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Service Properties Trust (SVC 0.08%)
Q4Â 2019 Earnings Call
Feb. 28, 2020, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good day, and welcome to Service Properties Trust Fourth Quarter 2019 Financial Results. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]
Now, I would like to turn the conference over to Ms. Kristin Brown, Director of Investor Relations. Please go ahead.
Kristin Brown -- Director, Investor Relations
Good morning. Joining me on today's call are John Murray, President; Brian Donley, Chief Financial Officer; and Todd Hargreaves, Vice President. Today's call includes a presentation by management followed by a question-and-answer session with analysts. Please note that the recording, retransmission, and transcription of today's conference call is prohibited without the prior written consent of SVC.
I would like to point out that today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on SEC's present beliefs and expectations as of today, February 28, 2020. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call other than through filings with the Securities and Exchange Commission or SEC.
In addition this call may contain non-GAAP financial measures including normalized funds from operations or normalized FFO and adjusted EBITDAre. Reconciliations of normalized FFO and adjusted EBITDAre to net income as well as components to calculate AFFO are available in our supplemental package found in the Investor Relations section of the company's website. Actual results may differ materially from those projected in these forward-looking statements.
Additional information concerning factors that could cause those differences is contained on our Form 10-K to be filed later today with the SEC and in our supplemental operating and financial data found on our website at www.svcreit.com. Investors are cautioned not to place undue reliance upon any forward-looking statements.
And with that, I'll turn the call over to John.
John G. Murray -- President and Chief Executive Officer
Thank you, Kristin and good morning. As this is both the fourth quarter and year end investor call, I want to start off by recapping some of the major strategic milestones we achieved in 2019 in an effort to improve the security and predictability of SVC's cash flow and improve growth prospects. First, in January, we agreed to sell 20 TravelCenters to TA for $308.2 million and amend our leases. We recorded a gain on sale of $160 million accelerated payment of previously deferred rent to start this year, and reduced rent to reflect the sale. These 20 sold TravelCenters were weaker performing locations and rent coverage has improved as a result.
Second, in late September of 2019, we closed on the SMTA transaction for $2.4 billion, which added 767 service and necessity-based retail properties providing considerable diversity by location, business type and brand, while increasing property level rent coverage and cash flow predictability. We financed this purchase with new senior notes and draws on our revolver, which brought leverage up. However, we also articulated a plan to reduce leverage, including the sale of approximately $500 million of net lease retail properties and $300 million of hotels.
The first step toward deleveraging began with the sale of shares we held in the RMR Group on July 1 at a price of $40 per share for net proceeds of $93.6 million. This investment generated a total return to us of 283%. We next executed the sale of 130 net lease assets during the fourth quarter for approximately $513 million. We also reached an agreement with Marriott to combine our three existing agreements and extend the term to 2,035 with $30 million of additional credit support. As part of the Marriott agreement, we plan to sell 33 non-core properties and fund between $350 million and $400 million for planned renovation over the next several years.
In addition, we amended our management agreement with Wyndham in October 2019, two full service hotels, the Wyndham Grand Chicago and the Wyndham Irvine were rebranded to Royal Sonesta and Sonesta Hotels in November, and the remaining 20 Wyndham branded hotels are currently being marketed for sale. Coverage at our Wyndham portfolio has been the lowest of any of our portfolios. So these sales should result in our overall coverage improving.
Yesterday, we entered into an agreement to restructure our business agreement with Sonesta. SVC and Sonesta have agreed to exit all 39 extended stay hotels managed by Sonesta, which currently require aggregate annual minimum returns of $49.5 million. As the hotels are sold, rebranded or repurposed, SVC's annual minimum returns under the Sonesta agreement will decrease by the applicable amount allocated to the hotels. After we exit these extended stay hotels Sonesta will continue to manage 14 full service hotels on behalf, where we believe they can compete more effectively.
As part of this agreement SVC received a 34% equity interest in Sonesta, so that SVC and its shareholders can share in the benefit of future growth at Sonesta. Between the sale of the 20 Wyndham and 33 Marriott hotels, we are confident we will reach or exceed our targeted goal of $300 million in hotel sales during the first half of 2020. The proceeds from which will primarily be used to further reduce leverage. Together with restructuring of our Sonesta agreement, we believe the steps we have taken will create a stronger hotel portfolio with higher coverage of our returns and rents.
Finally, as a key step in the Board's continuous focus on SVC's governance, which included last year's adoption of proxy access bylaws. We announced yesterday that we have appointed two new independent trustees, Laurie Burns and Robert Cramer to our Board, increasing the board size and diversity. Laurie brings extensive experience as a leader in the service and hotel industries, while Rob brings substantial expertise in both real estate and capital markets. We are pleased to welcome them to the Board and believe they will be tremendous assets to SVC going forward.
Turning to our financial results for the fourth quarter, we reported normalized FFO of $0.92 per share compared to the $0.61 per share reported in the fourth quarter of 2018. Brian will discuss the results in further detail later. In terms of consolidated hotel portfolio results, SVC's comparable non-renovation hotels performance was slightly below the industry average, with a 0.2% increase in RevPAR this quarter. Hotels that were renovated in 2018, and the first-three quarters of 2019 recognized healthy double-digit RevPAR growth this quarter and we expect growth from these hotels in 2020.
However, non-repeat disaster recovery business, renovations, citywide declines in several markets and supply growth offset this tailwind in 2019. In the fourth quarter, we had 15 comparable hotels under renovation versus 37 hotels under renovation in Q4 2018. Many of the historically well performing full service hotels under renovation have completed their projects and we expect these properties to have a positive impact on RevPAR growth and margin improvement this year.
Turning to the performance of our hotel portfolios. Our historical Marriott number one portfolio RevPAR increased by 1.4% as a result of occupancy gains. Renovation lift and increased transient demand was partially offset by non-repeat business and new supply. Coverage for these 53 hotels remained solid at 1.13 times for the 2019 calendar year. Our historical Marriott 234 portfolio experienced a RevPAR decline of 2%, driven by 90 percentage -- 90 basis point decrease in occupancy and an 80 basis point decline in rate. This portfolio had eight hotels under renovation in Q4, where RevPAR declined in aggregate by 15.9% as well as several property specific impacts from new supply and reduced citywide room nights.
Coverage for these 68 hotels was 1.01 times for the 2019 calendar year. RevPAR at our comparable IHG portfolio was flat with a 1 percentage point increase in occupancy, offset by 1.3% decline in rate. Performance was held back by renovation disruption at two hotels along with supply growth in Chicago, Seattle and Portland, which negatively impacted three Kimpton hotels. Our comparable Sonesta portfolio RevPAR decreased by 2.1% as a result of a 4.1% decline in rate, partially offset by an occupancy increase of 1.3 percentage points. Total comparable performance was diluted by renovations at three full service hotels, as well as non-repeat demand.
It is worth noting that the Clift Hotel in San Francisco, which was closed during the fourth quarter for a comp -- for a complete renovation is now opened and ramping up. Our Hyatt portfolio RevPAR declined 1.3% caused by a 3% decline in rate, partially offset by 1.2 percentage point increase in occupancy. With weakness driven by competition from new supply and weaker market demand due to decrease citywide events in Chicago and Houston.
Our Radisson Hotel Group portfolio RevPAR increased 4.7% this quarter versus last year, with material post-renovation lift at multiple properties, and the conversion of the Country Inn and Suites Hotel to a Radisson Hotel. RevPAR at Wyndham hotels was up 5.3% this quarter, reflecting a 6.1 percentage point increase in occupancy, partially offset by a 5.1% decline in rate. Positive RevPAR performance for the full service properties was generated by transient demand and partially offset by a decrease of 16 Hawthorn Suites.
For the first quarter of 2020, we expect to have 20 hotels under renovation compared to 28 last year. While, we continue to see positive lift from hotels that recently completed renovations, several factors indicate that SVC RevPAR growth for Q1 2020 may trail the industry, with certain factors potentially impact in future quarters as well. The following are a few of the key factors. Portfolio 2020 group pace is down nearly 1%, mostly influenced by the shift of the Super Bowl from Atlanta with 14 SVC hotels to Miami with only five SVC hotels.
While the potential headwinds of the coronavirus outbreak on the SVC portfolio, our net not yet readily quantified several hotels have reported group cancellations, as well as concerns about softening demand related to inbound travelers from impacted regions. Citywide projections a soft in San Francisco, Seattle, Philadelphia and San Antonio with many of these markets projecting reductions year-over-year in Q1 2020. Finally, supply growth is expected to continue to impact RevPAR growth in many major markets, including Nashville, Dallas and San Jose among others.
As a result, our rate growth expectations are muted. Hotels are increasingly taking longer to fill, allowing less opportunity to push higher short-term rates. SVC's managers project that the 2020, we will experience RevPAR growth from occupancy gains driven by post renovation improvement, but with little change in rate such that full year comparable RevPAR is likely to be flat to up 1%. We expect full year 2020 GOP margin to decline by 50 basis points to 150 basis points given flat revenue and continued upward pressure on wages and benefits.
Now, I'll turn it over to Todd to discuss our net lease portfolio and recent investment activity.
Todd Hargreaves -- Vice President
Thanks, John. As of December 31, 2019, SVC owned 816 net lease service-oriented retail properties, including our TravelCenters with 14.9 million square feet requiring annual minimum rents of $381.7 million which represented 38% of SVC's total annual minimum returns and rents. The portfolio was 98% leased by 194 tenants with a weighted average lease term of 11.4 years, operating under 131 brands in 23 distinct industries. The aggregate coverage of SVC's net lease portfolios' minimum rents were 2.32 times on the trailing 12 month basis as of December 31, 2019 compared with 2.27 times as of September 30, 2019. Rent coverage for our largest tenant TravelCenters of America was 1.92 times for the 2019 calendar year versus 1.88 times for the 2018 calendar year driven by improved fuel volumes and non-fuel margins.
During the fourth quarter, SVC entered lease renewals for an aggregate of 218,000 rentable square feet at weighted average minimum rents that were 75 basis points below prior rents from the same space. The weighted average lease term for these leases was 8.1 years and leasing concessions and capital commitments for these leases were $500,000 or $0.31 per square foot, per lease year. The 75 basis point decrease in rents was related to net lease retail tenants with either above market rent or declining sales that were on a watch list with the previous owner. In upcoming quarters, we may experience additional rent roll downs associated with other properties on our list of tenants we are monitoring and we'll continue to proactively asset managing properties which may result in early renewals with dispositions.
Turning to our recent investment activities, as previously announced, we acquired 261 room Chicago Palomar Hotel on October for purchase price of $55 million or $211,000 per key, which we believe is well below replacement costs. The hotel was added to our IHG management agreememt. As John mentioned, we sold 130 net lease assets acquired in the SMTA transaction for approximately $513 million during the fourth quarter.
Since January 1, 2020, we have sold four vacant net lease properties with approximately 160,000 square feet in three states for an aggregate sales price of $5 million, excluding closing costs. We are currently under agreement to sell three net lease properties with approximately 106,000 square feet in two states for an aggregate sales price of $5.3 million and marketing for sale or lease 37 net lease properties with approximately 1.1 million square feet.
In February 2020, we entered agreements to acquire three net lease properties with approximately 6,700 square feet in two states with leases requiring an aggregate of $387,000 of annual minimum rents for an aggregate sales price of $7 million, excluding closing costs. We are actively pursuing acquisition opportunities in the net lease space and are in various stages of the offering and the valuation process of several transactions. Our investment strategy six properties leased to growing operators and reputable brands and targeted industries and we are also focused on growing our relationships with current tenants, as well as developing relationships with the franchisees preferably with master leases. We continue to actively evaluate hotel offerings in specific markets as well.
I will now turn the call over to Brian.
Brian Donley -- Treasurer and Chief Financial Officer
Thank you, Todd. Starting with operating results at our 321 comparable hotels this quarter. RevPAR decreased 0.2%, gross operating profit margin percentage decreased by 206 basis points to 35%, gross operating profit decreased by approximately $9.7 million, which was primarily the result of the negative impacts of renovations and increased operating costs. All our comparable portfolios experienced declines in GOP with the exception of our Radisson portfolio. Below the GOP line cost at our comparable hotels were down slightly from the prior year as a result of lower real estate taxes, partially offset by higher insurance costs.
Cash flow available to pay our minimum returns and rents for our comparable hotels declined $9.4 million or 8.6%. Cash flow coverage of our minimum returns and rents for our 321 comparable hotels decreased to 0.71 times for the 2019 fourth quarter compared to 0.79 times for the prior year quarter. As we announced yesterday, our agreement with Sonesta will result in our exit of 39 extended stay hotels and Sonesta will continue to manage 14 full service hotels. The 39 extended stay hotels required minimum returns of $12.3 million and generated $2 million of cash flow available to pay these minimum returns for the 2019 fourth quarter. The 14 full service hotels required minimum returns of $22.8 million and generated cash flow available to pay these minimum returns of $7.7 million for 2019 fourth quarter.
Looking ahead to the 2020 first quarter, we currently estimate our 53 Sonesta hotels could produce cash flows available to pay our minimum returns that are 10% to 20% less than the fourth quarter 2019 results of this portfolio. Renovation ramp up from the full service hotels we have discussed on prior calls, will be more impactful in the second and third quarters of 2020. As a reminder, we did not have any credit support for our Sonesta agreement in the 53 hotels currently managed by Sonesta represent approximately 14.7% of our total annual minimum returns and rents as of year end. It is too early to predict the timing of when we will exit 39 Sonesta hotels or how much in proceeds we may generate from any sale. We estimate any sales from this portfolio may transact in the third quarter at the earliest.
Regarding our previously announced plan to sell 20 Wyndham hotels, we currently expect to complete the sale of the 16 Hawthorn Suites Hotels managed by Wyndham in early Q2 and to transact on the remaining four full service Wyndham hotels not too long after. Coverage of rental returns for these 20 hotels was 0.32 times for the fourth quarter and we will only receive cash flow generated from these hotels until they're sold. We currently expect to complete the sale of 33 Marriott hotels by the end of the second quarter, as we sell these hotel the annual minimum returns due under our Marriott agreement will decrease by the amount allocated to the individual hotels, which was an aggregate of $42.5 million. As of year end, the balance of our security deposits and guarantees available to cover shortfalls in cash flow available to pay our minimum returns and rents under certain of our hotel operating agreements was $200 million.
Turning to SVC's consolidated financial results, normalized FFO was $151.6 million in the 2019 fourth quarter compared to $100 million in the prior year quarter, an increase of $0.31 per share. The increase was due primarily to $53.6 million or $0.33 per share of business management incentive fee expense recorded in the 2018 fourth quarter, and increases in our minimum returns and rents related to 2019 acquisitions, partially offset by the disposition of 20 TravelCenters and our lease amendments with TA in January 2019, declined in realized returns under our Sonesta and Wyndham agreements and an increase in interest expense.
Adjusted EBITDAre was $227 million in the 2019 fourth quarter. Our adjusted EBITDAre to interest coverage ratio was 3.1 times for the seasonally weak fourth quarter and net debt to annualized adjusted EBITDAre was 6.7 times at quarter end. As we previously stated, our target leverage is to be around 6 times and we believe we will reach this goal through our disposition strategy. G&A expense for the 2019 fourth quarter was $17.7 million. Our business management fee expense increased $2.4 million over the prior year, primarily as a result of our increased market cap following the SMTA transaction in the third quarter.
As a reminder, our business management fee is paid based on the lesser of total market capitalization or assets under management and is currently being paid on total market capitalization. We believe this calculation is indicative of the alignment of interest with shareholders built into our management contract with the RMR Group. G&A for the fourth quarter also includes a $2 million non-recurring contingency loss.
Turning to our capital improvement activity, we funded $119.4 million of hotel improvements and $2.3 million of net lease improvements in the fourth quarter, bringing the 2019 full year total for capital expenditures to $245 million. We expect to fund approximately $150 million of hotel improvements and $5 million of net lease improvements in 2020. We expect to fund these improvements from operating cash flow.
Turning to our balance sheet, as of quarter end, debt was 50.2% of total gross assets, and we had $81.3 million of cash including $53.6 million of cash escrow primarily for future improvements to our hotels. At the year end, we had $377 million outstanding on our $1 billion credit facility and intend to continue to pay down the outstanding balance on our line with proceeds from asset sales. We have no term debt maturities until February 2021. In November, we paid a regular quarterly dividend to our common shareholders of $0.54 per share. We had a normalized FFO payout ratio of 58.7% for the fourth quarter. And as we look ahead, we believe our quarterly dividend at its current level is sustainable and continues to be well covered.
Operator, that concludes our prepared remarks. We are ready to open up the line for questions.
Questions and Answers:
Operator
We will now begin the question-and-answer session. [Operator Instructions] First question comes from Bryan Maher, B. Riley FBR. Please go ahead.
Bryan Maher -- B. Riley FBR -- Analyst
Good morning, guys. Just a couple of questions. And I know you briefly ran over some of these numbers. But on the sales of the Sonesta properties and some of the others, I think you talked about the timing of the Hawthorns and the Marriotts. But do you expect the entire process to take the bulk of the year or will it all play out in the second and third quarter?
John G. Murray -- President and Chief Executive Officer
We're in the final rounds of bidding on the Hawthorns and the TownePlace Suites in another week or so is the call for offers on the balance of the Marriott hotels. So I think then you allow a couple of weeks to get that purchase and sale agreed to. So we'll be, in the latter part of March, and if you figure at a minimum 30 days of diligence and 30 days to close, it brings you through April and May.
So I think that realistically, it will be in the second quarter that most of the Marriott and the Hawthorn portfolio trade. We haven't done a call for offers. We will set a call for offers date yet on the -- for Wyndham branded hotels. We're waiting on a couple of brands to complete pips to help buyers understand potential renovation costs. So we're waiting on that. The Sonesta assets to the extent they're sold will be -- we've engaged the broker, and they've been assembling a data room. We expect them to launch the -- start their marketing effort next week. So there will be a window of 30 days -- 45 days sort of initial marketing. So that will definitely be a third quarter event.
Bryan Maher -- B. Riley FBR -- Analyst
Okay. And then, who are these purchasers out there? And has anything changed in the last week or two, as it relates to people pulling back cap rates or trying to reprice deals with what's going on in the marketplace?
John G. Murray -- President and Chief Executive Officer
So far, we've gotten portfolio bids, multiple portfolio bids, I should say, on each of the subsegments. And a number of the bids have offered hard money deposits upfront because of a number of bids where we're very close to one another. We went back for second round offers and all of the bidders stuck with the deals. And as of just last night, we're seeing bids increase and we're seeing the portfolio bids on everything that we were calling for offers on. So and it's a private -- smaller private equity shops, high net worth individuals, some bidders from the Asian-American Hotel Owners Association, just a mix of buyers.
Bryan Maher -- B. Riley FBR -- Analyst
Okay. And then just lastly for me, John, when you look at it, the balance of 2020 to the extent that you do any more acquisitions, where is the bias with what you're seeing in the marketplace? Is it more net lease? Is it hotels? Is it TravelCenters?
John G. Murray -- President and Chief Executive Officer
Well, we are actively, since we're relatively new to the space. We are probably spending a little bit more time trying to develop relationships in the net lease space than we are in the hotel space. Because we've obviously been players there for a long time and have a number of good relationships. But we're not seeing that many opportunities that we find attractive either because of the current branding or because we're so late in the cycle. It's more difficult to get the type of deal structure that we like in hotels and that's historically been the case.
It's typically during the weaker periods, and early in the recovery stages, where we intend to buy hotels at the -- with the most volume. And later in the recovery cycles, we tend to be less active. And so I think that's kind of how it's playing out. We've been doing -- we've been selective about our investments on the hotel side. And mostly investing to improve or help expand existing relationships. And I kind of expect that, that's what you'll see for most of this year and more of a focus on net lease.
Bryan Maher -- B. Riley FBR -- Analyst
Okay. Thank you, John.
John G. Murray -- President and Chief Executive Officer
Thank you.
Operator
Our next question comes from Dori Kesten, Wells Fargo. Please go ahead.
Dori Kesten -- Wells Fargo -- Analyst
Thanks. If you guys exclude the hotels you expect to sell from rent coverage, what would that have been in 2019 or I mean, if you've cut it in a different way, you can...
Brian Donley -- Treasurer and Chief Financial Officer
Yeah. I mean, I think from the Marriott side, coverage would increase around 20 points on that portfolio. I didn't really run the math, what the net lease included, so just looking at it from a portfolio segment. If you can remove the Wyndham altogether, and that's pretty easy math. And at the end of the day, the Sonesta portfolio, the coverage for that portfolio really you could take out the $30 million, we knocked off the top and it approves another 15 points to 20 points on that portfolio.
Dori Kesten -- Wells Fargo -- Analyst
Okay. And I'm not sure, if you said this on the call, but when you separate the full service on the extended stay, what was the coverage for each of those?
Brian Donley -- Treasurer and Chief Financial Officer
Yeah. So...
Dori Kesten -- Wells Fargo -- Analyst
Not in the quarter for the year?
Brian Donley -- Treasurer and Chief Financial Officer
For 2019, yeah, coverage was -- sorry, I was going to pull it real quick. Of course, 0.4 times versus 0.7 times.
Dori Kesten -- Wells Fargo -- Analyst
Which was which?
Brian Donley -- Treasurer and Chief Financial Officer
The lower end is on the extended stay side of it.
Dori Kesten -- Wells Fargo -- Analyst
Okay. And has Marriott Intercon Hyatt, have any of them expressed interest in the 39 extended stay?
John G. Murray -- President and Chief Executive Officer
Well, we haven't -- we're not really launching marketing until Monday. We didn't -- the impacted hotels at Sonesta and related employees in the corporate office only found that about the strategic change last night or this morning. And so we didn't think it was appropriate to be discussing the 39 hotels outside of this office until we had -- everybody was in the know we need it to be. So that said, a number of the properties in the Sonesta ES program are formers Residence Inns and Summerfield Suites that are older generation with exterior entrances and multiple buildings.
So they're not brand standard for Marriott today for conversion to Residence Inn. I think the same is probably the case for Staybridge. So it would require for them to be interested in the all 39 would require them pending some of their brand standards, which probably unlikely. That said there are probably a dozen or so purpose-built -- former purpose-built Staybridges that are part of the ES portfolio. And so it may be that IHG either would have an interest in having them rebrand and added to our IHG portfolio or might bring franchisees of theirs to the table with a longer term franchise agreement on those assets. So we'll still have to see how it plays out.
Dori Kesten -- Wells Fargo -- Analyst
Okay. And how do you expect the remaining 14 full service to ramp over the next few years from the 0.7 times today?
John G. Murray -- President and Chief Executive Officer
We expect to see a pretty good ramp up the Fort Lauderdale hotel, the St. Louis, Chase Park Plaza hotel were both significantly impacted by major renovations during 2019. The Clift in San Francisco was totally closed for -- I think since August through December. It reopened in early January in time for the JP Morgan Healthcare Conference in San Francisco. But not with all of its rooms available, all of the rooms are available today. And but there's still a little bit of work going on, on some finishing some facade issues and some F&Bs space.
But so -- we expect very significant pickup, when you factor in a major market like San Francisco gone from being closed -- to being closed and not having been renovated since Ian Schrager renovated in 2002 to a brand new state-of-the-art facility, I think we're expecting significant growth there. We're already seeing a very strong group bookings, Chase Park Plaza and St. Louis, the Fort Lauderdale hotel beat [Phonetic]. So far, we don't have the end of the March, but was on track to beat first quarter budget and numbers. So we're feeling pretty good that we're going to see nice improvement across the 14 hotels.
Dori Kesten -- Wells Fargo -- Analyst
Okay. Thank you.
Operator
This concludes our question-and-answer session. I'd now like to turn the conference back over to Mr. John Murray for any closing remarks. Please go ahead.
John G. Murray -- President and Chief Executive Officer
Well, thank you all for joining us on the call today and we look forward to catching up with you in the coming weeks and month. Thank you.
Operator
[Operator Closing Remarks]
Duration: 36 minutes
Call participants:
Kristin Brown -- Director, Investor Relations
John G. Murray -- President and Chief Executive Officer
Todd Hargreaves -- Vice President
Brian Donley -- Treasurer and Chief Financial Officer
Bryan Maher -- B. Riley FBR -- Analyst
Dori Kesten -- Wells Fargo -- Analyst
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