Hotel REITs are hated today. They are on sale at just 8.7 times FFO on average – the second lowest multiple of the entire REIT sector (only second to mall REITs). That’s a ~50% discount to the average valuation multiple of REITs.
Why is that?
- Hotels are cyclical.
- Investors fear a recession.
- And finally, the rise of Airbnb (AIRB) has put off hotel investors.
If mall investments are hated due to the growth of Amazon (AMZN), hotels are similarly impacted by fears over Airbnb. The fears are so great here that hotel cap rates have actually expanded over the past 10 years. This is the only property sector to have experienced cap rate expansions:
The spread to other property types is reaching ~300 basis points – a historically high level. We believe that it opens an opportunity for more sophisticated investors who understand the nuances between hotels and Airbnb.
Airbnb is a significant threat to some hotels and should not be ignored. This is not however the case for all hotels. Some are much more resilient than others – and yet – the REIT market has priced all hotel REITs at deep discounts as if Airbnb posed a similar threat level to all of them.
There will be some losers, but also some winners over the coming decades. Here’s what we think about Airbnb and how we position our Hotel investments.
Airbnb: What Is It?
Let’s start with a quick definition for those of you who still haven’t given it a try. According to Wikipedia:
“Airbnb is an online marketplace for arranging or offering lodging, primarily homestays, or tourism experiences. The company does not own any of the real estate listings, nor does it host events; it acts as a broker, receiving commissions from each booking.”
As such, if you have an additional room in our home, you may rent it out to travelers and compete with traditional hotels. On the website, you can find various offerings ranging from rooms to mansions and everything in between.
I regularly use Airbnb and so I understand the appeal of it from a consumer standpoint. In fact, I recently spent three months in Asia hunting for Asian REIT opportunities and spend most of my time in various Airbnb apartments:
If anyone can rent their extra room, apartment, home on Airbnb and compete with hotels – this must be really bad for hotels, right?
Yes and no. Here we must first understand why people use Airbnb. I myself see it two reasons:
- Save money.
- Longer duration travel.
In some cases, Airbnb can be significantly cheaper than other hotel alternatives. Private hosts do not have the same cost to operate and they may cut prices to attract price conscious travelers.
Secondly, if and when you travel like me for a longer duration, it’s great to have access to a kitchen, working desk, and other amenities that a hotel room may not have.
Based on this, we already can identify which hotels are likely to be at the greatest risk:
- Limited service budget hotels: They compete directly on prices with Airbnb to attract price conscious travelers. CorePoint Lodging (CPLG) is a good example of a hotel REIT that specializes in such properties.
- Extended stay hotels: They attract long duration travelers in a similar way as Airbnb does. Extended Stay America (STAY) would be a good example here.
This does not mean that these properties are going out of business. Far from it. I myself often stay at budget hotels as they provide convenience, consistency, parking, a reasonable price, and a location in close proximity to a major intersection. You know what you are getting – and just like getting a meal at McDonald’s (MCD) – people value consistency.
There are however some real reasons to be concerned. These properties compete on similar needs as Airbnb and price plays a much greater factor. Moreover, these properties will often be outside of densely-populated urban areas and generally won’t be protected by anti airbnb regulation which has been emerging in many urban locations. It’s for this exact reason that we prefer upper scale hotels for long term investments.
Upper Scale and Luxurious Hotels
These 4-to-5 star hotels will generally have amenities that Aribnb cannot compete with. This includes a gym, spa, bar, restaurant, concierge service, room service, and many other services – such as airport shuttle, document printing, taxi booking, etc…
It’s much more than just a room with a bed. You are buying an entire package to make your trip more convenient. The hosts on Airbnb do not compete on this front and offer less amenities, convenience, and professionalism.
Very often, these upper scale hotels will be located in close proximity to highly desirable locations such as the central business district, the beach, or any other location that guests may want to access within a short walk or a quick Uber (UBER) ride.
Location, location, location is the mantra of real estate investing, and in the case of upperscale hotels, the superior location is a big factor.
Facing housing shortage and mass tourism, many major cities are regulating Airbnb to keep cities first and foremost for living in. More nuisances, feelings of insecurity and a “touristification” of their neighborhoods is not what residents want. When you already lack housing – the solution is not to convert apartments into hotels – and a lot of local governments are pushing for very strict regulations which protects local hotel owners.
We are not here to debate whether this is the right or wrong thing to do, but it’s clear that an unregulated vacation rental industry can have damaging effects on cities, and therefore, it’s likely that we will see more regulations to fight housing shortage problems.
In a recent letter from 10 major cities addressed to the European Union, the cities note that Airbnb is a big threat and regulation is quickly needed:
“Many cities suffer from a serious housing shortage. Where homes can be used more lucratively for renting out to tourists, they disappear from the traditional housing market,” the cities wrote. “Prices are driven up even further and housing of citizens who live and work in our cities is hampered.”
A negative for Airbnb here turns into a great positive for upper scale hotels located in densely populated and highly regulated cities. And this is exactly where we are investing.
Hersha Hospitality (HT) is one of the more attractive hotel REITs. It owns one of the most luxurious portfolios in some of most densely populated markets in the world:
Hersha was very proactive and undertook a massive portfolio repositioning over the past five years to position its properties for stronger long-term growth. These are hotel veterans who have been in this business for decades – and you can bet that they understand the risks that Airbnb presents.
The portfolio repositioning was a drag on the stock performance as it negatively affected growth, but now the company is left with a freshly-polished portfolio that’s well protected from the long-term impact of Airbnb.
Here are five examples of newly acquired assets to give you an idea of what we’re talking about:
#1 – Ritz Carlton Coconut Grove – Miami:
#2- The Envoy, Seaport – Boston:
#3 – Ritz Carlton Georgetown – Washington, D.C:
#4 – St. Gregory, Dupont Circle – Washington, D.C
#5 – Pan Pacific Hotel – Seattle
While not a perfect representation of the entire portfolio, these properties give a rough illustration of the targeted assets. We are talking about upscale to upper upscale properties in dense urban locations:
These hotels are tomorrow’s winners, in our opinion. They are built in, in-fill locations of growing cities that enjoy demand growth with greater supply constraints. They also have amenities that Airbnb cannot compete with, and regulations are surging to fight housing shortage. A perfect mix for these hotels.
Budget hotels and other extended stay hotels are at greater risk with abundant land available in their surroundings for new constructions, less amenities, less regulation, and more price competition from Airbnb.
Myself, when I travel, I generally stay at upper scale locations for their superior locations and amenities when I travel for short duration – and then I use Airbnb when I travel for longer duration.
If I’m looking to save money, I may use either or a budget hotel outside the center or Airbnb – and price is the main determinant factor.
It speaks highly for upper scale hotel investments, and much less so for other hotels. With HT, you get exposure to a premier portfolio of hotels, with a reasonable balance sheet, and a fantastic management team.
Yet, because of the perceived Aribnb risk (and other risks), HT is today priced along with other hotel REITs at deeply discounted valuations. HT is priced today at a low 6.9x FFO and an estimated 35% discount to estimated net asset value – which is even cheaper than the average Hotel REIT.
It pays an 8.2% dividend yield that represents only roughly 55% of the cash flow, and uses the other half for deleveraging, buy backs, and other growth initiatives. The insider ownership is some of the highest of all REITs at over 10% and the management keeps buying more and more shares very regularly – a strong vote of confidence.
This is one of those cases where HT appears to have suffered more than it should have from the “perceived Airbnb risk.” We are investing in the company at High Yield Landlord – along with several other real estate investments.
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Disclosure: I am/we are long HT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.