The corporate structure of a real estate investment trust is used by organizations wishing to avoid double taxation. Such a structure is required to distribute annual income to an entity's owners in order for the REIT -- and, by extension, its owners -- to not have to pay income taxes. Because of this, REITs are viewed as income vehicles by investors in most cases. There are exceptions to this, however, and the high-end hospitality segment of the hotel industry is one of them.
The hospitality sector may be broken down into two main groups: high end and all others. High-end hospitality properties are usually hotels and hotel conference centers located in or very near urban centers, and which primarily cater to business travelers. The financial performance of these properties, and of the REITs investing in them, is very volatile -- and it's the exact opposite of the economy segment of the industry (which I will discuss at another time).
High-end properties are also referred to as "trophy properties." As is the case with a trophy home, car, boat, plane or even a spouse, the benefits of having a trophy are often not easily defined financially, and may be derived from other than financial considerations.
Typically, the value of trophy hotel properties will rise in concert with their ability to create income. As a result, they are very sensitive to changes at the macroeconomic level -- and, in a growing economy, these properties will appreciate much more rapidly than will properties in the economy segment. During recessions, however, corporate budgets are cut, and the income these REITs produce could fall dramatically.
At both ends of these boom-bust cycles, we typically see exaggerated shifts in value in the properties and the REITs investing in them. The values will increase to a premium when economic activity is strong, and reverse quickly to trade at a discount when economic activity falters. So high-end hotels are not generally good as income vehicles, contrary other types of REITs.
The performance of the sector, however, provides investors with a tangible signal of real economic activity -- and should be monitored as a result. The REITs investing in the highest end of trophy properties will experience the greatest volatility in value since, again, this corresponds to general economic conditions.
To put this context, I'll review a few of these REITs.
Shares of Strategic Hotels & Resorts (BEE), a REIT investing in the premium trophy properties, are currently trading at about $9. That's up from a $0.65 low in early 2009 -- which the stock hit during the financial crisis, having lost 97% of its value since its July 9, 2007 high of $23.94. Since then, the stock has zoomed back to the current $9 level, even though the company is losing money and pays no dividend.
Ryman Hospitality Properties (RHP) owns and operates a group of Gaylord Convention Centers around the U.S. Like Strategic Hotels, though, Ryman has experienced extreme swings in value over the past seven years. Prior to the 2008 financial crisis -- in May 2007 -- the stock peaked at $56.33. Less than two years later, in February of 2009, it had dropped about 90% to $6.56. Shares have since rebounded to $42 and, unlike Strategic, it currently pays a 4.8% dividend.
The largest REIT in this segment is Host Hotels & Resorts (HST). At a market capitalization of about $14 billion, it is many times larger than the average market cap in the rest of the sector, which averages at around $2 billion to $3 billion market. Formerly known as Host Marriott, Host Hotels owns properties all over the world. This has done nothing to mitigate the share-price volatility, though. Even though Host Hotels currently pays a dividend of about 2.6% and is earning money, it has a price-to-earnings multiple of about 68x and has experienced the same wide swings in market price that the rest of the sector has seen over multiple business and economic cycles.
The bottom line is that, unlike other REITs, these high-end hotel trusts are not income vehicles. The best way to play them is to be aware of their relationship to the economic cycle -- and, when the economy turns bad, to put them on your watch list. When all is said and done, they do still possess physical collateral, and they can be purchased at deep discounts.