Lodging REITs over the past year or so got hammered. That's a fact, not an opinion. The striking thing about the lodging REITs' decline is the enormous gap in returns between the broader REIT market and the lodging REIT sub-sector.
The concern over the future performance of lodging REITs isn't directed towards any one specific city/region; while local market dynamics is important no doubt, the current concerns are broader and aren't local in nature, but of a broader, national scale.
In order to isolate the local arguments, I think it's instructive to have a look at Host Hotels (NYSE:HST). HST holds 99 hotels and is the largest lodging REIT traded with a current market cap of ~$10B (depending at what time one checks, given recent volatility..) and manages a sound balance sheet. Below is a graph showing the geographic breakdown of HST's hotel portfolio:
Source: company presentation
The portfolio is well diversified over most regions, so HST can broadly be viewed a representative non-concentrated national hotel portfolio (agreed, it isn't a perfect representation of regions/weights, but as close as we have).
Over the past twelve months there weren't any major HST specific issues which explain the substantial share price reduction, yet HST has returned to shareholders -41% over the past twelve months. I believe this exemplifies the broad concern over the lodging industry, as a whole, irrespective of any specific locality.
In addition, to further highlight this point, it's useful to have a look at valuation levels of various REITs making up the sector today, versus a year ago:
Source: SNL Financial
All would agree that this decline in valuations, over a time span of just 1 year, is fantastic and assuming the US economy isn't entering a recession - is extreme by all means (especially given performance of the wider REIT market).
So what is it that freaked out lodging REIT investors, that lodging REIT management teams don't see as I've described in a past article here, that may explain the fantastic divergence in returns from the broad REIT market?
Upon reviewing various articles on the subject as well as comments by readers, one can't escape the elephant in the room - Airbnb.
If comments to articles on the subject make for a fair barometer, It seems that Airbnb is THE biggest threat, in investor's minds, to the lodging REIT sector and the one that best explains why investors are selling, selling, selling.
In the 1995 film, the Usual suspects, the character around which the film revolves is Kaiser Soze (brilliantly acted by Kevin Spacey). Kaizer Soze is described as having had enemies and disloyal henchmen brutally murdered, along with everyone they hold dear, for the slightest infractions, as well as personally murdering anyone who can identify him. The name Kaizer Soze alone sends fear, tremble and hysteria in people. If anyone hasn't seen the film, it's a must. And while I don't want to spoil, suffice it to say that in the end, not all about Kaizer Soze turns out to be true.
I can't help thinking that Airbnb is the Kaizer Soze of the lodging REIT industry - an ever-present menace whose very name invokes perils far beyond his capability. Just stating the name "Airbnb," makes people unconsciously press the "sell" button, regardless of anything.
While Airbnb seem to be THE primary fear factor regarding lodging REITs in recent past, very little evidence has been provided by commentators and pundits alike, as to the actual impact Airbnb has on this industry. Is this Kaizer Soze for real? The fear and hysteria is there no doubt, but where's the evidence?
We're dealing here in investments, it would be useful to actually look into this. There are probably various ways to think of this phenomena, I'll present one angle which I found instructive.
Hotel Compression Nights
In hotel jargon, compression periods are those periods when a hotel is nearing full occupancy (say, 95% and above), presenting revenue-management opportunities for hotel operators.
Hotels strive for compression nights, since when compression nights occur, hotels normally, have more negotiating power to raise daily rates, and in fact enjoys eating the cake and leaving it whole- high occupancy AND high rates.
Compression nights are an important metric, data on the existence and frequency of which provides an indirect picture of supply/demand dynamics for hotels. It's somewhat of a derivative of the supply/demand dynamics.
Well, rationally then, it would make sense that all else being equal, the substantial new supply of alternative lodging solutions, created in large part by Airbnb, would reduce the number of compression nights for hotels, as customers have now much more to choose from in terms of supply and don't have to cram into already highly priced hotels - pushing occupancy rates and number of compression nights, lower. And if, say, compression nights don't decrease, than at least one would assume that the average daily premium during compression nights (versus daily rates during non-compression nights) would decrease, as again, clients have more to choose from.
If that is the case, it would provide strong solid evidence, through extrapolation, that Airbnb indeed hurts the lodging industry, hurting occupancy, average daily rates and RevPAR (revenue per available room).
A study based on data by STR (a leading hotel industry data provider), done by Morgan Stanley, doesn't support this thesis.
In fact, data shows the opposite - hotel compression nights in the top 25 US markets, have increased year on year, 2015 included:
Well, so the number of compression nights in the top 25 US lodging markets hasn't decreased in recent years, and in fact has increased. But what happened to the rate premiums during those nights, has there been a change in this aspect?
Source: MS Research
Not really. Average daily rate premiums have remained stable over the past several years, averaging about 25%, over non-compression nights.
Concluding remarks and a twist
Airbnb is a great company. I believe that the product they've so elegantly created makes for a great solution for millions of travelers around the globe. Having said that, not every great new company automatically destroys an existing industry (DVDs nor Netflix have destroyed the US cinema industry, the crowds and revenues of which are increasing on an annual basis, despite 25 years of estimations that this is "about to happen").
While the Kaizer Soze effect of Airbnb on the lodging REITs is great, no doubt, as anyone following the subject would attest, it's worthwhile to actually have a look at the numbers.
Analyzing the situation from the compression night angle, it seems that thus far, in the major US lodging markets, the impact of Airbnb hasn't been as great as described by some (who in most cases, haven't provided evidence to support their argument). In fact, compression night numbers are increasing and the rate premium remains relatively stable.
A "the future will be different" type argument may be argued and I'm not sure what the future holds - but the fact is that the argument that Airbnb is crashing the hotel industry is in high volume for a good couple of years now and the evidence doesn't really support this argument.
I believe that the main potential reason why this is happening (rise in both Airbnb performance AND hotel performance) is that Airbnb isn't a direct substitute for hotels it's more of a supplementary product. Airbnb is increasing the pie, perhaps catering other, new audiences, who use their product and who haven't used hotels that much. There could be other reasons - but this could be the subject of another study.
And now for a small twist in the plot line:
Could Airbnb be a net positive for hotels going forward? Bear with me on this: Airbnb charges ~3-4% from asset owners on the sale. Online travel agencies (Priceline/Expedia) charge ~15% from hotel owner on the sale. What would happen if Airbnb allows hotels to list rooms on its site, charging "only," say, 10% from hotel owners?.. Airbnb would then charge hotels x3 what it charges private room listings, it's still less than what hotels pay online travel agencies but far more than what Airbnb gets as commissions from private room listings.
Airbnb wins AND hotels win?
Disclosure: I am/we are long CLDT, HT, DRH, SHO, RHP.
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.