A Post-Pandemic View of the Real Estate Hospitality Sector
Baird’s Real Estate Group recently connected with investors to discuss trends and opportunities in the hospitality space. Michael Bellisario, Senior Research Analyst with Baird’s Equity Research team, joined the discussion and shared current trends and his outlook for the hospitality sector.
Overall, the hotel industry is seeing a shift in the way people travel. More people are taking road trips and seeking outdoor destinations. Short-term rentals, such as Airbnb, have performed well during and after the pandemic compared to traditional hotels, but hotels are expected to continue their recovery trajectory in 2023-2024, which should be driven by a continued improvement in business travel and strong group demand. Technology has become increasingly important in the hotel industry with contactless check-in and other digital features becoming more common. Additionally, sustainability is becoming more important to travelers with many hotels implementing eco-friendly practices and highlighting them as part of their marketing.
While recessionary concerns are broadly heightened, hotel fundamentals remain solid; demand and pricing power are robust. Revenue per available room (RevPAR) growth in the second half of 2023 and beyond is forecasted to be in the 2%-3%, which is more in line with the historical long-run average. Recent turmoil in the debt markets is likely to negatively affect new construction financing, which should keep overall supply growth muted for the next several years.
- Operating Challenges Affecting Hotels. With top-line growth normalizing and expense growth higher than historical averages, margins are anticipated to be negatively impacted in 2023. Increased wages and higher utilities, insurance, and property tax expenses are the drivers.
- Lasting Impact of COVID-19.The pandemic had a much greater impact on RevPAR compared to previous demand shocks; RevPAR declined over 50% in 2020. While 2023 is expected to be a year of more "normal" trends, year-over-year growth rates still are not normal due to the still-recovering business traveler and group/convention demand.
- Public Company Valuation Considerations. On-the-ground commentary suggests "no signs of slowing" and "no cracks in demand" for the hospitality industry, but public market investors are not willing to pay premiums for the stocks in the current environment despite solid fundamentals.
- For most portfolios, the Street uses EBITDA multiples or NOI cap rates. However, valuations often do not appropriately adjust for portfolios’ capex requirements or other factors such as ground leases, encumbrances, and union labor. Portfolios are valued in the aggregate, almost never on an asset-by-asset basis. This means that geographic exposure is key, and investors should consider who has the most exposure to the most favorable markets and who has the least exposure to the least favorable markets.
- Certain investors apply discounts/premiums for management quality, balance sheet leverage, and overall perceived portfolio "quality." However, making the best real estate decision does not always lead to a higher stock price or valuation multiple. When assets are not valued individually, investors rely on the portfolio averages.
- Selling higher cap rate assets is generally dilutive and selling lower cap rate assets is generally accretive, all else equal, which presents an opportunity for private equity investors to capitalize on the other side of the trade when a Hotel REIT transacts.
- Hotel Brands vs. Hotel REITs.The global hotel brand companies aim to expand their network and create greater value for their customers (i.e., more dots on the map). Consumers are more platform loyal than individual brand loyal, and price and quality matter. Investors value highly and compare closely the hotel brands' net unit growth profiles. Hotel REITs tend to focus on different markets over time. For example, from 2017-2018, the Hotel REITs acquired resorts, and from 2021-2022, they focused on resorts and leisure-focused markets again. From 2022-2023, they are focused on dispositions, deleveraging, and share repurchases. Hotel REITs have struggled to grow over time, especially on a per-share basis through cycle. They typically find a valuation floor near 10x NTM EBITDA during periods of slowing growth or when recessionary concerns become elevated. Tax reform, strong net unit growth, and robust shareholder capital returns have helped the Global Hotel Brand stocks re-rate higher in recent years.
Interested in learning more about these hospitality trends? Connect with Baird’s Real Estate Investment Banking team:
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