Lodging REITs enter the fall with fundamentals that are fairly positive, although softness in the leisure segment and broader macroeconomic concerns have led to some tempering of guidance for the year as a whole. At the same time, group and corporate demand is strong, supply remains muted, and transaction activity is expected to pick up as interest rates decline.
REIT.com spoke with Michael Bellisario, senior research analyst at Baird Equity Research, Patrick Scholes, managing director at Truist Securities, and Chris Woronka, senior research analyst at Deutsche Bank Securities, about their expectations for the sector in the months ahead.
How would you describe macro fundamentals for lodging REITs, and what are you anticipating for the rest of 2024?
Michael Bellisario: From a demand perspective, fundamentals are relatively positive. Corporate profitability is strong, employment trends are solid, and consumers continue to prioritize travel in a post-pandemic world. One offset, though, is the strong U.S. dollar, which is pushing more travelers abroad. Also, hotels’ pricing power has waned a bit recently as consumers have become more price sensitive as demand patterns and booking windows normalize.
From a supply perspective, elevated interest rates and high construction costs have caused a significant slowdown in new starts and openings, which should create a low-supply backdrop for the next several years.
For the remainder of 2024, the fundamental outlook remains solid and steady. Post-Labor Day, more business travel and group/convention demand should support low-single-digit RevPAR growth for the broader industry.
Patrick Scholes: Overall, U.S. trends are fairly lethargic.The relatively good news is that despite macro concerns about the possibility of an economic pullback in the not-too-distant future, we have not been seeing any sudden deceleration in bookings or pricing that would indicate any customer segment is abruptly pulling back.
The relatively bad news is that we do not see any upside to domestic RevPAR versus company/investor expectations for at least the next several quarters, as we see forward RevPAR trends tracking about 50-100 bps below current sell-side consensus expectations. Leisure trends continue to be marginally weaker than we would have expected just three to six months ago.
Chris Woronka: Overall, fundamentals are still healthy. A majority of the key economic indicators we track, including non-residential fixed investment, employment, consumer confidence, discretionary spend patterns, and domestic airline capacity, are continuing to show signs of positivity although some appear to be moderating.
Appetite for travel broadly remains at historically high levels, and supply growth broadly remains pretty muted, with only a few localized pockets of potential concern. We think most of these trends should remain largely intact for the balance of 2024 and into 2025, although most recently we are clearly putting more focus on the employment picture and how any changes there might impact lodging demand.
What performance trends are you seeing among the various lodging subsectors of leisure, business, and group?
Bellisario: Leisure is the softest customer segment. More U.S. travelers are going abroad, and inbound international travel is still nearly 10% below pre-pandemic levels. Also, consumers have more travel options, including cruises and alternative accommodations, and, as a result, hotels’ pricing power in the leisure segment has not been as strong as it was in 2021-2022.
Business travel remains solid given the strong corporate profitability backdrop. Tuesdays and Wednesdays are the strongest days due to the compressed post-pandemic work week.
Group is the strongest. Large citywide and convention business is back, and more small- and medium-sized corporate events are occurring. Hotels’ pricing power for business and group is relatively strong.
Woronka: Group and corporate demand and pricing power all remain quite solid. While leisure demand and pricing (particularly at resorts) have both leveled off a bit from lofty post-COVID peaks, we aren’t seeing any indications of a real downturn. We think certain resort markets are having to use rate as more of a tool to maintain or grow weekend occupancy, and that is something to monitor.
We think you could see some re-acceleration in RevPAR growth in the fourth quarter of 2024 relative to the third quarter, based on a favorable mix shift toward group and corporate, with urban markets benefiting the most.
Scholes: Demand from corporate customers is primarily driving RevPAR growth, and not the consumer. Over the next several quarters, on average, we anticipate the group segment finishing up 5%-7% year over year (it’s currently tracking higher, but we continue to expect a deceleration in revenue pace as arrival dates get closer, a trend we have observed for the past approximately 18 months). We anticipate transient businessup 1%-3%, with corporate outperforming small and midsized businesses, and leisure closerto flat to down slightly. The leisure segment is challenged in gainingany pricing growth without a subsequent offset in demand/occupancy.
Are you seeing differentiation among geographic markets?
Woronka: Absolutely. Many international markets are now outperforming the U.S. on RevPAR (mostly due to easier comps versus prior peaks and a return of American tourists, and/or stronger domestic business travel within those countries).
Within the U.S., we are seeing the continuation of a trend that began last year and contrasts with the first two years of post-COVID recovery. That is, outperformance in many urban markets in the northern half of the U.S., or at least outside of the areas that saw an influx of demand during the initial stages of recovery from COVID.
Scholes: Resort locations, which benefited from “revenge travel” in 2021-2023, continue to struggle with RevPAR growth today. On the other hand, markets such as Boston, Chicago, and New York City, which were slow to recover coming out of COVID, are seeing stronger growth rates.
Bellisario: East Coast markets have been performing better, including New York City and Boston; the West Coast markets have lagged as technology- and media-related demand have been weaker, including in San Francisco, Los Angeles, and Seattle. Performance in Baltimore, Minneapolis, and Portland have lagged as well. The Sunbelt markets have remained strong, given favorable demographic trends, but softer leisure performance recently has caused growth in many of these markets to slow.
What are you seeing in terms of deals getting done?
Bellisario: The transaction market has been slow for the last 18-24 months. Performance has been good enough and lenders have generally “kicked the can,” and this dynamic has not caused many forced sellers or distressed transactions. On the buy-side, elevated interest rates have kept buyers cautious in their outlooks and underwriting despite have plenty of capital to deploy; as such, the bid-ask spread has been wide, and few transactions have occurred.
Recently, though, base rates have declined, and spreads have compressed, and the outlook has improved for prospective buyers. Fewer deals have going-in yields that are inside of the cost of debt, and we expect transaction activity over the next six to 12 months to pick up.
Woronka: Well-capitalized liquid buyers have been transacting pretty regularly for a few years now, often with a focus on trophy-type assets where they are making a bullish call on market fundamentals and acquiring at a discount to replacement cost. Now we are beginning to see green shoots on more complex deals, and from a wider range of buyer/seller groups. As we appear to have entered a Fed easing cycle, we expect transactional volumes to accelerate.
We think you will see a larger variety of deals getting across the finish line, from distressed properties to recapitalization situations, and even on up to perhaps some small to medium sized portfolios. Our general expectation is that you will see some of the larger traditional players continuing to build scale, while certain non-institutional lodging owners use more liquid transactional markets as a catalyst to exit.
Scholes: For the public REITs, the volume of deals has been fairly minimal, but that is also a reflection of the environment today for full-service hotel owners more broadly. Transaction activity has been challenged by the depressed valuations where most of the public REITs currently trade. Historically, hotel REITs were able to accretively issue equity and subsequently purchase hotels, whereas today that type of transaction has essentially been cut off. With lower expected interest rates, we anticipate the long-awaited increased transactions activity among private and public hotel owners, and for the REITs, more capital recycling of non-core assets.
What does the lodging supply picture look like today?
Scholes: For upper-upscale hotels and above, new supply is very minimal by historical standards. Growth is primarily in the midscale and upscale segments, driven by brands from the parent companies of Hilton, Hyatt, and Marriott.
Bellisario: Supply growth has been approximately 0.5% recently, which is one-quarter of the long-term historical average. Higher interest rates and elevated construction costs have made it difficult for the development math to pencil. Supply growth should gradually increase over the next few years as fundamentals remain steady and financing costs come down.
Woronka: We are anticipating a multiyear period of sub-1.5% net supply growth for the industry as a whole, and we are quite likely to be at or below 1.0% for several years given our expectation that hotel closures (including cases of adaptive reuse) should remain elevated in certain urban markets and within the lower chain scales where obsolescence remains an issue.
Even for select service projects, the all-in development costs (including land) have risen materially since 2019 and have not yet retraced in a meaningful way. Lower interest rates could certainly help, but it’ll be a while before the impact from that will be seen in the form of shovels in the ground.
What strategies are being used by the most successful REITs to maintain and increase occupancy?
Bellisario: We have seen owners and operators “group up” in order to shrink their hotel and rely less on the short-term transient customer, and also open more third-party demand channels, including international wholesalers, Costco, Capital One, Chase, and OTAs.
Woronka: Meeting and convention demand remains robust, so lower rated groups can be used to fill in shoulder periods when it can otherwise be difficult to make breakeven occupancy levels. That said, we think there is less overall focus on the old “heads in beds” strategy aimed at maximizing occupancy (at all times) that used to be a guiding principle for the industry. The extra occupancy that was coming from price-sensitive leisure customers, often via online travel agencies (OTAs), doesn’t necessarily pencil out profitably anymore, given current labor costs and the fact that those guests rarely utilize the more profitable ancillary services.
Scholes: For REITs that have a greater urban or resort focus, different strategies have been undertaken depending on the property or market. In some cases, brand changes and major renovations have been additive to occupancy. However, the macro environment is challenging for occupancy growth today without rate loss, and where occupancy gains from current asset management efforts may take time.
Are there other themes or developments that you see impacting lodging real estate going forward?
Scholes: Investor sentiment for the public lodging REITs is heavily influenced by the direction of interest rates. Should rate cuts happen sooner than expected, we see such unexpected cuts as a positive tailwind to investor sentiment and subsequently a boost to stock performance.
Bellisario: The biggest fundamental theme for hotel owners and public market investors is the lack of bottom-line growth; the top-line has been sluggish despite relatively solid GDP, business profitability, and consumer spending, while expenses have been elevated. Cycle dynamics are not too favorable at present and having a high level of confidence about the 12-24 month outlook is far from certain.
Woronka: We’re monitoring the extent to which an expected uptick in deal flow might result in more concentrated ownership of hotels. This is a very scalable business, but ownership in the U.S. is incredibly fragmented today, especially within the lower chain scales. There are likely to be more and more instances where properties that have been in family ownership for decades might be looking for an opportunistic exit strategy. Those situations could pretty conveniently intersect with enhanced liquidity on the private side that might be seeking to grow lodging sector exposure.
We also see the potential for conversion of lodging assets to various residential uses happening at an accelerated clip. Meanwhile, additional institutional capital could be allocated toward experiential travel platforms like glamping and luxury RV/camper sites.