These REITs Are Living in Luxury: Should Investors Join Them?

Pebblebrook Hotel Trust (PEB 2.19%), LaSalle Hotel Properties (LHO), and Strategic Hotels (NYSE: BEE) are three REITs that target upscale hotel properties in desirable destinations. With such a unique focus, investors should consider all three for their portfolio, as these REITs have the potential to outperform the broader hotel industry in the United States.

Strategic selection
Each of these three luxury hotel REITs have properties that cannot be replicated in both location and character. Strategic Hotels has some of the most notable properties in the U.S., including the Hotel Del Coronado and the Ritz-Carlton Half Moon Bay.

Hotel Del Coronado San Diego, California  Source: Wikimedia Commons.

Pebblebrook and LaSalle, however, are not too far behind the curve in terms of notoriety and respectively operate the Sir Francis Drake in San Francisco and the L'Auberge Del Mar in San Diego.

Being picky isn't always a bad thing
And while these properties are remarkable, it is the precision with which these upscale properties are selected that is most attractive for investors.

Jon Bortz, Pebblebrook's Founder and CEO, provided insight into how Pebblebrook recently selected the Prescott Hotel for its property portfolio:

The property is central to San Francisco's primary business demand drivers, including the Financial District, the Moscone Convention Center and the Union Square submarket, which has historically outperformed all other submarkets within San Francisco due to its well-balanced, diversified mix of leisure, corporate, group and convention demand.

Pebblebrook has added 30 upscale properties to its portfolio since its IPO in 2009 and specifically targets urban properties in coastal gateway cities. Whereas, LaSalle and Strategic Hotels also operate resort properties. 

Pebblebrook's focal point of coastal gateway cities, however, paid off last quarter when it reported the highest increase in revenue per available room, or RevPAR, of the three REITs.

Upward trend in RevPAR
Perhaps the most alluring aspect for investors is that this strategic property selection might allow these REITs to outperform the broader hotel industry in the United States on a RevPAR basis.

RevPAR is calculated by multiplying the average daily room rate by the hotel's occupancy percentage. For example, Pebblebrook had an average daily room rate of $209.98 and an occupancy percentage of 80.5% for a RevPAR of $168.98—an 8.5% increase compared to the first quarter in 2013. 

Pebblebrook clearly blew away its last quarter but all three of these luxury hotel REITs are seeing an upward trend in RevPAR:

  Source: Company Filings

Pebblebrook has the most promising near term prospects of the three luxury hotel REITs, as last quarter it had the highest occupancy percentage at 80.5%. It also has a solid 2014 RevPAR growth outlook between 6.5% and 7.5%.

Paying for luxury
But this outlook does come at a price for investors.

Of the three REITs, Pebblebrook has the highest price to funds from operations, or P/FFO, ratio of 21 (using 2014 estimated FFO). P/FFO is the preferred ratio for REITs because it adds back depreciation and other costs and like other valuation ratios: the lower the multiple, the better. Strategic Hotels also has a high P/FFO ratio of 19.   

LaSalle has the most attractive P/FFO of 14 but had the lowest RevPAR percentage growth last quarter. Clearly, investors will have to pay the price for Pebblebrook's prospects. 

Foolish conclusion
These three REITs' strategic selection of upscale hotel properties is an approach that might allow them to outpace the broader hotel industry on a RevPAR basis. All three REITs have an upward trend in RevPAR and have properties that cannot be replicated in both location and character.

While this trend might be great, keep in mind that you'll be paying five-star prices for these stocks.