Understanding hospitality REITs
Like other real estate investment trusts, hospitality REITs invest in real estate and return profits to shareholders. Unlike other REITs, however, hotel REITs invest in extremely short-term leases -- most commonly, a single night at a hotel. Consequently, they have features unique to the REIT space.
Hotel REITs make their money in a very straightforward way: They rent rooms and conference spaces to the general public. Although real estate purchases and sales are part of a hospitality REIT's regular business, they're not the primary driver of income.
Most income comes from tenants -- one day, two days, or a week at a time. The sector obviously includes hotels of all sorts, but it also encompasses resorts and business lodging.
How hospitality REITs work
Hospitality REITs own hotels but, due to various laws, cannot directly receive rent from tenants. They typically hire an independent management team to run the hotel operations.
So, before you even get to the pricing models or the cyclical nature, you're dealing with a very different kind of ownership and management structure than that of a typical office, industrial, or residential REIT, since those generally own the property and lease it to companies that want to occupy it.
With a hospitality REIT, you're also facing a very dynamic pricing environment. Since rooms are rented daily or weekly, pricing can change on a dime based on consumer demand. Hospitality REITs not only continually invest in finding new tenants but also regularly spend to update and refresh units to stay competitive.
Hotel REITs can be cyclical, moving in years-long cycles of growth, oversupply, underutilization, and recovery. Some performance metrics to watch include occupancy, average daily rate (ADR), and revenue per available room (RevPAR).
Benefits and risks of investing in hospitality REITS
REITs in general tend to be fairly stable, solid long-term investments when managed properly, and hotel REITs aren't much different when times are good. There are some distinct advantages of these REITs, including:
- Improved returns: Hospitality REITs offer investors a way to own a stake in the lucrative hospitality industry, potentially delivering higher returns and dividends than other investments.
- Truly passive income: Unlike real estate purchases, REIT investors have no active involvement in the property. Professional management teams behind the REITs do all the heavy lifting.
However, hospitality REITs are not without risk, though these risks can be avoided or minimized with good management.
- Interest rates: REITs tend to move inversely to low-risk interest rates, such as the 10-year Treasury note. REIT investors forgo the opportunity to earn interest with absolute certainty. As those safe investment yields rise, investors expect REIT yields to rise as well. However, higher REIT yields can translate to lower stock prices.
- Oversupply: If there are too many hotels in one place competing directly, vacancy rates can become so high that room prices fall, stimulating demand. A thoroughly diversified hospitality REIT can be a better choice, as a wide range of locations and property types will help spread risk.
- Economics: Because hotels are often a discretionary expense, they don't do great when times are tough. However, hotel REITs also include properties that are popular with business travelers and luxury vacationers who travel regardless of the economy. Also, because hotels offer essentially daily leases, they can respond quickly to an upturn and increase rents without hesitation when the tide turns back in their favor.
- Financing: As with all REITs, financing is crucial to the expansion and upkeep of hotel REITs. Hospitality REITs may need lines of credit to weather tough economic times, acquire new real estate, or upgrade properties. Because they can suffer quickly in difficult times, it's important for hospitality REITs to maintain a low debt-to-capitalization ratio to avoid being dragged down if rents dry up.
Methodology: How these stocks were chosen
The hospitality REITs featured here were chosen based on their current dividend yield, market mix, debt load, and long-term viability. Sustainable dividends are important for this sector, as is responsible financial management, because dividend investors generally prioritize dividend payouts over stock price growth.
What to consider before choosing hospitality REITs
Hospitality REITs are not investments for the faint of heart. The daily operations are challenging, the environment ever-changing, and the cycles long and mentally exhausting. Here's a short list of things to consider before jumping in.
- They're long-term investments. Hotel industry cycles run too long and can take a lot of money to move a hotel from point A to point B. If you can't hold for the long run, don't buy these stocks.
- Hotel economics are ever-changing. What it takes to get someone in the door one day may be very different from what it was a week ago. These expenses can't always be anticipated, so you'll have to trust your hospitality REIT's management.
- They're constantly spending money. Hotels and other hospitality REITs are part of the overall traveler experience and thus require constant refreshing, renewal, and reimagining. That all costs money and can create a dangerous spending cycle. Keep a close eye on financials with these kinds of investments.
The bottom line
With so much uncertainty in the macroeconomic environment, it's hard to say what the future holds for hospitality REITs, except that the short term may be difficult. With a decline in foreign visitors, uncertainty among middle-class vacationers, and ongoing labor issues, hospitality REITs could struggle -- but this can also present an opportunity to acquire good businesses at bargain prices.
In the longer term, there's significant potential for hospitality REITs to reposition themselves, including packaging their rooms as part of all-in-one experiences or developing more mixed-use properties on or near the same facilities, which can be attractive to guests.
Increased use of technology in hospitality and travel can help offset staffing shortages and create efficiencies in the long term. Vacations have been popular since the Roman Empire, so there's no reason to think the hospitality REIT as a concept is done and dusted.
