Slowing Fundamentals Hamper Hotel REIT Performance

In the midst of an economic downturn in the U.S., hotel REITS face challenging times ahead. The health of hotel assets are greatly tied to the performance of the U.S. economy, and, since a hotel’s “leases” are nightly room rentals, the effects of an economic downturn are felt almost immediately, in comparison to an office building, which has tenants committed to five-to-10 year leases, said Maria Maslovsky (pictured), assistant vice president and analyst at Moody’s Investors Service.The difficult times that hotel REITS are facing is illustrated in a report released recently by Robert W. Baird & Co. Analysts David Loeb, Andrew Wittmann and Eric Palm cut price targets on the twelve REITs and real estate operating companies it covers, and two received downgrades. Ashford Hospitality Trust was downgraded from outperform to neutral, because of its substantial amount of floating rate debt. Red Lion Hotels also received a similar downgrade, as the company has been pursuing strategic alternatives, but the analysts believe a transaction is unlikely to occur given the current dislocation in the capital markets.The report notes that hotel owners face some heavy headwinds, as the analysts estimate that 2009 RevPar will drop between 3 and 5 percent, as the industry will be battered by a combination of growing room supply and slackening demand. The analysts also cut net-asset-value-based price targets on the companies covered, due to higher cap rate assumptions, as a significant gulf still exists between bid-ask spreads, with owners demanding a higher spread because of the increased cost of their debt.== In addition, the upper-upscale segment, which has the largest representation in the publicly-traded hotel space, should be the segment hardest hit by flight reductions by the major airlines. A recent study from PKF Hospitality Research found a .39 reduction in room demand per 1 percent reduction in airlift, but these cuts disproportionately affect upper upscale hotels because of the high percentage of business travelers they attract.There are some positives, Maslovsky notes. The industry did not go on as large a building binge as it did in past positive lodging cycles, so while supply should exceed demand, it should not be as wide a gap as in past years.The four REITs and REOCs Moody’s rates have made some smart moves, she said. During the recent good years in the lodging sector, they have taken steps to strengthen their balance sheets, and refurbished their properties. “They are entering the downturn in relatively good shape,” she said. In addition, they have well-laddered debt maturities, so they don’t have to face a large number of loans coming due at the same time.Maslovsky said some developments in the banking sector do bear watching. Bank of America did extend a significant amount of bank lines of credit to REITS, while Merrill Lynch did much less. She also noted that the new entity may decide they are overextended in that space. The Wachovia-Wells Fargo combination should also be monitored, as Wachovia was a significant lender to REITS, with Wells Fargo much less so. So the acquirer will gain increased exposure to the REIT sector. One positive is that the Federal government is increasingly paying close attention to the health of banks, she noted.