveling off. The outlook for second-half 2017 and for 2018 looks bright.
Corgel: Flat and not very exciting.

What are chief concerns for lodging REITs at the moment?
Craven: New supply is the biggest concern. In addition to approving the development of new hotels in existing brands, the brands continue to push out new brands. Supply growth has adversely impacted most lodging REITs even though the supply growth rate on a historical basis is within the norm.

Additionally, GDP growth has been steady but muted. We need stronger economic growth and we would certainly like to see the folks in Washington, DC, get back to tax reform and pro-economic growth initiatives.
Knight: Our chief concerns are focused around the political and macro-economic environment within which we operate.
O’Neill: At the moment, it seems the lodging industry is seeing a historical high—and it has been for a while. We are seeing a high revenue brought forth by a strong economy. The concerns around lodging REITs now revolve around deciphering which way the hotel business and occupancy rates will go from here.

Are you being active or conservative in terms of buying, selling?
Craven: At Chatham Lodging Trust, we are being conservatively active. The hotel transaction market is not deep in terms of available opportunities so we must work hard to uncover deals in markets that meet our investment criteria. Our company specializes in understanding where those markets are by utilizing our knowledge as asset managers.
Knight: We are selectively looking at both acquisitions and dispositions that we feel further align our portfolio around our core strategy and increase our exposure to markets and demand generators likely to see outsized growth in the coming years.
O’Neill: AHIP has maintained a disciplined investment strategy and remained very active in terms of purchasing new properties (see Hotel Business, Aug. 7, 2017). AHIP has every inclination to continue along this path; however, we also are remaining patient and waiting on the right opportunities to arise based on the current environment of the lodging REIT industry and our investment strategy.

Where are you putting the Trust’s focus right now?
Craven: We have identified hotels to acquire and we intend to fund that growth through…selling certain hotels and recycling capital. We are in the process [with]the sale of two hotels and redeployment of that capital into what we expect will be three acquisitions. These will be the first asset sales since our inception in 2010. Second, we’re going to leverage existing assets where there is an opportunity to add significant value, where we already own the land and have invested in the infrastructure and already own a hotel there. Additionally, we are looking at little opportunities where we’ve added more guestrooms by converting other types of space (meeting, storage, retail) in limited-service or upscale, extended-stay hotels that were overbuilt and not being used very often. These investments are very accretive.

Third, we’re going to develop a hotel or two on a very select basis… We’re looking for yields that are 10% unlevered and better in order to undertake that kind of activity.
Knight: We are focused on the fundamentals of our business, managing the mix of customers in our hotels and controlling expenses in order to maximize profitability.  We are monitoring our markets and making adjustments to our portfolio through strategic renovations, asset sales and acquisitions in order to ensure continued relevance for our customers and long-term profitability for our investors.
O’Neill: Given our recent acquisitions, we are focusing on working with our hotel management partner on the assimilation of these new properties across the country.

Is there a particular direction you see lodging REITs heading in 2018?
Craven: I see lodging REITs going up over the long term. Our rents reset daily and in a rising economic environment, lodging REITs should be best positioned to benefit. The quality of the real estate held by most lodging REITs is very good. Our cash flow is strong and our dividends are meaningful.
Knight: I anticipate that we will see some increase in transaction volume in the coming year as private owners look to secure profits and buyers and sellers find a way to bridge the gap that currently exists around pricing expectations. REITs are likely to continue to manage their businesses as they have in 2017 with a focus on maintaining margins and conservative balance-sheet management to provide maximum security and flexibility given continued uncertainty on both the political and economic fronts.
O’Neill: Right now, the lodging REIT industry is sitting at a historical high, and I remain positive that it will continue to prosper and expand. Financing for acquisitions continues to be readily available and at historically low interest rates. Revenue is high, and the economy is driving forward, which means good business for lodging REITs, so we maintain a positive outlook for 2018. HB