Are Lodging REITs Priced to Buy?

This article is republished with permission from REITCafe.

Last week, it was reported that Hyatt is in talks to buy hotel operator Starwood Hotels and Resorts Worldwide in a deal that could be worth $17 billion. While neither company is a real estate investment trust (REIT), the transaction is emblematic of what is happening in the sector, where hotel REITs that are trading below the value of their underlying assets are creating an opportunity for mergers, acquisitions, and buybacks.

After beating third-quarter consensus earnings estimates, the largest lodging REIT, Host Hotels and Resorts, authorized an additional $500 million for share repurchases this week, bringing total 2015 authorizations to about $1 billion. Its shares rose 4 percent after earnings were announced, but share values are still down about 25 percent year-to-date.

In another reaction to REITs’ trading below asset value, Blackstone announced a $6 billion deal to privatize Strategic Hotels and Resorts last month.

Lodging REIT returns are down about 20 percent during 2015. The sector’s downward slide this year is due in part to softness in the overall equities markets. At the same time, hotel market fundamentals are currently very healthy. The lodging sector has benefited from strong demand and limited new supply. Job growth has been healthy, and both businesses and people are spending more on travel. Lower oil prices are putting more money in consumers’ pocketbooks and also reducing the cost of travel. Third-quarter revenue per available room (RevPAR) growth of 5.9 percent was down slightly from 6.5 percent during the second quarter, but still healthy. During the third quarter, national hotel occupancy gained 1.4 percent to 71.3 percent and average daily rate (ADR) rose 4.5 percent to $122.66 from year-ago levels, according to STR. Year-to-date through the three quarters, U.S. RevPAR gained 6.7 percent.

Global turmoil is affecting lodging sector performance on many levels. It has heightened concern that the United States will enter a recession. Global turmoil has affected the performance of U.S.-owned hotels in international locations, with implications for international expansion of U.S. lodging companies. The strong dollar also is affecting international travel to the United States. It is too soon to know whether China’s economic troubles will lead to more or less investment in U.S. lodging assets. On one hand, the United States provides a relatively safe haven for Chinese investment, but investors may also need more money at home. Still, Chinese investors are reportedly in the mix in bidding for Starwood Hotels and Resorts.

Many eyes have been on New York, which is facing an influx of new supply and weakening international tourism. Still, the area’s hotel occupancy of 88.6 percent in the third quarter ranked second only to the San Francisco Bay area, according to STR.

While lodging sector performance in 2015 does not seem to justify the lower valuations, some chinks are appearing in the armor. For example, before announcing earnings that beat estimates, HST had previously noted weak performance growth in August because of slower leisure traffic and lower-than-expected growth at its international assets. In addition, lower oil prices have negatively affected markets like North Dakota and Texas.

Lodging REIT performance in 2015 indicates that investors may believe that hotels are near the peak of their growth cycle and that future growth will be slower or declining. However, robust sector fundamentals, lower share prices, and a 4.3 percent dividend yield make lodging REITs attractive.

* 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 10/30/2015.