The Next Hot High-Yield Sector

Lodging is the commercial real estate sector that is most sensitive to the level of economic activity. Strong GDP growth usually leads to expanding profits for hotel owners. The lodging REITs have been in a slump since the sector’s recent bear market that lasted the full year of 2015.

In the spectrum of rent contract lengths, hotels have the shortest time. Room rates can change daily based on supply and demand conditions. When the economy starts to grow faster, there is greater demand for hotel rooms, which allows the lodging companies to fill more rooms at higher average prices.

The lodging real estate investment trusts (REITs) own portfolios of hotels. Most REITs focus on a specific sector of the hotel business. A REIT will own the properties and contract with third-party management companies. To keep it’s REIT status, the hotel owner cannot also be the operator. Lease contracts between the lodging REIT and the tenant/management company usually include a fixed lease payment and a percentage of revenues. The hotel REITs do experience greater revenue and free cash flow when hotel revenues are improving.

The metric to follow in this sector is RevPAR: revenue per available room. Quarter to quarter changes in RevPAR show you how well a specific REIT is doing. Flat or declining RevPAR means a flat dividend. If the metric starts to increase nicely, you can expect the REIT to start boosting the quarterly dividend. Most lodging REITs keep the dividend/FFO payout ratio low. This avoids the need to cut the dividend if there is slowing in the lodging space.

The hotel REITs had a tremendous run-up from the bear market bottom in 2009 until the sector peaked in January 2015. Investors saw rising dividends and share price gains of several hundred percent. When the RevPAR growth flattened, the hotel REITs went into a yearlong bear market covering 2015. For the last two years both RevPAR growth and hotel REIT share prices have been flat. Here is the five-year comparison chart of three hotel REITs that nicely illustrate the up, down and flat trends of the past half-decade.

With the U.S. economy hitting 3% GDP growth for several quarters in a row, investors are once again getting interested in the hotel REITs. Share values have risen nicely over the last five months, but be assured this is likely just the start of a run that could see share prices double or better. You should see RevPAR increasing and dividend increase announcements. Here are three lodging REITs that are well positioned to benefit from the stronger economic growth.

Host Hotels and Resorts Inc. (NYSE: HST) is the largest lodging REITs with a $15 billion market cap. The company owns a diversified portfolio of 89 premium hotels with over 50,000 rooms. These include upscale central business district locations, resort locations, and prime airport lodging facilities. Third party management contracts are with Marriott, Sheraton, Hyatt, Hilton and other premium hotel operators. For 2017, the company generated adjusted FFO of $1.65 per shares. Out of that dividends of $0.85 per share were paid. FFO per share was basically flat compared to 2016 and the dividend stayed level. Host Hotels did declare an additional $0.05 per share dividend in December.

Third quarter 2017 RevPAR was $176.87, down 1.5% from $179.63 for Q3 2016. These numbers are a good indication of how lodging revenues and profits have been very flat. A shift to increasing RevPAR will allow the company to grow the dividend and propel the share price higher. Full year 2017 results come out on February 22. HST currently yields 4.7%.

RLJ Lodging Trust (NYSE: RLJ) is a mid-cap, $4.1 billion market cap lodging REIT. The company is focused on acquiring premium-branded, focused-service and compact full-service hotels. RLJ Lodging Trust has a portfolio that consists of 157 properties with approximately 30,800 rooms. In September 2017, RLJ completed a merger with Felcor Lodging Trust, another mid-sized publicly traded REIT. For the 2017 third quarter, RevPAR declined 1.1% compared to a year earlier. This decline would have been 2.3% without the acquisition of the FelCor assets. FFO per share for the first nine months of 2017 was $1.84, handily covering the 40.99 per share of dividends paid. The merger will boost bottom line efficiency in 2018, setting the company up nicely for greater hotel demand this year and for the next few years. RLJ currently yields 5.6%.

LaSalle Hotel Properties (NYSE: LHO) is a $3.5 billion market cap REIT that owns hotels in 11 large urban markets and two resort hotels in Key West, FL. About 65% of the portfolio is managed by independent operators with the remaining third run by name brand hotel companies. The urban and resort focus allows LaSalle to generate high RevPAR rates, averaging $219 in the 2017 third quarter. RevPAR for that quarter was down 3.6% compared to a year earlier.

Last year was a tough year for competition in several of LaSalle’s target markets including Philadelphia and San Francisco. Those and the other urban hotel markets are the ones likely to benefit most from increased corporate travel spending associated with a growing economy and expanding corporate profits. LHO currently yields 5.9%.

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Source: Investors Alley