Indicators of future demand are looking up. The first quarter earnings season could reset future expectations for the entire lodging industry, which many lodging business forex thought would experience the end of the cycle shortly.
A pickup in demand could justify recent outperformance and possibly position the sector for future gains. The strong stock performance has likely been in anticipation of the pro-growth and pro-business agenda that President Trump’s election symbolized. AFFO is a REIT metric most similar to earnings per share and is representative of cash flow after capital expenditures. RMS as of March 31, 2018. In addition, the sector was one of the worst performers over the same period. In other words, investors took on higher risk while receiving lower return. However, across short time horizons there have been periods of outperformance which creates opportunities for active managers to generate alpha.
2018 RevPAR to grow by a cyclical low of only 2. If tax reform could help 2018 RevPAR growth buck the trend, this could be one of the opportunities for lodging REITs to deliver outsized returns. While important, RevPAR is not the only driver of lodging REIT performance. Heavy operating expenses and capital expenditures required to maintain relevance with guests can compress margins and cash flow available for dividend growth. In our opinion, this is one of the biggest reasons for the historical underperformance.
The economy has been accelerating since the presidential election, but the improvement in economic data hasn’t translated into improved hotel fundamentals – at least not yet. Additionally, due to the locations within major markets and bias toward high quality, lodging REITs have experienced a disproportionate headwind from new supply. Supply within the major markets has grown 3. As a result, the average REIT RevPAR growth in 2017 was 1. Within the major markets, the lodging REIT portfolios are mostly weighted toward higher quality urban and full service hotels. In the industry, these hotels are labeled as Luxury, Upper Upscale, and Upscale, which include brands such as the Four Seasons, Marriott, and Courtyard, respectively. As the economic recovery has gotten long in the tooth, many corporations have cut costs, which has included travel and conference budgets.
Since 2012, the lodging REIT average EBITDA margin has grown from 23. EBITDA margins can vary significantly in the hotel business. Large ballrooms and convention space need to be used often to justify the upkeep costs. Hotel restaurants and bars can be significant drags to margins if they aren’t popular among guests and locals.
Many cities have hotel labor unions that require certain wages and hours, which constrain the ability to cut expenses. Even how the guests are sourced can have a large effect on margins. Recent cost-saving initiatives have been made possible due to advances in technology. In addition, this keeps a lobby less crowded, which can allow the space to be used for another purpose. Some hotels are cutting back on room service, which has historically been unprofitable. CEO Jon Bortz has long been a proponent of imposing cancellation and change fees similar to the airline industry.
A Case Study In Value Creation PEB has also been one of the leaders in cutting costs at the property level to drive EBITDA growth. The Sir Francis Drake hotel on Union Square in San Francisco was one of Bortz’s first purchases after taking PEB public in December 2009. Despite acquiring the hotel at a year one EBITDA yield of only 3. B best practices included a new purchasing program, revising the menu to reduce waste and control portions, installing beverage controls to monitor pours, and a monthly monitoring system.