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Hotel REITs were among the hardest-hit sectors during COVID. While the Vanguard Real Estate ETF (VNQ) dipped some 30% in April 2020, 3 of the 4 Largest Hotel REITs:
Host Hotels & Resorts (HST),
Apple Hospitality (APLE ),
Ryman Hospitality (RHP), and
Park Hotels & Resorts (PK)
dived much lower, shedding 60 – 70% of their share value. They recovered rapidly, however, and by March of 2021 all four were outperforming the VNQ by a wide margin.
Data by YCharts
For the next year, the VNQ took off like a rocket, up over 30% at one point, while Hotel REITs languished. Then, as most REITs sold off heavily in 2022 and the first nine months of 2023, the top 3 Hotel REITs rallied fitfully, surpassing the VNQ in total return in late 2022, and that trend continues to this day.
Data by YCharts
Thus far this year, Hotel REITs have posted the fourth-best total returns of the 18 REIT sectors, at 2.86%, while the equity REIT average stands at a disappointing (-4.02)%. The S&P 400, meanwhile, has returned an almost identical 2.80%.
Hoya Capital Income Builder
According to a recent article on Seeking Alpha, consumer spending is trending away from discretionary goods, toward services such as travel and leisure in 2024. This bodes well for Hotel REITs. Demand for hotel stays is closely tied to travel volume.
According to the International Air Transport Association, a record high 4.7 billion people are expected to travel by plane in 2024, up from the pre-pandemic high of 4.5 billion, and airlines are expected to turn a total profit of about $25.7 billion, with passenger revenues rising 12% to $717 billion. Of passengers sampled in a recent poll, 44% say that they will travel more in the next 12 months than in the previous 12 months. Only 7% say they will travel less.
This article examines liquidity, revenue growth, size, volatility, dividend yield, dividend growth, and pricing considerations for 16 Hotel REITs, to single out the one company best poised to deliver outperformance over the next 2 to 5 years.
What the numbers say
My FROG-hunting approach to REIT investing relies on just 7 numbers:
Liquidity ratio (Assets/Liabilities) Growth in Funds From Operations (FFO) Growth in Total Cash From Operations (TCFO) Growth in Dividends Market Cap Growth in share price Volatility
Hey, what is a FROG anyway?
FROG stands for Fast Rate of Growth. FROG REITs are significant, because they usually outperform the market in total return (Gain + Yield). The criteria for identifying a FROG are as follows:
Positive price gain over the past 3 years Liquidity Ratio >= 1.66 (preferably >=2.00) FFO and TCFO Growth rate >= 10% (preferably >=20%) Market cap of at least $1.4 billion. Modeled Return greater than the return posted by the Vanguard Real Estate ETF (VNQ) over the past 3 years.
Modeled Return is my own Rube Goldberg invention that combines price gain, dividend yield, dividend growth rate, and volatility to arrive at one number, for comparison to VNQ.
The opposite of a FROG is a COW (Cash Only Wanted), which is a company notable for its prodigious stream of cash dividends and plodding or mediocre revenue growth.
How do the candidates stack up?
There are 15 Hotel REITs tracked by Hoya Capital. The candidates are as follows, in order by market cap:
Host Hotels (HST)
Ryman Hospitality (RHP)
Apple Hospitality (APLE)
Park Hotels (PK)
Sunstone Hotel (SHO)
DiamondRock Hospitality (DRH)
Pebblebrook Hotel (PEB)
RLJ Lodging (RLJ)
Xenia Hotels (XHR)
Services Properties (SVC)
Summit Hotel (INN)
Chatham Lodging (CLDT)
Braemar Hotels (BHR)
Ashford Hospitality (AHT)
Sotherly Hotels (SOHO)
First we screen on Liquidity, FFO growth rate per share, TCFO growth rate, and Market Cap, using the criteria above.
Ticker Liquidity FFO Growth % TCFO Growth % Market Cap HST 2.21 2.3 (-5.2) $14.3 B RHP 1.02 6.7 27.9 $7.1 B APLE 2.99 0.2 0.9 $3.9 B PK 1.73 (-3.7) NA $3.3 B SHO 3.20 (-6.9) 9.7 $2.3 B DRH 2.04 (-2.9) (-17.1) $2.0 B PEB 1.96 (-12.8) NA $1.9 B RLJ 1.93 (-5.2) (-12.7) $1.8 B XHR 1.86 (-9.2) (-4.2) $1.4 B SVC 1.21 (-17.9) NA $1.3 B INN 1.92 (-6.1) NA $0.7 B CLDT 2.49 (-10.9) (-15.4) $0.5 B BHR 1.60 (-18.6) NA $0.2 B AHT 0.95 (-5.5) NA $0.05 B SOHO 1.15 (-9.6) 69.1 $0.03 B Click to enlarge
Source: Hoya Capital Income Builder and Seeking Alpha Premium
(In all tables in this article, growth rates are 4-year CAGR, unless otherwise specified).
First, we check for companies with Liquidity Ratio less than 1.66. This eliminates RHP, SVC, BHR, AHT, and SOHO.
Next, we check for FFO growth or TCFO growth less than 10.0%. That eliminates all the other companies. There simply are no FROGs in the Hotel REIT sector. If you are a growth investor, Hotel REITs are not the place for you.
What now, brown COW?
As I have pointed out a number of times, there are essentially two approaches to REIT investing. One is to hunt FROGs (REITs with Fast Rate Of Growth), which is my favorite way. However, during times of rising interest rates or inflation, or at times when yields are relatively high, herding COWs (Cash Only Wanted) makes a lot of sense.
COWs are slow-growing REITs that produce prodigious and dependable amounts of milk (dividend cash flow in this analogy). Due to the relentless sell-off from November 2021 to October 2023, REIT yields are quite a bit higher than usual right now, and high, safe yield opportunities abound.
Let’s pick a COW out of the herd.
Round ’em up!
We start by rounding up all the Hotel REITs that passed the Liquidity screen. Any REIT with balance sheet weakness will tend to underperform in unexpected downturns, so it gets culled out of the herd.
Next we will screen them for dividend score and dividend safety. Dividend score projects the Yield three years from now, assuming the dividend growth rate remains unchanged. In order to correct for the effects of the pandemic, I calculate the 5-year dividend growth rate, by comparing total regular dividends for 2018 with the same figure for 2023.
Here are the survivors, ranked by Dividend Score.
Ticker Yield 2018 Div. 2023 Div. Div. Growth % Div. Score Div. Safety PK 8.70% 1.99 1.38 (-7.1) 6.98 A- APLE 6.03% 1.20 0.96 (-4.4) 5.27 B+ HST 3.98% 0.80 0.90 2.4 4.27 A INN 3.66% 0.72 0.22 (-21.1) 1.80 A XHR 3.07% 1.10 0.40 (-18.3) 1.67 A RLJ 3.43% 1.32 0.28 (-26.7) 1.35 A+ SHO 2.58% 0.69 0.20 (-21.9) 1.20 A+ CLDT 2.74% 1.32 0.28 (-26.7) 1.80 A DRH 1.31% 0.38 0.12 (-20.4) 0.66 A+ PEB 0.25% 1.52 0.04 (-51.7) 0.03 A+ VNQ 3.84% 3.53 3.49 (-0.2) 3.81 C Click to enlarge
Source: Seeking Alpha Premium and Hoya Capital Income Builder
The entire Hotel REIT sector slashed dividends drastically during the pandemic. Only HST has fully restored its regular dividend to pre-pandemic levels. APLE was the first to resume paying dividends, and is nearly back to 2018 levels, and PK has been paying small quarterly divvies, then spiking the punch bowl in the fourth quarter only.
All of our survivors have very safe dividends. According to Steven Cress, a stock with a grade of B- or better from the Seeking Alpha Quant ratings system has only about a 1 in 50 chance of cutting its dividend in the next year. In fact, I consider it likely that most of the companies on this list will continue growing the dividend back toward and beyond the pre-pandemic levels over the next 2 years.
Since we are evaluating these companies as COWs, it doesn’t make any sense to settle for a YAP nor a Divided Score that is below the REIT average as represented by the VNQ. Thus, all Hotel REITs are eliminated from consideration, except PK, APLE, and HST.
Into the Corral
We now have three finalists in the corral. All three have sturdy balance sheets and provide safe, higher-than-REIT-average yields. However, investors can get 10-year treasury notes at approximately 4.25%, with no risk. If you are going to invest in a risk asset for its income stream right now, you need to get at least a 100 basis point (bps) spread over the no-risk rate, and preferably more.
That narrows our list of candidates to just two: PK and APLE, since HST yields under the no-risk rate.
Let’s take a closer look at these two companies’ balance sheets, and 2024 FFO per share growth projections.
Ticker Div. Yield Debt Ratio Debt/ EBITDA Variable Debt % Bond Rating 2024 FFO Growth PK 8.70% 74% 8.9 0.3 BB- 1.9% APLE 6.03% 29% 3.5 18.1 — 3.7% REIT 3.84% 30% 6.26 3.5 — Click to enlarge
Source: Hoya Capital Income Builder
PK sports the higher yield, but the company is struggling under the weight of a 74% debt ratio, and its debt/EBITDA ratio is weak, at 8.9. Although the dividend is safe, the company is likely to issue more new shares than APLE, thus depressing the share price, and may need to dispose of some assets to address its unwieldy debt.
APLE’s yield is 178 basis points above the no-risk rate, and the company has a superb debt ratio and a very strong 3.5 debt/EBITDA ratio. Although 18.1% of the debt is held at variable (therefore higher) rates, and that is concerning, the Debt/EBITDA ratio is so strong and the debt burden so light that this probably will not occasion an increase in share count, nor pressure the company to dispose of assets.
Both companies are projected to grow FFO per share by low single digits, with the projected growth for APLE coming in 180 basis points higher than PK.
Into the Arena
To my way of thinking, APLE is the clear leader, because of its much stronger balance sheet. However, if you find PK’s 267 basis point advantage in yield an overwhelming consideration, there is one more thing I would like to point out.
APLE pays its dividend monthly, and it is the picture of consistency, unchanged for the last 18 months.
APLE Dividend History (Seeking Alpha Premium)
By contrast, PK pays quarterly, and tends to pay a dribble for the first three quarters, then a big bonanza in the fourth quarter.
PK Dividend History (Seeking Alpha Premium)
Both companies are likely to increase their dividends in 2024, in my opinion, striving to recover to pre-pandemic payouts.
Most income investors want a steady flow of cash, as opposed than a dribble all year long followed by a gush in December. So unless you find yourself needing a lot of extra income in December, to pay for holiday expenses perhaps, the steady stream offered by APLE is more desirable.
And the winner is…
For high yield and low risk, with healthy growth prospects and consistent cash flow, I choose . . .
Apple Hospitality
Income investors willing to take considerably more risk to secure a higher yield may prefer . . .
Park Hotels and Resorts
Editor’s Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.
Picking A Winner In Hotel REITs
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