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3 Hotel REITs to Buy in July

Jul 07, 2020 by Matt Frankel, CFP

Hotel real estate investment trusts can be excellent businesses when economies are good, but they are also the most vulnerable type of commercial real estate during recessions and other turbulent times. In simple terms, when times are tough, people travel less and businesses are more conservative when it comes to paying for their employees to travel to meetings and conferences.

However, this also means that during times of weakness, there can be bargains in the hotel REIT subsector for patient long-term investors. Here's a quick primer on what investors should know about the hotel real estate business as well as three excellent hotel REITs you might want to put on your radar.

What is a hotel REIT?

A real estate investment trust, or REIT (pronounced "reet"), is a special type of corporation that primarily owns, operates, develops, or manages real estate assets. Among other requirements, REITs are required to invest at least three-fourths of their assets in real estate investments and must pay out 90% or more of their taxable income.

Most REITs specialize in a certain type of property, and there is a REIT subsector that primarily owns hotel properties. Many specialize even further -- for example, there are REITs that only own luxury resorts.

Why are hotel REITs so recession-prone?

Some types of commercial real estate are not particularly cyclical, meaning that they tend to do just fine no matter what the economy is doing. Healthcare properties are a good example, as are office buildings. On the other hand, hotel real estate is the most economically-sensitive type of commercial real estate there is.

There are two big reasons why. First, staying at a hotel is typically a discretionary expense. In tough times, people can choose not to go on vacation and businesses can choose to cut back on employee travel. And second, unlike other types of commercial real estate, there are no leases that guarantee income. Office tenants typically sign leases that last for 10 years or so. Even apartment tenants are generally committing to a year's worth of rent payments.

On the other hand, the "lease" for a hotel room is on a daily basis. This can be a tremendous asset in good times: If the market allows it, a hotel is free to increase its rates whenever it wants. But in bad times, it not only means vacancies spike, but also pricing power can disappear.

The COVID-19 pandemic has hit hotel REITs especially hard, because hotels are dependent on the willingness and ability of people to go places. Many hotels -- especially larger-scale destination properties -- were forced to close entirely as the pandemic worsened, and others have remained open but at occupancy rates so low they aren't profitable.

Three hotel REITs to buy in July

In uncertain times like this, it becomes extremely important to focus on quality. Look for hotel REITs with strong balance sheets, unique assets, and top-notch management teams. In tough times, weaker companies tend to run into serious trouble, while the strongest operators in the industry tend to emerge just as strong, if not stronger, than before. We saw this with banks during the financial crisis, retail operators over the past decade or so, and we're likely to see the same trend play out in the hotel industry as the COVID-19 pandemic continues.

Here are three well-run hotel REITs with excellent management, plenty of liquidity, and lots of potential for long-term value creation.

Company (ticker) Property type Year-to-date change
Ryman Hospitality Properties (NYSE: RHP) Group-focused hotels, entertainment properties (61.0%)
Apple Hospitality Properties (NASDAQ: APLE) Select service hotels (41.2%)
Xenia Hotels & Resorts (NYSE: XHR) Luxury hotels (58.0%)

Data source: yCharts. YTD performance as of 7/6/2020, and parenthesis indicate negative numbers.

Group-focused hotels have been hit really hard

I'd actually call Ryman's assets and long-term growth potential the best of the three companies here, and its balance sheet is perhaps the most solid. So why is it the worst-performing REIT in this discussion?

The short answer is that Ryman's business has been hit by the pandemic far worse than most hotel REITs. The company owns five large-scale luxury hotels that operate under the Gaylord brand name, as well as a portfolio of entertainment assets such as the Grand Ole Opry and Ryman Auditorium venues and the up-and-coming Ole Red restaurant chain. Ryman's hotels are among the largest group-focused hotel properties outside of the gaming industry, and conferences and conventions are simply not happening right now. And it's a bad time to be the owner of concert venues when large gatherings are largely being postponed until at least 2021.

That said, I'm a major believer in Ryman's business from a long-term perspective. To illustrate just how much demand there is for group events, Ryman has successfully rebooked 457,000 cancelled room nights and actually has more net room nights on its books for 2021 and 2022 than it did at this point last year.

Ryman has a portfolio of unique and extremely valuable hotel and entertainment assets that should thrive in the post-pandemic world. With plenty of liquidity to get through the tough times, now could be a great time to add Ryman to your portfolio at a huge discount.

When business travel rebounds, so will this REIT

Apple Hospitality Properties invests in mid-range hotel properties, a category referred to as "select-service" hotels. The company currently owns 233 hotel properties, averaging about 125 rooms each. The idea is that these are smaller and require less ongoing capital expenditure than luxury properties but offer a higher level of amenities than discount motel chains.

Just to give you an idea of what we're talking about, Hilton Garden Inn, Hampton, Residence Inn, and Homewood Suites are some of the major brands in the company's hotel portfolio. These types of hotel require relatively little staffing and maintenance and operate at higher margins than higher-end properties.

One key point to know is that these hotels cater to business travelers, an area of the travel industry that tends to hold up better than leisure travel during recessions. Obviously, business travel ground to a halt this year, but as things start to normalize, Apple Hospitality Properties should be in a good position to rebound.

Because people want to get out

Xenia Hotels & Resorts focuses on the higher end of the hotel industry, with 39 luxury resorts in some of the top leisure and lodging markets in the United States. Just to name a few, Westin, Ritz-Carlton, Hyatt Regency, and Kimpton are some of Xenia's hotel brands.

In a nutshell, Xenia benefits when people are willing and able to travel to their favorite destinations. Two-thirds of the properties in the company's portfolio remained closed at the end of May, which is certainly understandable as no non-essential travel was happening in the spring, and when people travel for essential purposes, large-scale destination resorts are typically not the top choice, especially when amenities like bars, restaurants, and pools cannot be used.

Most of Xenia's properties are expected to reopen by the end of July and all are expected to be operational by October. Xenia has taken steps to ensure ample liquidity and is even taking advantage of the temporary shutdowns to accelerate some of its planned renovations.

Xenia has a highly experienced management team that has a great track record of value creation. Its hotels are in very desirable locations and are operated under some of the most well-known luxury brand names in the industry. The next year or so could be quite a roller coaster ride, but this is a business that should do quite well once all the pent-up demand is unleashed on the leisure travel market.

Invest with the long term in mind

Hotel REITs are a relatively volatile type of real estate stock even in strong economic times, so that's likely to be the case even more during times of uncertainty. I'd expect quite a roller coaster ride in these hotel REITs as the pandemic continues, and if things get worse before they get better, we could see these stocks come under pressure.

The bottom line is that these hotel REITs should reward investors who have the patience and risk tolerance to hang on through the tough times, but there's no telling where they'll go in the near term. Invest accordingly.

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Matthew Frankel, CFP owns shares of Ryman Hospitality Properties. The Motley Fool owns shares of and recommends Ryman Hospitality Properties. The Motley Fool has a disclosure policy.

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