Shares of hotel real estate investment trust (REIT) Pebblebrook Hotels (PEB -0.56%) rocketed higher by nearly 20% in early Wall Street trading on June 5. Following close behind was Park Hotels & Resorts (PK -0.69%), with a roughly 19% gain. Meanwhile, DiamondRock Hospitality's (DRH -0.49%) advance was relatively subdued at a still-impressive 15% shortly after the start of the trading day.
The big news that got this trio of hotel REITs, and the broader stock market, headed higher was the May unemployment report. Market watchers had been expecting the number to come in as high as 20%, which would have been a terrible number and a huge comment about how devastating the impact of the efforts to contain COVID-19 has been on the U.S. economy. When the number came out, however, it was 13.3%, down from the previous month's 14.7%.
Investors cheered the news, since it was nowhere near as bad as some had been projecting. There's a logic to the excitement, too, since it hints at an economy that is more resilient than previously thought. And it suggests that a recovery is taking shape relatively quickly. These are all good news and realistic takeaways, but it would be hard to suggest that a 13.3% unemployment rate is a good number. In reality, it's probably best to describe it as "less bad."
And that's an important nuance here, particularly for hotel REITs. Unique in the REIT space, hotels basically have a lease length of a single day. So when the U.S. economy starts to falter, hotels feel the hit very quickly. To put that into perspective, Park Hotels & Resorts provided full-year guidance on Feb. 27, when the spread of COVID-19 was just starting to take shape. It then pulled that guidance on March 9, less than two weeks later, because of the rapid pace of cancellations at its properties.
It clearly doesn't take long for the economic winds to flow through to hotel REITs. But that also means that hotels are likely to be an early beneficiary of an economic uptick, which is likely why investors are pushing the stocks higher today. Only this time around, there's a good reason to be worried that a recovery will be slow. First off, the 13.3% unemployment rate is still high and the U.S. economy could still fall into a recession from here. That would be bad for hotel REITs.
More important, however, is the reliance hotels have on business-focused group gatherings. For example, Pebblebrook CEO Jon Bortz noted during in his company's first-quarter earnings release that he expects "weakened hotel demand for the remainder of 2020 due to the likelihood of ongoing travel and meeting restrictions, anxiety on the part of travelers, restrictions on travel instituted by businesses of all kinds and general economic weakness and uncertainty." COVID-19 appears to spread more easily in group settings, so it's likely that it will take some time before businesses are willing to send staff to big meetings or conferences (another business that has been shut down by the coronavirus and is likely to stay moribund for a long time).
Mark Brugger, CEO of DiamondRock, took a similar tone in his company's first-quarter earnings release, but gave a small glimpse of the future: "We remain focused on the future and have developed hotel reopening plans, while reassessing operating procedures to be able to safely and profitably welcome back hotel employees and guests when travel demand begins to slowly return in the coming months."
There are two key issues here. The first is the expectation of a slow return, which suggests hotel REITs have a long road ahead of them. The second is that reopening isn't going to be as simple as unlocking the doors and letting people back in. Hotels are going to have to deal with increased cleaning regimens and will need to contend with the continuation of social distancing protocols. Both of those issues are likely to raise costs and retard the pace of recovery while the hotels are dealing with weak occupancy levels.
Wall Street gets excited pretty easily, and today is a prime example of that. Yes, the unemployment news was better than expected, but it still wasn't good. And, specific to hotel REITs like Park, DiamondRock, and Pebblebrook, there's still a long road to traverse before things are back to any semblance of normal. Long-term investors should go in here with their eyes wide open.