There are many reasons to consider investing in real estate at this time, including inflation, expected increase of real estate prices, favorable taxation of real estate investment trust (REIT) dividends, and the feeling of owning something tangible. Hospitality Properties Trust (HPT) offers such an investment opportunity. First, it has attractive fundamentals, including reasonable valuation and a 7.2% dividend yield. Second, it maintains its properties well and is currently renovating many of them. Historically, the company has had strong room utilization and consistently higher rankings on Tripadvisor.com (TRIP). The renovations should help continue these trends. Third and last, the company should benefit from a number of broader tailwinds, including a weaker US dollar, higher inflation, and increase in demand for hotel rooms in the foreseeable future.
Hospitality Properties has about 123.6 million shares outstanding for a market capitalization of about $3 billion, an enterprise value of $5.6 billion, and a total long-term debt to equity ratio of about 75%. This is in line with the industry average capital structure. For example, some of its competitors, such as LaSalle Hotel Properties (LHO), Host Hotels & Resorts (HST), Pebblebrook Hotel Trust (PEB), and Sunstone Hotel Investors (SHO), have total long-term debt to equity ratios of 72%, 75%, 21%, and 92%, respectively.
At the same time, Hospitality Properties debt has a S&P rating of BBB-, which compares favorably to BB- for Host Hotels (LaSalle, Pebblebrook, and Sunstone are not rated and have higher costs of debt). It also pays one of the highest dividends with an annualized dividend yield of 7.2% compared to a dividend yield of about 3%, 2%, 2%, and zero for LaSalle, Host Hotels, Pebblebrook, and Sunstone, respectively. Hospitality Properties is paying a generous dividend, but it represented only about 60% of its most recent quarterly funds from operations (FFO), which is sustainable. For comparison, LaSalle, Host Hotels, and Pebblebrook recent dividend-to-FFO payout was 28%, 24%, and 32%, respectively. Historically, Hospitality Properties has paid between 50-60% of its FFO as dividend compared to about 20-30% for LaSalle, Host Hotels, and Pebblebrook.
Hospitality Properties is able to maintain a high payout simply because it has one of the best margins in the industry, with earnings before interest, tax, depreciation, and amortization (EBITDA) of 40.8%. LaSalle, Host Hotels, Pebblebrook, and Sunstone are trailing behind with EBITDA margins of 37%, 25.4%, 28.4%, and 32.6%, respectively. While Hospitality Properties has solid fundamentals and margins, it is undervalued based on 2012 estimated price to earnings ratio of 23.7. LaSalle, Host Hotels, and Pebblebrook have much higher fiscal 2012 price to earnings ratios of 47, 101.1, and 83.7 (Sunstone is expected to lose money in 2012). The table below summarizes the findings discussed above.
Debt to Equity
EBITDA Q2 '12
Estimated 2012 PE
Occupancy Rate Q2 '12
Source: Thomson Reuters and companies' press releases.
Hospitality Properties has 290 hotels and 185 travel centers. The properties are located in 44 states, Puerto Rico, and Canada. During Q2 '12, the company had $343.2 million in revenue, of which 77.2% was from hotels and 19.7% from travel centers. While its hotels are well-diversified geographically and by brand, they have consistently good customer satisfaction. A study done in 2010 noted that Tripadvisor.com users give its hotel properties a thumbs up in an average of 75.5% of the ratings and its hotels are ranked in the top-45 percentile.
More recently, the company started renovating its properties, which should further improve the profitability, occupancy, and customer satisfaction once the renovations are complete at each respective hotel. These renovations, which started in 2011 and are expected to be complete in 2013 for most of them, will cost $145 million for 68 Marriott operated hotels, $290 million for 91 InterContinental hotels, $75 million for 20 Wyndham hotels, and an estimated $130-$150 million for the 19 hotels to be converted under the Sonesta brand. Once the renovations are complete, Hospitality Properties estimates the renovations will produce a rate of return of about 8%.
Continued monetary policies aimed at stimulating the economy in the United States, Japan, and Europe will likely cause inflation. Real estate and in particular hotels are a good investment in inflationary environments as hotels are real property and also they can raise prices more easily due to a limited supply of hotels. In particular, Hospitality Properties is well protected from inflation. Its contracts with the property operators have a fixed minimum rent but also allow for additional payments to Hospitality Properties once each property reaches certain revenue and cash flow levels.
A number of leading consulting companies, such as Smith Travel Research and PricewaterhouseCoopers, expect occupancy rates and hotel prices to continue their increase into 2013. Also, many economists expect a weaker dollar due to the excessive quantitative easing in the United States. A weaker dollar means that more foreign tourists from Europe as well as Canada, Japan, Australia, and emerging economies will be able to travel to the United States. All this will further boost the demand for hotel rooms.
Hospitality Properties Trust is managed by Reit Management & Research, which has proven leadership and outstanding ability to manage properties. The company manages over 1,600 properties and a number of other REITs. Most importantly, it is a good long-term owner who is willing to acquire new properties, sell underperforming hotels, and renovate existing ones. While short-term performance could be impacted from the decrease in occupancy and increase in capital spending due to its property renovation program, the company will emerge even stronger. In addition, its favorable valuation compared to competitors, a high dividend yield, and economic and industry trends make Hospitality Properties stock an attractive but conservative investment opportunity.