Can Hotel REITs Capitalize on a Banner 2016?

This article is republished with permission from REITCafe.

Hotel real estate investment trusts (REITs) made a splash this past year as the sector outperformed expectations. Capitalizing on a strong fourth quarter, hotel REITs posted a healthy 25 percent total return for the year. The quarter-over-quarter jump of 15.29 percent far outpaced the broader REIT sector, which dropped 0.5 percent in the same time frame. This late-year boost is not completely surprising because travel was expected to increase through November and December due to the holiday season. The difference can also be explained by the pliability of hotel REITs in an environment with higher interest rates. Hotel REITs are more sensitive to movements in the equity markets and therefore are valuable to real estate investors who have exposure to interest-rate risk in their portfolios.

Despite the uncertainly and turmoil in both the political and economic spheres, it was a relatively standard year for the hotel industry, with revenue per available room (RevPAR) growth just north of 3 percent. Michael Bellisario, senior hotel research analyst and vice president at Robert W. Baird & Co., provided some insight on hotel valuations. “Hotel stock valuations appear to be pricing in a significant rebound in fundamentals for 2017,” he said, “although we believe management teams will remain relatively cautious as they set guidance expectations for the upcoming year.”
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The biggest future hurdle for hotel REITs will be managing supply as Airbnb continues to add 1 to 2 percent of supply to the market each year. However, the regulatory environment might hinder future Airbnb growth, providing a welcome valve to ease the pressure of continued growth of the homestay network.

Even after posting a strong 2016, the hotel sector still draws a mostly pessimistic outlook from experts. According to a recent post on Seeking Alpha, this will likely be the first year since the recession that the supply/demand balance becomes a headwind on performance rather than a tailwind; it reports that supply growth is expected to exceed demand growth by 0 to 2 percent. Hotel consulting firm STR is expecting 2.8 percent RevPAR growth this year, which would be the lowest since 2009.

However, the outlook is not all doom and gloom. Hotel REITs have unique characteristics that make them attractive to investors. In addition to their resilience to interest rates, their pro-cyclical nature can provide relief when other investments might underperform during good economic times.

* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.