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Hotel REITs Benefit from Moderate Business Demand

01/09/2013 | By Carisa Chappell

Moderate demand and limited supply growth are helping the hotel sector display signs of life, according to industry analysts, who say corporate demand continues to drive the sector's recovery.

Low supply growth remains key for the sector, noted Lukas Hartwich, an analyst with Green Street advisors. The firm estimates supply growth from 2012 through 2016 to be at approximately 1.4 percent. When coupled with the current demand rates, estimated at around 3 percent demand growth for 2013, it "provides a decent backdrop for lodging fundamentals," according to Hartwich.

"With limited new supply coming online, hotel REITs should be able to raise their average daily rate (ADR) and revenue per available room (RevPAR) in 2013," said Jason Lail, manager of the real estate finance group at SNL Financial.

Hotel owners continue to gain pricing power as occupancy levels pass the previous peak of 71 percent in 2007. Occupancy for 2013 is estimated to be 72 percent, according to Green Street. As a result, rate gains could push operating margins to levels not seen since the 1990s.

"Low supply growth should push occupancy past 2007 levels during 2013, which is good news for pricing power," he said.

Corporate spending has helped boost the sector. Hartwich, however, said business travel could be on the wane soon.

"All-time high corporate profits have been a huge boon, but may be running out of steam," he said.

Conversely, Hartwich pointed out that while demand from leisure travelers has lagged, a housing bottom could help reverse this trend.

Although the past two years brought modest gains for hotel REITs, they have trailed the broader commercial real estate market. The hotel sector posted total returns of 12.5 percent for 2012, according to the FTSE NAREIT U.S. Real Estate Index. Equity REITs had total returns of 19.7 percent for the year.

Hotel asset values are also lagging. Severe declines in cash flows pushed hotel values down significantly during the downturn. Most other property sectors are approaching prior peaks, according to Hartwich.

"We are seeing a period where lodging is slightly exceeding expectations, but not showing through quite yet in transaction value," said Aran Ryan, director of hospitality and lesiure at PwC. "Maybe the asset values haven't caught up to some of the performance we've seen so far."

Like the rest of the REIT market, hotel REITs have taken advantage of low interest rates, Lail said. Given the appeal of low interest rates, Lail encouraged hotel REITs to use caution when refinancing debt.

"Current rates make debt refinancing very attractive, but hotel REITs must also remain vigilant in maintaining strong balance sheets," he warned.