Large REIT transactions over the past cycle haven’t been deemed successful by the public market, but analysts said some hotel REITs could be bought through public-to-private transactions in the next year or so.
REPORT FROM THE U.S.—There could be fewer hotel real estate investment trusts in the next year or so, and public-to-private transactions are more likely than public-to-public transactions in the current environment, sources said.
Michael Bellisario, director of equity research and senior analyst at Baird, said many investors believe there are too many hotel REITs and that consolidation is a good thing at all points of a cycle.
In this last cycle, the industry has seen three public-to-public REIT transactions: FelCor Lodging Trust and RLJ Lodging Trust; Park Hotels & Resorts and Chesapeake Lodging Trust; and Pebblebrook Hotel Trust and LaSalle Hotel Properties. The public market has not been receptive to those deals, he said.
“Whether they were ‘good’ deals or ‘bad’ deals. … the public markets did not view them positively, did not reward the companies, the management companies (or) the share price for being bigger,” he said. “That doesn’t mean consolidation is bad, but there’s a high hurdle to get over.”
David Loeb, founder of Dirigo Consulting, said there are many hotel REITs that look similar and have similar assets, which is why many investors would rather see fewer companies, much bigger market caps and better trading volume, yet many investors gripe when one company buys another because it never pays off as quickly as they want it to.
“LaSalle and Pebblebrook, great example. Did it really pay off? Well, the pandemic came along and having a bunch of assets that you were in the process of selling was a really good thing,” he said. “But I’m not really sure it allowed demonstration of the synergies that this larger portfolio could have.”
If REITs can eliminate general and administrative expenses and prove there are synergies and benefits of scale, then REIT M&A makes sense, Bellisario said.
“There’s some impediment that prevents (large public-to-public) deals from happening more frequently,” he added.
“Maybe there’s one fewer REIT or two fewer REITs and that’s because one of the bigger companies acquires a smaller company, because in today’s environment where liquidity is at a premium and valuations are a little bit more out of whack, there could be an opportunity there to take advantage,” he said. “But I’ll believe it when I see it. Maybe there’s a deal here, a small deal there, but a Host buying Sunstone or a Host buying Park, the math doesn’t pencil.”
Bellisario said public-to-public REIT mergers and acquisitions could be difficult to achieve, while a private equity firm buying a hotel REIT could be more likely. But that doesn’t mean it’s going to happen today.
“Because cash flows are still negative and stock prices have moved up pretty significantly (at the end of November and into December), but as the debt market improves and more capital is available … depending on where the stock prices are at, depending what people's view of fundamentals is, that might actually be a more likely outcome to getting fewer REITs than public-to-public M&A,” he added.
Loeb agreed that the public market won’t be the primary outlet for the consolidation of assets.
“There’s a lot on money in the private setting, private equity, recently raised funds, things like that, that is looking for bargains to come out of the economic carnage of the pandemic,” he said.
Rich Hightower, managing director and lodging research analyst at Evercore ISI, said that out of the 19 or 20 hotel REITs, it makes sense that a couple of them could go away in the next six to 12 months.
“If you’re talking about public to private, if they’re good assets with the potential to cash flow in the future but you’re stuck with a bad legacy balance sheet today, that’s the opportunity for a new owner to come in … and redo the capital structure in a more sustainable way that’s more indicative of the current environment and go from there,” he said.
He agreed that deals on the public-to-public side are trickier.
“You never want to be in a situation where you are a stronger company acquiring another company’s problems,” he said. “The balance sheet is still a factor in that instance. But if you look and the assets are good and you can solve the capital structure problems, and if you have a willing seller, which is always the first key piece of any of these deals happening, those are the key ingredients for something to happen.”
Winners and losers
Loeb said there will be winners and losers in the REIT space coming out of this pandemic.
“Nobody’s really winning now, some are just losing less. But I think (markets will) come back rather than just stock prices coming back at different rates, different kinds of hotels doing better that may very well lead to investors putting a premium on the ones that are successful and looking at everyone else saying ‘you’re at a discount relative to that.’ And that creates opportunities for M&A,” he said.