Hotel REITs Benefit From Growing Demand, But Revenues Still Well Below 2019 Levels

Rising hotel demand has helped improve revenue for hotel owners, but the lingering effects of the coronavirus pandemic have kept many large owners millions in the red.

Hotel real estate investment trusts, the largest publicly traded owners of U.S. hotels, have been reporting their third-quarter earnings over the past two weeks, and the financial filings provide a window into how one of the hardest-hit sectors is recovering from the pandemic. 

Hotel demand increased toward the end of the third quarter and into October, including a much-needed uptick in business travel, the REITs reported. This helped boost their top-line revenues ahead of previous quarters, but they still are seeing more money go out than come in. Several of the largest hotel REITs reported net losses in the tens of millions of dollars during the third quarter. 

The losses, largely expected by hotel REIT analysts, come in part because the owners are still bringing in revenue well below their pre-pandemic levels. R.W. Baird Senior Research Analyst Michael Bellisario, who covers the hotel REIT sector, said analysts typically look more at an earnings measure called EBITDA, or Earnings Before Interest Taxes, Depreciation and Amortization, than at net income, but either metric shows the hotel REITs are still far behind their 2019 performance. 

"The driver of it, whether its net income being negative or adjusted EBITDA being down substantially on a two-year basis, it’s demand," Bellisario said. "Demand is down, and the hotel ownership business has a lot of operating leverage, and when revenues go down, earnings go down."

While hotel revenues are still below 2019 levels, they are up significantly from the second quarter, and Bellisario said most hotel REITs beat their projections in Q3. The delta variant had slowed demand for part of the quarter, but REITs said their occupancies have been rising since mid-September and projected a positive outlook for demand going forward. 

"The quarter for almost every [hotel REIT] was better than expected, or maybe better than feared given the impact of the delta variant," Bellisario said. "There’s certainly a renewed, broader sense of optimism about travel."

While demand is moving in the right direction, Bellisario expects it will take until at least the middle of next year for hotel REITs to return to pre-pandemic levels of revenue and profitability. 

As they work to return to pre-pandemic levels of visitors, the bottom line of hotel REITs has also been impacted by rising costs of labor and supplies. Hotels are working to staff up to meet demand in a competitive hiring market, and they are dealing with global supply chain issues that are pushing up the costs of their goods. To combat these rising expenses, some REITs said they are passing the costs onto hotel guests in the form of higher fees. 

Host Hotels & Resorts, by far the largest U.S. hotel REIT, in Q3 averaged $129 of revenue per available room, a key metric for the hotel industry. That represented a 26% increase in RevPAR over the prior quarter, but it was still 31.3% below Q3 2019, the last comparable pre-pandemic period. 

The Bethesda-based REIT also said that its RevPAR in October, a month that came after Q3 that it wasn't required to report, is expected to rise to $143.

Host Hotels' third-quarter occupancy averaged 55.6%, down from 80.4% in Q3 2019, but it saw promising increases in specific segments and markets that have been slower to recover.

The REIT's hotels saw a 49% increase in business transient demand and a 72% increase in group business demand over the second quarter. In its urban and downtown markets, occupancy ended the third quarter at 56%, up from 50% at the start of the quarter, and those markets also experienced 89% RevPAR growth from Q2 to Q3.

"While much of the recovery was concentrated at resorts in Sun Belt markets during the first half of the year, our urban markets saw significant RevPAR improvements during the third quarter," Host Hotels CEO James Risoleo said on the REIT's earnings call Thursday, according to a Motley Fool transcript. 

Despite these improvements, Host Hotels reported a net loss of $120M during the third quarter. That was better than its Q3 2020 net loss of $316M, but before the pandemic, it brought in $372M in profit in Q3 2019. 

The company's expenses are rising in part because of the cost of labor. Host Hotels Chief Financial Officer Sourav Ghosh said on the earnings call he expects to see a compound annual growth rate on labor costs of between 5% and 7% from 2019 to 2022.

"Depending on how quickly we get back to '19 levels of revenue, we can see all that benefit sort of come through to the bottom line," Ghosh said. "Obviously, depending on how much inflationary, above inflationary growth we see in wages and benefits, it will be shaved off and that will impact margin going forward."

Several other large hotel REITs reported similar trends to Host Hotels, showing strong revenue growth compared to previous quarters but still well below 2019 levels, and many also posted eight-figure losses. 

Pebblebrook Hotels Trust reported Q3 RevPAR growth of 49% over Q2, but it was down 37.9% from Q3 2019. It attributed the growing revenue to an increase in business and group demand, and it said it expects further tailwinds following the U.S. lifting travel bans from 33 countries this week. 

Pebblebrook posted a net loss of $23.5M, better than its Q3 2020 net loss of $130.6M, but worse than its Q3 2019 profit of $30M. It said its expenses have been impacted by the global supply chain issues. 

"We've all been experiencing increasing levels of supply chain disruptions, including higher costs for many commodities like food and beverages, but also operating supplies in some of our services," Pebblebrook CEO Jon Bortz said on the REIT's Oct. 29 earnings call, according to a Motley Fool transcript. 

In response to those higher costs, Bortz said the company has increased prices on food and beverage offerings, parking, audiovisual equipment services and other fees by an average of 15%.

"We've experienced little to no pushback on pricing increases so far," Bortz said. "It seems both the leisure customer and the business customer are in great financial shape with plenty of discretionary income or high profits. And with prices increasing for all sorts of goods and services, our customers have been accepting of the increases."

Bellisario said he sees the labor and supply chain issues as headwinds, but he said hotels are finding ways to adjust. On the labor front, they are finding efficiencies that could allow them to operate with 10% to 20% less staff over the long term, and they are passing the supply costs onto customers. 

"There’s just lots of cost pressures that owners are facing, and the offset right now is record-high rates that can justify absorbing some of those higher expenses," Bellisario said. 

RLJ Lodging Trust, another large hotel REIT based in Bethesda, reported RevPAR of $98.16, more than double its Q3 2020 levels but still around 70% of its Q3 2019 RevPAR. The REIT also said demand has continued to improve, with October RevPAR projected to come in 11% higher than September. 

RLJ's occupancy averaged 63.8% for the quarter, a 310 basis point increase over the second quarter. Occupancy was especially strong on the weekends, when leisure travel boosted it to 76.8%. RLJ CEO Leslie Hale said on the REIT's Friday earnings call it has seen an increase in business travel in recent months, according to a Seeking Alpha transcript.

"We were pleased that the recovery of the lodging fundamentals continued during the third quarter, despite some choppiness caused by the delta variant from mid-August through early September," Hale said. "Although the industry's RevPAR growth was primarily driven by leisure demand, the improvement in business travel and group trends also contributed."

Despite this demand growth, RLJ posted a net loss of $151.8M in Q3, compared to its Q3 2020 net loss of $174M.

Hale said she sees strong tailwinds in the market that should help it recover in the coming quarters, including the reopening of international travel, the gradual growth of business travel as offices reopen and a continued increase in small group bookings. She said these trends will especially benefit urban markets, which have been slow to recover from the pandemic. 

Park Hotels & Resorts reported Q3 RevPAR of $105.48, three times the same period in 2020 but down 43.4% from Q3 2019. The REIT saw its group business revenues increase 130% from Q2, and business transient demand nearly doubled. This has helped the REIT fill its hotels during the weekdays, which have been slower than weekends this year as tourism has driven the recovery. 

"There has been a noticeable improvement in midweek demand in October, which aligns with the increased confidence we have been seeing among travelers following the late summer delta surge," Park Hotels CEO Thomas Baltimore said on the REIT's Thursday earnings call, according to a Seeking Alpha transcript. 

Park Hotels posted a net loss of $82M during Q3, down from its Q3 2020 net loss of $276M. 

Sunstone Hotel Investors and Xenia Hotels & Resorts, two other large hotel REITs, each posted net losses of around $22M during Q3.

One REIT that posted positive net income was Apple Hospitality REIT, which has a portfolio largely composed of select-service hotels in secondary markets and has performed better than the REITs with large full-service hotels in major cities. Apple Hospitality posted $31.7M of profit in Q3 after posting a net loss of $40.9M in Q3 2020. 

The hotel brand giants have been quicker to return to profitability than the REITs. Marriott International reported a Q3 net income of $220M, Hilton Worldwide posted a Q3 net income of $240M, and Hyatt Hotels Corp. reported a net income of $120M. 

Bellisario said the global hotel brands recovered much faster than the hotel REITs because they make fees from the revenue hotels earn and don't have to assume the underlying costs or leverage of owning a hotel. 

"The brands get paid on the top line, as a percentage of revenues, and they have other fee streams," he said. "The business was just less cyclical. Hotel REITs are at bottom of the cash-flow waterfall. They’re the owner. They bear the brunt of the losses."