This article is republished with permission from REITCafe.
The overwhelming majority of hotel real estate investment trusts (REITs) are trading at prices that represent discounts to their net asset value, as has been the case for more than a year now. The thinking in many circles is that the hotel sector is approaching its cyclical peak.
While performance data indicate continued growth, that growth has slowed appreciably. Meanwhile, some geographic areas are starting to see a glut of new construction, which is affecting occupancy and room rates.
STR (formerly Smith Travel Research) projects that the supply of rooms in the United States this year will increase by 1.7 percent, while demand will increase by 2.1 percent. Between 2011 and 2015, room supply grew by less than 1 percent annually.
| TREPP-i Survey Loan Spreads (50–59% LTV)* |
| This Week | Previous Week | Previous Month | End 2015 | End 2014 | |
| Industrial | 168 | 165 | 166 | 163 | 138.5 |
| Multifamily | 168 | 165 | 166 | 168 | 139.8 |
| Office | 179 | 180 | 179 | 168 | 148 |
| Retail | 168 | 165 | 165 | 168 | 139.8 |
| Average Spread | 170.75 | 168.75 | 169 | 166.75 | 141.5 |
| 10-year Treasury Yield** | 1.58 | 1.61 | 1.87 | 2.27 | 2.17 |
According to STR, the number of rooms in the development pipeline this year is running 15.2 percent ahead of last year. That compares with the 13.6 percent increase last year. The pipeline is expected to remain healthy for at least another year. So demand, while still strong, is softening at the same time that growth in the supply of rooms is accelerating.
STR also estimates that demand will remain strong enough for the hotel sector to see a 4.4 percent increase in revenue per available room (RevPAR), the industry’s key metric. However, that was not the case in the first quarter. Room supply increased by 1.5 percent and demand increased by only 1 percent, resulting in a 0.5 percent drop in occupancy, marking the first such fall since the end of 2009. So far this year, RevPAR growth has amounted to 3.3 percent, since demand has not quite reached expected levels.
For next year, the Hendersonville, Tennessee, research company is projecting supply to increase by 1.9 percent. While demand is expected to keep up, occupancy will be flat. But because room rates are expected to continue inching up, RevPAR should increase by 3.8 percent.
So which markets are seeing the biggest increases in supply? Lodging Econometrics pegs the following: New York, with 187 hotel projects underway; Houston, with 169; Dallas, with 128; Los Angeles, with 94; and Nashville, with 89.
Softening demand and a (still) red-hot development pipeline will undoubtedly have an impact on the performance of certain hotel REITs, particularly those with properties in markets with the biggest pipelines. Investors have figured that out.
For the past year, most hotel REITs tracked by R.W. Baird have had share prices drop by some increment. Some declines have been substantial. For instance, LaSalle Hotel Properties Inc. is down 36 percent over the past year; Pebblebrook Hotel Trust is down more than 40 percent in that same time frame.
While things are not dreary by any stretch of the imagination, an economic slowdown would likely have a negative impact on room demand.
The silver lining is that construction financing is getting tougher to line up at the same time that construction costs are increasing. So, growth in the development pipeline should taper off.
* TREPP-i Survey Loan Spreads levels are based on a survey of balance sheet lenders. For more information, visit Trepp.com.
** - 10 yr. Treasury Yield as of 6/24/2016.
