Summary
- Hotel REITs are a niche class among the REIT sector, consisting of 20 publicly traded REIT constituents that own and operate hotels, resorts and other lodging facilities.
- The hotel REIT subsector has historically outperformed other types of REITs and the S&P 500.
- Strategies vary by company, but include alignment with specific brands (i.e. Marriott, Hilton, Hyatt) and market segments (i.e. premium, economy, etc).
- Hotels are subject to greater volatility than most other types of real estate due to the discretionary nature of travel.
- REITs own more than 2,200 hotels throughout the US.
- Total Market Cap:
- Hotel REITs: $55,178
- All REITs: $1,087,402
- Average dividend yield of Hotel REIT Subsector: 5.5% compared to REIT Sector average: 3.9%. (FTSE, 2019)
What are Hotel REITs?
Hotel REITs specialize in the ownership of hotel and lodging related real estate. Among the first subsector of REIT to emerge in the early 1970s, hotel REITs have benefited from tremendous growth in business and personal travel. (NAREIT, 2019) From 2009 to 2017, gross bookings of US hotels grew from $116B to $185B. (2019 US Travel and Hospitality Outlook, 2019)
Strategies of the various hotel REITs vary based on several factors including brand alignment. Four out of five of the top performing hotel REITs align with premium managers with strong loyalty programs, namely Marriott, Hilton and Hyatt. The fifth has developed a premium brand of their own but has a much smaller portfolio than most peers.
Hotel REITs also diversify based on service level and price point. While REITs own only four budget hotels in total, limited service hotels are among the most popular making up 43% of hotel REIT portfolios. Three out of five of the top performing hotel REITs invest almost exclusively in premium, and upper upscale assets. These assets make up approximately 30% of REIT owned hotels.
Fundamentally, the assets are subject to the basics of all real estate investments, of which, location is foremost. Hotel REITs prefer to own hotels with significant volume and scale in top travel markets, particularly gateway cities. A portfolio diversified geographically and across price points can help to mitigate some volatility.
Hotel REITs yield an above average dividend of 5.55%. REITs are required to pay out 90% of taxable earnings, which means an investment in the niche subsector of REITs can be an excellent source of cash flow for a portfolio.
Evaluating a Hotel REIT
A few KPIs are helpful when considering an investment:
- Average Daily Rate (ADR)-represents the average rate charged per room, per night. ADR is calculated by taking the gross rental revenue for a certain period and dividing it by the number of rooms sold during that same period. Ideally, this number increases period over period, and can be used to compare rates across similar assets.
- Revenue Per Available Room (RevPAR)– RevPAR is calculated by multiplying the Average Daily Rate by Occupancy. Discounted rental rates, and complimentary stays are typically excluded from this calculation. An increase in RevPAR indicates that a hotel is either increasing rental rates, occupancy, or both.
- Occupancy-Occupancy reflects the ratio of occupied rooms to available rooms for a defined period. A positive trend in occupancy is a favorable indicator but not if it’s at the expense of the ADR. Managers continually seek to identify the ideal balance between these metrics.
These indicators can be used to identify trends in a portfolio’s performance relative to its own past performance, or to compare with other hotel portfolios of similar make up.
Performance of Hotel REITs
Dividend yields, and total returns trend well above average for hotel REITs. However, relative to other REITs, Hotel REITs tend to be subject to greater volatility. Historically Hotel REITs have outperformed in a strong market, as consumers and businesses allocated a disproportionate share of discretionary spending to travel. Conversely, travel is typically among the first cuts made. The table below shows a comparison of hotel REITs to the broader REIT sector, as well as the S&P 500.
Gateway cities with large volumes of international travelers, can help curb some of the pain of a weakening local economy. It’s also beneficial to be aligned with brands that have strong customer loyalty programs, which drive consistent patterns among frequent travelers.
Below is a breakdown of the top 10 travel destinations in the US, along with the number of REIT owned assets in each market:
- Atlanta 40
- Chicago 28
- Denver 18
- Las Vegas 6
- Los Angeles 11
- Miami 14
- New York City 43
- Orlando 23
- San Francisco 31
- Washington DC 35
Hotel REITs tend to be leading market indicators and represent a unique opportunity during a weak economy when valuations are low. As the economy begins to regain strength and travelers resume, you’ll likely begin to see increases in dividend payouts and market valuations sooner than the broader market and to a greater degree.
Pros and Cons of Hotel REITs
Pros
- Hotels have experienced impressive growth over the last decade with an industry CAGR of 6%.(2019 Travel and Hospitality Outlook, 2019)
- Dividend yields trend well above average for hotel REITs and can be an excellent source of cash flow.
- Hotel REITs have historically outperformed other REIT sectors, and the broader market.
- Millennials are driving substantial growth in the travel industry, positioning hotel REITs well for continued expansion in the long term.
Cons
- The hotel industry is likely to experience a contraction, in the short term, following 10 years of expansion.
- Cash flows tend to be more volatile than other real estate subsectors, due to hotel’s exposure to daily rate volatility, local market conditions and the broader economy.
- Hotels are subject to high capital expenditures, which can negatively impact yields. Average effective age is a metric to consider when evaluating hotel REITs.
- REITs are especially sensitive to interest rate fluctuations.
2019 Outlook for Hotel REITs
ADR, RevPAR and occupancy are all expected to continue to trend favorably in 2019, though at a pace slightly less so than 2018. ADR and RevPAR are expected to grow by 2.4%. Occupancy is forecast to increase .2%. (2019 Travel and Hospitality Outlook, 2019) The long-term outlook for the travel industry remains positive. Historically, hospitality has seen growth cycles of roughly 10 years, with short periods of contraction. Currently, in the tenth consecutive year of growth it is unlikely that we will see a contraction in 2019 but is becoming increasingly likely.
REITs in general are sensitive to fluctuations in interest rates, which can have a dramatic impact on cost of capital, in the current late-stage cycle, it’s important to identify a REITs exposure to variable interest rate risk. Rising interest rate expense, and a dip in occupancy could absorb much of your dividend.