Any reader of my blog recognizes that I generally have an affinity for consumer products and retail facing stocks. In this recession, I’ve also become quite the fan of dividends as manifested in my recent investments – GE, VLO, MO, and LINE. As such, this investment idea probably comes as no surprise – Hotel REITS.
What are Hotel REITs?
Hotel REITs are a subcategory of Real Estate Investment Trusts. These are businesses which invest and (usually) operate income producing real estate. The benefit of this classification is that qualifying REITs do not need to pay corporate taxes on income which they distribute to shareholders in the form of dividends. As a result, there’s a particular incentive for these businesses to remit 100% of their earnings in the form of dividends. Hotel REITS focus on the purchase and operation of hotel (and other lodging) properties.
Any special considerations?
Researching in Hotel REITs is a significantly different animal than looking at more typical stock investments. Hotel REITs derive value in two ways – appreciation in the value of their underlying property and the cash flow/earnings power of the properties they operate. Which valuation dominates public market trading depends on the real estate market, consumer appetites with respect to travel and lodging, and a whole host of other things. With real estate market in shambles, the focus for Hotel REITs is increasingly placed on their cash flow power.
To assess this, get comfortable with two “novel” financial measurements often used by analysts and the companies themselves. Funds from Operations (FFO) or Adjusted Funds from Operations (AFFO) and RevPAR.
Funds from operations is a statistic which attempts to correct for issues that arise from GAAP accounting (specifically, historical cost depreciation) and provide a “clean” number representing exactly the earnings power of a business stripping out depreciation costs (which, for these businesses, are more of a representation of investment). In simplest terms, basically net income minus depreciation. Adjusted funds from operations takes this one step further and subtracts capital expenditures. This allows you to get to a number which is closer to that of the Company’s distributable net income because the Company must allocate some of its earnings to pay for maintenance of its properties or invest in new ones.
RevPAR stands for Revenue per Available Room. This is the fundamental driver of operating cash flow/earnings at a hotel. It is basically a hotel’s occupancy rate multiplied by its average daily room rate which provides a metric for how well a Company is monetizing its rooms. Furthermore, this metric allows you to compare operational performance across different hotel operators which may charge differing average daily rates or have significantly different physical capacity.
Overall Perspective
Admittedly, this industry/asset class has done exceedingly well in the last month, but prices of several of stocks in this category remain greater than 50% below their 52-week highs. Many, despite reducing dividends to conserve capital during this unprecedented credit crisis, continue to pay significant dividends. A few particularly interesting stocks in the category might include: Hersha Hospitality Trust (HT), Starwood Hotels & Resorts (HOT), Ashford Hospitality Trust (AHT), and Sunstone Hotel Investors (SHO). These stocks all offer significant dividends and continue to trade at relative discounts and could be prime pickings when the current rally eventually corrects.
Full Disclosure: Author is long shares of GE, VLO, LINE, and MO at the time of writing. No positions in the Hotel REITs mentioned, though positions may change at any time.
