This Stock Has a 6.5% Dividend and Room to Grow

Image source: Getty Images.

Hotel real estate investment trust Apple Hospitality REIT (APLE -1.26%) pays a 6.5% dividend yield and has produced some impressive growth numbers for the last several years. I recently spoke with Apple Hospitality REIT's CEO, Justin Knight, who thinks that the company's best days are still ahead of it. Here's why dividend investors may want to take a closer look at this high-yielding REIT.

Apple Hospitality REIT: The short version

Apple Hospitality REIT invests in hotel properties, all of which are under various Hilton and Marriott brand names. The brands Courtyard by Marriott, Residence Inn, Springhill Suites, Homewood Suites, Hilton Garden Inn, and Hampton make up particularly large portions of the portfolio.

The company owns a total of 236 hotel properties with just over 30,000 guest rooms, the average effective age of which (the time since construction or the most recent renovation) is just four years.

Apple Hospitality REIT has a rather simple business model. The aim is to build a geographically diverse portfolio of upscale select-service hotels, align with well-known hotel brands and excellent operators, and consistently reinvest into the business to maintain its competitive advantage.

Why invest in hotels?

According to Mr. Knight, there are a few reasons why real estate investors should consider hotel properties.

For one thing, it offers the opportunity to invest in nationally recognized brands. In Apple Hospitality REIT's case, hotel brands don't get much more recognizable than Hilton and Marriott. The same type of brand recognition simply doesn't exist in other types of real estate. Can you name a brand of apartment building or shopping mall with the same type of worldwide strength?

Another unique aspect of the hotel business is the ability to adjust rental rates on a daily basis. Think of it this way: If you lease an apartment to a tenant, you'll get the same amount of rent each month for the next year. If you lease a retail building, your rental income may be predetermined for more than a decade. On the other hand, a hotel can adapt to changing market conditions literally overnight. If particularly high demand occurs in summer 2017, hotels can instantly change their rates to take advantage.

What makes Apple Hospitality REIT unique?

According to Knight, Apple Hospitality REIT is a particularly good way for investors to get exposure to the hotel industry, thanks to its scale, financial flexibility, and brand recognition. "We invest exclusively in Hilton- and Marriott-branded properties, the two biggest names in the industry, and we are in over 90 markets across the country," said Knight. "We have lower debt and greater financial flexibility than most peers."

As you can see, Apple Hospitality REIT operates at a higher EBITDA (earnings before interest, taxes, depreciation, and amortization) margin than most of its peers.

Image source: Apple Hospitality REIT.

Growth opportunities going forward

Apple Hospitality REIT is already the second largest publicly traded hospitality REIT, but there's still plenty of room to grow.

For one example, Knight is excited about Marriott's merger with Starwood Hotels, which adds well-known brands like Sheraton, Westin, W Hotels, and more to Marriott's already impressive portfolio. "The merger will be a game-changing opportunity to create value for consumers, as it will combine two massive loyalty programs," says Knight.

Above all, Knight emphasizes that the company's priority is sustainable and steady growth. Priorities going forward include consistently growing the value of the hotel portfolio, with a focus on further geographic diversification.

As far as the dividend is concerned, Knight wants investors to know that even though the yield is high, it's well covered. "We have more than adequate dividend coverage, and continue to build a cushion through our modified FFO [funds from operations] per share growth, which has been approximately 14% year to date," Knight said. Also, it's important for investors to realize that Apple Hospitality REIT makes monthly dividend payments, which means that your dividends can compound faster.

Risks to be aware of

There are a couple of major risk factors investors should be aware of. Most obvious is demand risk -- consumers could simply reduce travel. This is especially true during recessions or other tough economic times.

Interest rates also pose a risk to the REIT sector as a whole. Apple Hospitality REIT's income shouldn't suffer too much if rates rise more rapidly than expected. With a 25% leverage ratio and a majority of the company's debt of the fixed-rate variety, the company isn't too reliant on access to cheap financing.

However, it's important to point out that rising rates can create lots of selling pressure on REITs. Simply put, when interest rates rise, investments perceived to be safer, like bonds and CDs, become more attractive, and investors often sell dividend stocks and buy these when they become appealing. I generally view interest-rate-triggered price drops like the one after Donald Trump's election as buying opportunities, but it's still important to be aware of this risk factor.

The bottom line

No stock capable of market-beating returns is without risk, and Apple Hospitality REIT is certainly not an exception. However, between the dividend and potential for growth, I feel that any risks are justified. Apple Hospitality REIT could be a smart addition to any dividend portfolio with a long-term focus, and could become even more attractive if the REIT sector continues to fall on interest rate concerns.