What will become of pressured REITs?

NATIONAL REPORT – Some hotel REITs are under pressure and there is ongoing conversation about whether or not this will spread and if the sector is ripe for M&A and take-privates.

With Dallas-based Braemar Hotels & Resorts initiating a process for the immediate sale of potentially nine resorts and five urban properties and Sunstone Hotel Investor activist investor Tarsadia Capital calling on the board to sell the undervalued company or liquidate assets, Hotel Investment Today reached out to two REIT veterans to get their opinions on what will happen and why REITs are under pressure.

CapStar Advisor’s Paul Whetsell, founder of CapStar Hotel Co. in 1987, which in 1996 split into REIT Meristar Hospitality Corp. and MeriStar Hotels and Resorts operating company, isn’t sure the basic reasons for forming a REIT are as prominent or valid as they were when he did it nearly 30 years ago. “Almost since the financial crisis, the dividend payout hasn’t been on a percentage basis so extraordinary to attract a tremendous amount of investor interest,” he said.

Paul Whetsell

He even pointed to the likes of what is considered the best-in-class REIT Host Hotels & Resorts, which has been trading within a narrow range since its inception. “Something like that broken up or converted could have a lot of potential in a different ways and formats,” he said. “You give up the tax benefits, but is it worth giving up the growth?”

Whetsell added that he believes REITs will continue to try to find other avenues, which means going private, converting to a C Corp, or doing something that gives them some growth. “Just staying where you are for the next 25 years and paying a 3% or 4% dividend, I don't know what investor that excites,” he said.

He cited Boyd Gaming as a company that considered REIT status similar to other gaming companies but resisted the pressure of converting its real estate. In fact, Whetsell sits on the Boyd board and said they looked closely at the concept but didn’t see the growth opportunity.

“I joined the board and Boyd was trading between $25 and $30 per share. Today, it is trading at $85,” Whetsell said. “They have been able to take advantage of the improvements operationally, which is hard for the lodging REITs. They’ve been able to grow both organically and with acquisitions. It’s just changed the dynamic completely. The REITs just don't have the structure to allow them to do something like that.

“It was really eye-opening to me to watch and realize if they formed a REIT the OpCo would have been so much smaller. Would Boyd have had that same kind of growth as a REIT? I don’t believe so.”

If you’re trading at a significant discount to NAV, that’s what these private equity guys look for. When interest rates come down, which undoubtedly, they are, you’ll see it pick up more and the REIT management teams will be under extreme pressure to do something like that.

Paul Whetsell

Share this quote

Former FelCor Lodging Trust REIT CEO Tom Corcoran added that he thinks there should be more REIT consolidation. FelCor merged with RLJ Lodging Trust in 2017. “By taking out the overhead cost of two public companies alone would create some value,” he said. “I don’t think any REITs are being run badly. They are all victims of the circumstances in a market today that is extremely difficult, and most of it caused by higher interest rates than we originally underwrote the hotels for... What was cash flow for dividends ends up being cash to the bank for the higher interest rates.”

Increasing relevance

So, what can REITs do to improve their outlooks? Certainly, industry fundamentals are not helping with GOPs suffering from cost issues and perhaps next a slowing economy. Lower interest rates will help their 4% dividend look a bit more attractive to investors, but it is not likely going to be enough to drive share prices beyond typical ranges.

Both Whetsell and Corcoran posit the question of extending their business models beyond hotels. What about vacation rentals, student housing, single family rentals through a Taxable REIT Subsidiary? Or would diversification muddy their stories and hurt their investment profile?

“Finding something that’s somewhat countercyclical to the hotel business would be an interesting discussion just to think through whether it could create value for the shareholders if, in fact, you had more than one segment of the real estate business,” Corcoran suggested.

Then there is the age-old question about unlocking asset values, which the Street has never valued.

Tom Corcoran

“You can try to work on narrowing that NAV gap and where they trade at, but it’s a slog,” Whetsell said. “Maybe you get a one-time pop, but where’s the growth after that?... When you eliminate the growth, you eliminate a lot of investors. How do they compete at 3% or 4% against a growth company that’s still paying at 2% or 3% or 4% dividend, and it’s hard.”

Prediction time

Bottom line, will the industry see M&A or serious paring, or will it remain business as usual with some asset sales and more well-positioned companies opportunistically growing their portfolios?

While Whetsell and Corcoran said either scenario is possible, they lean more toward private equity jumping in with a few REITs disappearing into that world over the next 12 months.

“If you’re trading at a significant discount to NAV, that’s what these private equity guys look for,” Whetsell said. “When interest rates come down, which undoubtedly, they are, you’ll see it pick up more and the REIT management teams will be under extreme pressure to do something like that.”

Whetsell added that Sunstone activist investor Tarsadia Capital, while not a huge shareholder at about 3.4%, is going to put pressure on management. “I don’t think Sunstone can withstand that kind of pressure because it won’t just be Tarsadia... They’ll club enough people together and it’s going to be tough for Sunstone not to at least explore a sale... Braemar and Sunstone are probably the beginning. I think the big kahuna is going to be Host. Eventually, they’re going to be under a lot of pressure to try to unlock some of the value they have in their portfolio. That one’s going to turn the industry upside down if it does happen.”