Hospitality Properties Trust’s (NYSE: HPT) management operates by the philosophy that there’s strength in numbers. Instead of buying single hotels, the company prefers to buy in bulk.
There are currently 290 hotels and 185 travel centers, which consist of full-service rest stops, in Hospitality Properties’ portfolio, which spans across the United States and into Canada and Puerto Rico. The firm focuses on major brands, and the hotels in its portfolio are run by well-established operators, including Marriott International, InterContinental Hotels, Hyatt Corp., Wyndham and Carlson Hotels Worldwide. The travel centers are operated by TravelCenters of America LLC.
“We rarely buy a single hotel by itself. We try to buy properties in geographically diverse locations in groups of 10 or more properties,” says John Murray, the lodging REIT’s president and CEO. “Most of our competitors buy single hotels, but we buy hotels in a strategic portfolio.”
Standing Out from the Crowd
In addition to purchasing group portfolios, Murray says the company’s willingness to invest in not only full-service hotels but select-service hotels as well as sets Hospitality Properties apart from its competitors. These brands, such as Courtyard, Residence Inn, Staybridge Suites, Hyatt Place, and Candlewood Suites, offer fewer amenities than full-service competitors.
“There’s much less volatility in select-service hotels versus full-service,” says Daniel Donlan, an analyst with Janney Montgomery Scott. He adds that select-service hotels don’t have to cover ancillary expenses, such as catering.
Hospitality Properties’ assets are more diverse than most REITs, according to Murray. He explains that the majority of REITs either invest exclusively in urban properties or are even more focused on urban properties in major gateway cities.
“While there’s some wisdom in only investing in urban and gateway properties, we also think there’s wisdom in having a more stable cash flow by being more geographically diverse and having lower cost structures in select-service hotels,” he says.
David Loeb, an analyst with Baird and Werner, says the company’s strategy offers security. “I think the company has this kind of unique structure that gives it less exposure to hotel risk and fixed returns from most of its investments,” he says.
While Hospitality Properties may stand out from its competition, Donlan says the company’s goal to seek out larger portfolios also can present challenges.
“I think they’re having a hard time finding portfolios to buy, given the unique structure of how they lease hotels from brands. It’s going to be a tough chore,” Donlan notes.
In the current market environment, unless companies are well capitalized and have strong brands in attractive locations, Murray explains that it can be challenging to build new hotels. As a result, he says he anticipates that the trend of low supply growth will continue.
“It’s been very challenging for developers to find that capital,” Murray says. “The banks are giving out liberal rates, but they are far more selective about what kind of projects they are providing financing for. Development is on the bottom of the list.”
Supply growth is projected at less than 1 percent throughout the end of the year, resulting in tighter supply and demand for rooms, according to Loeb. As a result, Hospitality Properties is now focusing on acquisitions and redevelopment to capitalize on the increasing demand for hotel space.
As part of the company’s rebranding strategy, Hospitality Properties entered into an agreement in August to put 20 of its hotels under the Wyndham Hotel Group’s brand and management.
“Hospitality Properties Trust believes that the refurbishment and rebranding of these 20 hotels and their management by Wyndham Hotel Group will result in improved operating results at these hotels,” Murray says.
The company also entered into a management agreement with Sonesta International Hotels Corp. for four hotels, which were converted to Sonesta brands and management during the second quarter of 2012. Since June 2012, Hospitality Properties has entered into an additional management agreement with Sonesta for the conversion of 12 more hotel properties. All are expected to be converted in the third quarter of 2012.
Murray says part of the strategy in acquiring hotels and establishing an affiliated relationship with Sonesta is to enable the Hospitality to grow through an established brand.
That growth has become a large undertaking for Hospitality Properties. Hospitality Properties had 73 of its hotels under renovation during the second quarter, and 112 were under renovation during the first half of the year. The company also expects the refurbishment of the 20 Wyndham hotels to continue into 2013 and 2014.
“The challenges will be working through that renovation disruption, but, obviously, you come out the other end with a better product,” says Smedes Rose, analyst with KBW. “As part of that, they’re rolling out more of the recently bought Sonesta Hotels brand.”
Loeb says the money that the company is putting into the renovations is essentially a new investment with expected returns of 8 percent to 9 percent.
As part of those renovations the company recently spent $165 million to upgrade 77 of its extended-stay hotels managed by International Hotels Group. Renovations included technology upgrades, social gathering spaces and more spaces for guests to put their personal items when on extended travel.
However, the large volume of capital improvements will have an effect on Hospitality Properties’ bottom line in the immediate future, according to analysts.
“Because of all of the capital improvements they have to do between the year’s end and 2013, their [revenue per available room] growth will be muted by disruption and their true cash flow will remain low because of the money spent on capital expenditures,” Donlan says.
A Slow Bounce Back to Recovery
Hospitality Properties’ overall operating performance has declined slightly from a year ago. The firm had normalized funds from operations (FFO) of $93.0 million, or 75 cents per share, in the second quarter of 2012. It marked a 16 percent decline from the year-earlier amount of 89 cents.
However, analysts say the hotel REIT’s dividend yields continue to make the stock attractive. As of Aug.20, the company had a dividend yield of 7.7 percent. The stock price closed at $23.85 on Aug. 20, representing an increase of 1.4 percent for the year.
“We are very positive on the company given the dividend yield today. It’s really especially attractive,” Loeb says.
Looking ahead, Murray admits that while fundamentals in the hotel sector have improved greatly since the depths of the Great Recession, the sector is in the middle of a long road back to recovery.
“The industry hasn’t bounced back as quickly and as strongly as people hoped,” Murray says. “We’re definitely in a period of prolonged recovery.”