A Different Kind of Distress for Public Lodging REITs

More than 1,500 lodging industry executives were at The Lodging Conference last week in Phoenix.

In recent months, publicly traded lodging REITs have taken it on the chin as tumbling stock prices have robbed the companies of the ability to effectively compete for hotel acquisitions, a marketplace the sector dominated in the past couple of years. The Dow Jones U.S. Hotel & Lodging REIT Index has fallen nearly 40% since early July, despite stellar earnings reports by nearly all the 16 REITs covered in the index.

“There’s been a huge disconnect between Wall Street and Main Street when it comes to hotel REITs,” said Ken Cruse, president of Sunstone Hotel Investors, during a REIT panel discussion at The Lodging Conference last week in Phoenix. Sunstone is a San Diego-based owner of 33 upper upscale properties that’s seen its share price fall 46% since early July despite a healthy (16.7%) rise in comparable hotel EBITDA in its second-quarterly earnings release last month. “The hotels in our portfolio were purchased at a cap rate of about 5%, but today the cap rate of our company is about 8%. This economic recovery isn’t that much different from other recoveries and doesn’t really affect the underlying value of our assets.”

Other CEOs on the panel expressed the same frustrations as Kruse at how the market has unfairly punished the segment. As another speaker, Chesapeake Lodging Trust’s Jim Francis, said, “Our operating numbers are stronger today than they were at any other time this year and we see solid corporate and group demand growth going into next year.”

Indeed, two-year-old Chesapeake, owner of $1 billion of hotel assets, increased its RevPAR by more than 11% in the second quarter, yet its stock price fell about 35% in the past two months.

Sunstone’s Cruse further argued that lodging REITs have become better owners and operators than during the industry downturn. Through a series of strategic operational changes, Cruse says profit margins for the hotels Sunstone owns were nearly three percentage points better at the bottom of the most recent cycle (2008) than at the trough of the previous downturn (2003). “We made a number of operational changes that have become permanent,” he said. The company streamlined the leadership structure at its properties and reduced the number of salaried workers by 15%. It consolidated food and beverage outlets and often added versatile gastropubs as its properties’ restaurants and bars.

“Our entire system has been worked over, from energy consumption to housekeeping operations and more,” said Cruse.

The REIT executives also contested the notion that private equity funds will fill the gap in the hotel acquisitions market. “Most private equity deals are usually leveraged with debt, so with the high cost of capital and its scarcity, I don’t see a tidal wave of private equity entering the acquisitions market,” said Francis of Chesapeake. “Also, REITs tend to be long-term buy and add value players whereas private equity firms are momentum buyers. The current environment doesn’t favor them.”

Despite the stress they feel, lodging REIT managers don’t plan to sit by idly until stock prices recuperate and they’re able to again buy hotel assets. Sunstone, for example, has what Cruse calls a “multiple pillars” strategy. “We’ll continue to selectively make transactions while keeping our intense focus on operations,” he said. “We may also work our balance sheet through refinancings of some assets or deleveraging the company. It’s even possible that circumstances will warrant some divestitures of assets.”

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