Return of the REITs

Hotel REITs are well-positioned for ongoing economic uncertainty in 2023

BY NICOLE DI TOMASSO

After a period of devastating impacts, hotel REITs experienced steady improvement in 2022, augmented by resilient leisure travellers. While hotel performance remains strong, macroeconomic and geo-political headwinds are expected to remain challenging. As a result, hotel REITs are taking a conservative approach as they re-gain their appetites for investment in 2023 and beyond.

“The threat of a recession has prompted companies to be a little more conservative,” says Deborah Friedland, managing director and head of the Hospitality Advisory Practice at New York-based Eisner Advisory Group LLC. “Although the industry continues to face multiple headwinds, it continues to benefit from a strong recovery following the pandemic. Many well-known REITs have conserved cash and are well-prepared to weather a recession.”

Obviously, the COVID19 pandemic caused an unprecedented level of disruption to the hotel sector and corresponding REIT share prices in 2020 and 2021. However, with the development of vaccines, rigorous cleaning protocols, technology adoption and experience-starved consumers, hotel REITs operating performance began to recover.

“Generally speaking, hotel REITs are riskier than other asset classes, which have long-term leases, predictable monthly payments and lower operating and maintenance costs,” says Friedland. “There are many different factors that affect hotel REITs more quickly and deeply than other asset classes. As interest rates go up, the cost of capital goes up, and there’s more competition for the yield.”

“Most REITs lost roughly 50 per cent of their value at the onset of the pandemic, but values have recovered somewhat – but nowhere near the levels achieved several years ago,” says Alan Tantleff, senior managing director, leader of Hospitality, Gaming & Leisure, Washington, D.C.-based FTI Consulting. “High interest rates and the prospects for a slowing economy seem to be holding them back.”

Traditionally, hotel REITs have focused on growing assets primarily in major urban markets, but the COVID-19 pandemic prompted a new strategy. Now, more REITs are focused on branching out geographically and re-allocating assets from urban markets to leisure destinations. While business travel has shown signs of recovery, a return to pre-pandemic levels remains far off.

Vancouver-based American Hotel Income Properties REIT LP (AHIP) has been evaluating growth opportunities that would expand the hotel portfolio and geographic footprint. The company has also been reviewing strategies for divesting assets to recycle proceeds into higher-return assets in more attractive markets.

In January and June 2022, AHIP completed the strategic dispositions of two hotel properties in Florida and Pennsylvania for gross proceeds of $10.3 million and $5.7 million respectively. In Q4 2022, AHIP also completed the disposition of five non-core hotel properties, one in Pennsylvania and four in Oklahoma, for gross proceeds of $5.3 million and $26.3 million respectively. Collectively, these dispositions allowed AHIP to avoid future PIP (price interest point) investments that would not have met returns available elsewhere in the portfolio; increased portfolio RevPAR by approximately $3; and improved its debt to EBITDA ratio by approximately 0.4x. Additionally, the Oklahoma portfolio sale resulted in the return of $3.2 million of restricted cash. Overall, AHIP’s revenue increased 16.6 per cent to $281.4 million for the year ended December 31, 2022, compared to $241.3 million in 2021, and RevPAR reached 100 per cent of its 2019 level.

“We continued to achieve strong revenue performance from our select-service hotel portfolio in Q4,” said Jonathan Korol, CEO, American Hotel Income Properties REIT LP in a press release about the company’s 2022 financial results. “Despite macroeconomic challenges, we have not seen any weakness in corporate, group or leisure demand channels. Consistent with prior periods of high inflation, we are experiencing rate growth that exceeds inflation with an annual increase in Average Daily Rate (ADR) of 12.7 per cent. However, broad cost pressures remain, particularly in labour, which continues to put pressure on operating margins.”

Korol continued, ““The last three quarters of 2022 were negatively impacted by inflation, labour shortages and supplychain disruptions. To address these issues, we are continuing to focus on hiring more in-house labour, reducing turnover and improving housekeeping productivity. Top line results for January 2023 suggest continued strong revenue performance with occupancy of 57 per cent, ADR of $123 and RevPAR of $70, which is 113 per cent of January 2022 RevPAR on the same property basis. While we are making some progress on managing operating expenses, cost pressure and labour issues are expected to remain a challenge for most of 2023. We made steady progress on our leverage reduction goals over the last two years, achieving a decrease in each year and a two-year reduction in leverage by 570 basis point to 52.6 per cent as measured by debt to gross book value. Our financial position allows us to be patient, with no debt maturities until late 2023 and 92.8 per cent fixed rate debt.”

“Throughout the pandemic and possibly into the future, it seems that hotel REITS believe resorts have better prospects,” says Tantleff. “[Additionally,] some REITs have been buying back their stock lately instead of buying hotels, arguing they’re trading at a discount to net asset value. Rather than putting cash to work buying new hotels, they see better prospects purchasing their discounted shares.”

While the depth of the pandemic’s impact on travel was like nothing the industry has experienced in modern times, it has given hotel REITs and operators a better idea of what to expect and how to respond in times of crisis moving forward.

“Hotel operators have been forced to embrace new operating and management techniques, and those that have survived the worst of the pandemic are strong and have learned how to manage through extreme distress,” says Friedland. “I’m optimistic about the future. ”◆