The Next Hot High-Yield Sector

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The Next Hot High-Yield Sector


Lodging is the commercial real estate sector that is most sensitive to the level of economic activity. Strong GDP growth usually leads to expanding profits for hotel owners. The lodging REITs have been in a slump since the sector’s recent bear market that lasted the full year of 2015.

In the spectrum of rent contract lengths, hotels have the shortest time. Room rates can change daily based on supply and demand conditions. When the economy starts to grow faster, there is greater demand for hotel rooms, which allows the lodging companies to fill more rooms at higher average prices.

The lodging real estate investment trusts (REITs) own portfolios of hotels. Most REITs focus on a specific sector of the hotel business. A REIT will own the properties and contract with third-party management companies. To keep it’s REIT status, the hotel owner cannot also be the operator. Lease contracts between the lodging REIT and the tenant/management company usually include a fixed lease payment and a percentage of revenues. The hotel REITs do experience greater revenue and free cash flow when hotel revenues are improving.

The metric to follow in this sector is RevPAR: revenue per available room. Quarter to quarter changes in RevPAR show you how well a specific REIT is doing. Flat or declining RevPAR means a flat dividend. If the metric starts to increase nicely, you can expect the REIT to start boosting the quarterly dividend. Most lodging REITs keep the dividend/FFO payout ratio low. This avoids the need to cut the dividend if there is slowing in the lodging space.

The hotel REITs had a tremendous run-up from the bear market bottom in 2009 until the sector peaked in January 2015. Investors saw rising dividends and share price gains of several hundred percent. When the RevPAR growth flattened, the hotel REITs went into a yearlong bear market covering 2015. For the last two years both RevPAR growth and hotel REIT share prices have been flat. Here is the five-year comparison chart of three hotel REITs that nicely illustrate the up, down and flat trends of the past half-decade.


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