What happened
Shares of hotel real estate investment trust (REIT) Hersha Hospitality Trust (HT) rose as much as 13% on June 8. Peers DiamondRock Hospitality (DRH -1.52%) and Pebblebrook Hotel Trust (PEB -3.85%) advanced nearly 14% and 16%, respectively, at their highs. By 3 p.m. Wall Street time, they had all pulled back, but still had substantial gains. Hersha was up roughly 10% an hour before the close, with DiamondRock and Pebblebrook higher by about 12% and 14%.
So what
Investors are excited by the continued progress in the reopening of the U.S. economy. As states and cities ease the social distancing and nonessential business restrictions put in place to help slow the spread of COVID-19, people are slowly going back to their normal lives. The gains today come despite the fact that the National Bureau of Economic Research officially decided that a recession started in February.
Image source: Getty Images.
It's now time to wonder how long the recession will last and how long the impact of the downturn will linger, particularly for hotel real estate investment trusts.
All three REITs here saw occupancy collapse as expected in an economic downturn. Hersha's occupancy fell dramatically in the first quarter. After the quarter, the company provided data for 27 hotels that were open in April and May. Occupancy for this group reached a nadir of around 20% in early April. It has since started to rebound, reaching nearly 40% by the end of May. The average occupancy in the first quarter was roughly 62%, compared to fourth quarter 2019 average occupancy of nearly 80%. Clearly, Hersha's business isn't anywhere near back to normal yet.
The trends at DiamondRock and Pebblebrook are similarly rough. Pebblebrook provided a case study of its L'Auberge Del Mar hotel in California, which reopened for Memorial Day weekend only to see occupancy down 30% year over year. The holiday kicks off the summer and typically entails high travel volume, so that performance was not a good showing.
DiamondRock, meanwhile, offered up two different sets of numbers that were both worrying. On the occupancy front, its average seven-day occupancy rate fell from around 80% at the end of February to less than 10% at the end of March. Occupancy was around 17% in mid-May. Taking a different look at the issue, DiamondRock estimates that it has received around $100 million in cancellations so far in 2020. That's a lot of revenue that it just won't earn this year.
This is a bad situation for hotel owners. The fix may not be as the same as in past recessions because the economic impact is so intertwined with the COVID-19 pandemic.
With lease terms that effectively last a single day, hotels are very sensitive to economic activity. Normally, as the economy picks up after a downturn, hotel occupancy picks up alongside. However, there are still restrictions on the group gatherings (like trade shows) that tend to motivate business travel. Lingering health concerns and social distancing guidelines are likely to hamper leisure travel. Amusement parks, for example, are only just reopening with restrictions on how many guests can enter each day.
There has been a slight pickup and these REITs are starting to see some signs of improvement, but there's no good historical precedent for a full recovery timeline. It could be a very long time before hotels see anything close to pre-pandemic occupancy and room rate levels.
The stocks of REITs like Pebblebrook, Hersha, and DiamondRock have come a long way from their lows. At the worst of the sell-off, each was down around 75%. Today, they are down around 30% year to date. That suggests that investors aren't taking the information being shared by management as evidence that things are close to getting back to normal.
Now what
DiamondRock, Hersha, and Pebblebrook are turnaround stories at this point. The big gains today simply add to a burgeoning recovery as investors become increasingly upbeat about the future of the U.S. economy. Still, a complete economic revival is a long way off, and the economy isn't the only headwind these REITs face. Long-term investors should tread cautiously here because COVID-19 is likely to lengthen the time it takes this trio to get back to normal.
