Apple Hospitality REIT (APLE -1.75%) is a real estate investment trust that invests in high-quality hotel properties, and it's the largest select service-focused lodging REIT in the market. With nearly 180 hotels operating under various Hilton and Marriott brand names, Apple Hospitality offers strong performance. And APLE stock currently pays a 6% dividend yield in desirable monthly installments.

Image source: Apple Hospitality REIT.

About Apple Hospitality REIT's business model

Apple Hospitality REIT invests in hotel properties under the Hilton and Marriott brand names and owns nearly 23,000 hotel rooms in 179 properties, spread across 32 states. Fifty-four percent of the portfolio is Marriott-branded, with particularly large concentrations of Courtyard Marriott, Residence Inn, and Springhill Suites branded hotels. The remaining 46% are Hilton brands, particularly Homewood Suites, Hilton Garden Inn, and Hampton properties.

The company's strategy is pretty simple: build a geographically diverse portfolio of upscale hotels, partner with well-known brands, hire great operators, and continuously reinvest to maintain the competitive advantage. The idea is that if Apple Hospitality offers a product with high demand and keeps its operating model simple, the result will be high profit margins and limited volatility. And this seems to be the case: Apple Hospitality operates at one of the highest profit margins in its peer group.

Image source: Apple Hospitality REIT investor presentation. 

The entire portfolio is operated by third-party managers, the majority of whom have their fees tied to the performance of the hotels. The effective age of the portfolio is about four years, meaning that on average, not much time has passed since construction or the last renovation. In fact, only 1% of the portfolio has an effective age of nine years or more. As the company grows, the amount of money it reinvests in its properties has grown as well.

Valuation, dividends, and growth potential

While the REIT has only existed in its current form since March 2014, the results have been impressive so far. During the first quarter of 2016, the company's revenue grew by 4.2% year over year, and margins expanded by 60 basis points.

Apple Hospitality REIT pays a dividend of $1.20 per year in monthly installments, which translates to a 6% dividend yield as of this writing. This represents 73% of the company's past 12 months' FFO -- a relatively low payout ratio for a REIT -- so there's no reason to question its sustainability.

As far as valuation goes, the FFO figure I just mentioned corresponds to a price-to-FFO ratio of just 12.2, which is extremely cheap compared to most other types of REITs. For comparison, leading retail REIT Realty Income trades for 25 times trailing FFO, and healthcare REIT Welltower, which I consider "cheap," trades for 17.4 times FFO. Now, with a smaller size and untested long-term strategy, Apple Hospitality REIT is somewhat riskier than those other two, but the risk is offset by such a cheap valuation.

According to several different reports, the U.S. hotel market is expected to have a strong year in 2016. In fact, Smith Travel Research, CBRE Hotels America Research, and PwC Hospitality all project hotel demand will grow at a faster pace than supply, resulting in strong revenue growth.

Proposed merger

Another reason to give Apple Hospitality a look is the proposed merger with Apple REIT Ten, a non-listed public REIT operated by most of the same managers. Once the merger is complete, the company will own 234 hotels, with a 50-50 split between Marriott and Hilton branded properties.

Increasing the scale of a real estate operation is one benefit, as it often results in cost synergies. Since Apple Hospitality REIT is already the largest of its kind, this merger will create even more distance between the company and its competitors.

The companies also have complementary portfolios and similar balance sheets, so the merger won't cause much of a change in the business model. The increased scale will be an advantage to shareholders, however.

The bottom line

With a rock-bottom valuation and a simple yet effective strategy, Apple Hospitality REIT may be worth a look. While it's a bit riskier than some of the larger, leading REITs, a smaller, growing company like this has the potential to pay off tremendously over the long run -- just ask Realty Income and Welltower investors who got in on the ground floor.