Financial Review Of The Debt Structure Of The 3 Biggest Lodging REITs

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Includes: APLE, HPT, HST
by: Robin Nieland

Summary

Two weeks ago, the Federal Reserve leaders decided not to increase the bank's key interest rate.

The most recent jobs report showed that the economy added 156,000 jobs. The unemployment rate ticked up to 5% from 4.9%.

Which lodging REIT is best equipped to handle a possible future interest rate hike?

This article provides an overview of the debt structure of three of the biggest lodging REITs.

HST and APLE seem the least sensitive to an interest rate hike in the short term.

Two weeks ago, the Federal Reserve ("FED") leaders decided not to increase the bank's key interest rate. The FED is still waiting for the right moment to raise interest rates. Some say that a possible rate hike could occur later this year but that remains to be seen. Last week the most recent jobs report showed that The economy added 156,000 jobs last month, slightly lower than the revised job gains for August. The unemployment rate ticked up to 5% from 4.9%.

Recently, I wrote a few articles where I discussed the debt structure of the biggest REITs in various subsectors.

I discussed various debt and financing metrics to compare the various REITs in that particular subsector. The main premise behind these articles is that a possible future rate hike will impact short-term share prices of almost every REIT, regardless of their actual sensitivity to interest rate changes. However, these articles are meant to provide answers to the question: which REIT is best equipped, from an operational perspective, to withstand rising rates in the future?

Some readers suggested I do a similar analysis on the lodging subsector. Here we go!

Lodging REITs

Lodging REITs are Equity REITs that own and manage hotels and rent space in those properties to tenants. Lodging REITs own different classes of hotels based on features such as the hotels' level of service and amenities. Lodging REITs' properties service a wide spectrum of customers, from business travelers to vacationers.

In this article I will review three of the biggest REITs in terms of market cap.

  • Host Hotels & Resorts (NYSE:HST)
  • Hospitality Properties Trust (NYSE:HPT)
  • Apple Hospitality REIT (NYSE:APLE)

HST is by far the biggest data center REIT in terms of market cap. It's roughly three to four times bigger than the other mentioned REITs. All the data in this article are from the latest quarterly earnings reports (Q2 2016). Therefore, I did not take into account the financing activities for each of these companies between June 31 and today.

Capital structure

As a starting point in our analysis, let's take a look at the capital structure. The idea is that a REIT with high amount of debt financing (more leverage) usually is more sensitive to interest rate hikes. The table below provides a breakdown of the debt-to-equity (D/E) ratios of different REITs.

Source: data from Morningstar

We can see that HST and APLE are both quite conservative in terms of their capital structure. HPT uses significantly more debt than its peers. Therefore HPT seems more sensitive to a possible interest rate hike in the future, based on this indicator.

The next question is how much debt is variable rate debt and how much debt is fixed rate debt. The underlying rationale is that a higher amount of variable rate debt is riskier than fixed rated debt.

Source: table created by author, data from latest Q2 2016 earnings and supplemental reports

HST and APLE's debt loads are roughly two thirds fixed rate debt whereas HTP has a slightly higher fixed rate debt portion. The differences between these REITs are not that big however.

Debt maturities

The amount of variable rate debt, however, is not the only indicator. Fixed rated debt that matures in the short term is just as sensitive to rising interest rates as variable rate debt. The table below provides an overview of the amount of debt maturities between now and 2019 relative to the outstanding long-term total debt.

Source: table created by author, data from latest Q2 2016 earnings and supplemental reports

An analysis of the debt maturity schedule shows that HST has the least amount of short-term debt maturities (23%) and HPT has the highest amount (36%). The average amount of debt maturities is still relatively low compared to other sectors. Healthcare REITs need to refinance on average 35% of their debt load before 2020, triple net lease REITs around 40-45%. Only data center REITs like EQIX and DLR have much lower short term debt maturities.

Another way to look at the debt maturity schedule is to calculate the maturity of the various debt instruments. The fixed debt issues are up for refinancing in 4 to 7 years. The variable rate debt instruments have shorter durations (3 to 4 years).

Click to enlarge

Source: table created by author, data from latest Q2 2016 earnings and supplemental reports

HST and HPT have the longest maturity on their debt portfolios. Especially HST's fixed rate debt has a high maturity. APLE has the lowest maturity.

It's also important to check what the average rate of the maturing debt is. Debt with a relatively high interest rate that matures in the short term actually offers a chance to improve the financial operations. If a company is able to refinance expensive debt with cheap debt, it is a good thing. The table below provides an overview of the average weighted debt rate of the debt that matures between 2016 and 2019

Source: table created by author, data from latest Q2 2016 earnings and supplemental reports

The interest rates on the maturing debt varies greatly. On the one hand, HST has a low interest rate for short-term debt whereas HPT and APLE both have (slightly) more expensive short-term debt. HPT and APLE have the potential to refinance their short-term debt load in the current low rate environment. This is harder to do for HST because their short-term debt load is much cheaper.

Other indicators

In the section above, I've discussed the capital structure and the debt maturity schedule of the three data lodging REITs. I will finalize my analysis of the rate sensitivity with a few more general indicators of the health of the companies as it relates to debt and interest payments.

Click to enlarge

Source: table created by author, data from latest Q2 2016 earnings and supplemental reports

The (net) debt, cash and EBITDA numbers are all in million USD.

The net debt/EBITDA multiple shows how many years it would take for a company to pay back its debt. The net debt/EBITDA ratio usually hovers somewhere between 4-5x so HST definitely has one of the best net debt/EBITDA multiples around. HST and APLE both have low multiples which is no surprise given their low D/E ratios.

However, this ratio and the D/E ratio are not exactly similar because the net debt/EBITDA ratio takes into account the earnings of a company (and thus the current operations). The D/E ratio is merely a snapshot view of the balance sheet.

The table below provides the interest rate coverage ratio.

Click to enlarge

Source: table created by author, data from latest Q2 2016 earnings and supplemental reports

The interest expense (in million USD ) is based on the first six months of 2016 and extrapolated through the end of this year. The interest coverage ratio measures a company's ability to pay the interest on its outstanding debt. Both HST and APLE score well (again) on this indicator. Usually the interest coverage ratio hovers somewhere between 3 to 5x. Given the lower amount of debt in the capital structure, it is logical that HST and APLE have higher interest coverage ratios.

Summary

The table below provides a summary of the various indicators I have mentioned in this article. The number (1 to 5) represents the rank where 1 is the best and 5 is the worst company based solely on that indicator. Obviously, this table and the ordinal ranking system do not take into account the degree of differences between them.

From the data, we can see that each of these REITs have their strong and weak points. However because their more conservative capital structure, HST and APLE score better on most of these metrics. The differences between these REITs in the debt composition (fixed vs. variable rate debt) were quite small however the differences in capital structure, debt/ebitda and interest coverage ratio are quite big.

So all in all, from an operational perspective, HST and APLE seem better equipped to withstand rising rates in the future. This does not subsequently mean that you should invest in both companies right now. I did not address future growth potential and valuation. These are both important arguments in whether you should invest in the common shares or not. This analysis provides a starting point!

Author's Note: If you have thoughts about this article or interest rate sensitivity in general, please leave your reply in the comment section below. Furthermore, if you have suggestions or requests for future articles, let me know! Finally, if you would like to be notified of my future articles, please follow me! (by clicking my name at the top of the page).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.