Quick Insights into Hospitality REITs

Snippets from the book "DIY Guide to Winning with REITs" 

Four Seasons, JW Marriott and Westin hotels and resorts: all these names are synonymous with one of my favorite words. A holiday!

But for Hospitality reit unit-holders, investing in hotels may not be all that enjoyable for the following reasons:

Capital expenditure may not be for growth

REIT unit-holders usually expect higher returns (higher DPUs) after their reit spends money on renewing their buildings (recall the concept of organic growth-asset enhancement initiatives). But for Hospitality reits, they must enhance their properties regardless of whether it leads to higher DPU. This is to stay competitive amidst newer rivals.

Vulnerable to many uncontrollable factors

Unlike Healthcare reits with their long lease agreements that help ensure distribution stability, the hospitality industry can have its fortune changed overnight based on conditions which are totally outside of anyone’s control, such as the weather pattern which disrupts tourism, terror attacks and more. This can be a real headache for someone who has a huge proportion of their portfolio allocated to such reits.

In light of this, some Hospitality reits do negotiate a master lease agreement with a hotel operator which provides for a minimum fixed revenue amount. This is one matrix to look out for when investing in such reits.

An example of a worthy hospitality-industry reit is OUE Hospitality Trust (SGX: SK7). This reit pledges a minimum yield of 4.5% simply due to the master lease agreement they contracted with their hotels. If their hotels have great daily occupancy rates for the year, that’s just gravy on top of an already healthy rate of return.

A new threat

Booking.com and Hotel.com are some of the latest social media initiatives that help boost the occupancy for hotels. However, there is a new threat to the industry, which is this social website called Airbnb. Airbnb is an online platform for people to list their own homes and apartments to travelers.

A study conducted by HVS (Hospitality Valuation Services, a consulting firm that provides market studies and educational information relating to the hospitality industry) from 2014 to 2015 shows that hotels lost more than $400 million in direct revenues per year to Airbnb. The popularity of Airbnb is bad news to REITs that hold hotels catering to the low and middle class clientele.

So, based on the considerations above, here are some factors to note for Hotel REIT unit-holders.

Focus on quality

When looking at Hospitality REITs, pay attention to the overall feel and look of the underlying properties. Unlike some other REITs such as Industrial reits where the appearance of the property may not matter much, Hospitality REITs need their hotels and service apartments to keep up with appearances and standards. Moreover, with the threat of Airbnb, you want your Hospitality REIT to hold higher quality hotels whose service standard and experience cannot be so easily replicated by homeowners.

While some of these hotel properties can be evaluated by personally going down to the hotel, the quantitative method of determining the earnings potential of a hotel is to calculate the revenue per available room or “RevPAR”.

RevPAR: Average Daily Rate (ADR) * Average Occupancy Rate (AOR)

Although the higher the RevPAR, the better, there is a common misconception that high RevPAR is only achieved from operating five-star hotels due to the higher pricing.

This is not true, as star rating achievements do not necessarily mean better investment results.

Modify your investment strategy via lease structures

As mentioned earlier, the relatively unique lease structure of hotels is a big advantage of owning a Hospitality reit over the other types of property. Understanding the lease structure plays an important role in your portfolio objective.

An investor looking to take advantage of an upcoming tourism boom in a country, for example, should go for Hospitality reits that have negotiated a larger proportion of their lease structure on the variable side. Vice versa, an investor looking for more stability in the sector should go for Hospitality reits with a higher fixed portion in their lease structure.

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