3 Hotel REITs to Buy Now

Bret is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The recent rise in interest rates has caused significant declines in many of the high yield sectors including utilities, REITs and energy MLPs. One sector that I think still offers income investors some good values after the sell-off is hotel REITs.

A key hotel metric, revenue per available room (RevPAR), is forecast to rise 6% this year and next year, as business and leisure travel continues to rebound. In addition, new supply is still scant, financing for acquisitions is readily available and the asset values in hotel portfolios are going up. Investors looking to take advantage of the recent decline in this sector should consider the following three hotel REITs in order of preference.

Diamondrock

Diamondrock Hospitality (NYSE: DRH) owns 27 urban, upscale hotels with approximately 12,000 rooms, in top urban gateway cities and resorts. A little more than 50% of its room base is in NYC, Boston, Chicago and Washington D.C. The stock yields 3.5% and is selling for just 11 times 2014’s projected FFO (funds from operations). This compares favorably to industry heavyweight Starwood Hotels & Resorts, which trades at more than 22 times 2014's expected FFO. Analysts project Diamondrock's revenues will grow more than 10% in FY2013, and in the high single digits during FY2014 on continued RevPAR and occupancy rate growth.

Diamondrock’s core strategy lies in building an upscale "urban" portfolio of hotels. Hotel properties are harder to build and are subject to less supply growth in these markets. DRH is selling at just 16% over book value. The market is valuing the company’s hotel portfolio at just $250,000 per room. However, this understates the company’s portfolio from a replacement value perspective.

For example, 18% of the company’s rooms are in Manhattan, where recent acquisitions have been made for over $500,000 per room in this hotel segment. Diamondrock is selling at a lower book value ratio than competitors like Ashford Hospitality Trust, Strategic Hotel & Resorts, and Hospitality Properties Trust

Chatham

My second pick in the sector is Chatham Lodging Trust (NYSE: CLDT). Followers of my columns in RealMoney and SeekingAlpha know that I have owned and written about this Hotel REIT since early last year, when it was trading at less than $13 a share. It is now at $19 a share, but still sells at a reasonable valuation.

Chatham Lodging Trust is another hotel REIT that focuses on investing in upscale extended-stay hotels and premium-branded, select-service hotels. The company owns interests in 73 hotels, including:

  • 21 hotels it wholly owns, with an aggregate of 2,911 rooms/suites in 11 states and the District of Columbia
  • A minority investment in a joint venture that owns 52 hotels, with an aggregate of 6,927 rooms/suites.

Its hotels are concentrated in top 25 markets.

Chatham yields 4.4% and pays a dividend monthly. Chatham’s overall occupancy in 2012 was over 80%, significantly over the overall’s industry’s 70% occupancy rate. In addition, the company recently completed a renovation program which should boost RevPAR growth. Despite growing FFO more than 40% in FY 2012, and with an expected FY 2013 increase near 20%, Chatham sells for a little more than 12 times this year’s expected FFO.

Summit

My final pick in the sector is Summit Hotel Properties (NYSE: INN). The company focuses primarily on upscale and upper-midscale select service hotels on a national basis. It has roughly 95 hotels throughout the country, with more than 11,000 rooms. The company came public in February 2011. Summit yields 4.5% and sells for a little over nine times 2014’s projected FFO, which is a lower valuation than the other two hotel REITs profiled.

Thanks to RevPAR increases, acquisitions, and organic growth, revenue growth should clock in at more than 60% for FY 2013. Analysts project almost 20% revenue gains for FY 2014 as well. Summit clusters its hotels in mid-tier cities near venues that draw travelers, such as sports stadiums and college campuses. It also offers a consistent set of amenities that business & leisure travelers demand -- for example, every room has free wi-fi. Operating cash flow has grown some 400% since the end of FY2010, and the REIT sells near book value.

In conclusion...

The hotel industry is continuing to recover from the recession, and has additional revenue increases on the horizon given strong demand. The recent pullback in this sector offers a good entry point right now for long term investors that want to add some real estate holdings to their portfolios. Income investors looking for yield at reasonable prices would also be well served by “checking into” these three hotel REITs.


Bret Jensen owns shares of SUMMIT HOTEL PROPERTIES INC, Chatham Lodging Trust, and DiamondRock Hospitality Company. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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