Hersha Hospitality Trust: A Hotel REIT As An Inflation Hedge (NYSE:HT)

Robert Roffulo

Ziga Plahutar/E+ via Getty Images I was expecting to recommend hotel REIT Hersha Hospitality Trust (HT) as a hedge against inflation, but I can’t because of my expectation for continued weak business travel in 2022. Parts of the country are back close to normal, but some major cities remain far […]

Ziga Plahutar/E+ via Getty Images

I was expecting to recommend hotel REIT Hersha Hospitality Trust (HT) as a hedge against inflation, but I can’t because of my expectation for continued weak business travel in 2022. Parts of the country are back close to normal, but some major cities remain far from normal. Based on what I experienced in New York City last week, I think the city is actually currently moving in the wrong direction. Hersha was able to avoid bankruptcy, but REIT investors still need to follow the hotel REIT bankruptcy case of Eagle Hospitality Trust when considering REIT investments.

Hotels As An Inflation Hedge

Hersha Hospitality Trust is taxed as a REIT and owns 36 hotels with 5802 rooms, which are all open, in urban areas such as New York City, Boston, Philadelphia, Washington, D.C. Miami, and in California.

Usually hotels/motels offer an excellent hedge against inflation because they are able to raise room prices almost immediately. These increased room prices are frequently more than their increased operating expenses, which results in higher profits for investors. The current problem for Hersha is that many of the hotels are located in areas hardest hit by a plunge in demand for hotel rooms, so they can’t raise room prices to reflect the current high inflation economy.

For example, the current room pricing in New York City remains horrible for hotels. There are rooms offered in Manhattan at less than $100 per night on many days over the next few weeks. No inflation pricing here. The supply/demand imbalance may not get much better this year because as demand increases, closed hotels will reopen. In addition, there are some newly constructed hotels that started construction before the pandemic that are just being completed. According to a market research report by STR Global, 21,878 new hotel rooms were under construction in New York City as of July 2021. This compares to approximately 138K total hotel rooms and 703 hotels at the end of 2019 in the city. The current number of New York hotel rooms, however, is much lower than in 2019 because many hotels in New York remain closed.

Management gave upbeat comments about New York in their October conference call, but that was before Omicron. I just got back from New York City and there was a dramatic difference in the city from just a few weeks ago-very downbeat. Omicron has forced the cancellation of large business events such as the Toy Show in New York that usually draws a huge number of hotel guests to the city.

For investors that are 1) expecting some return to a more normal economy by the end of 2022 and 2) expecting inflation to continue at a fairly high level for the next few years, buying a Hotel REIT might be an interesting speculation, especially if the REIT is highly leveraged to get the maximum gain. Of course, if the economy does not return to normal soon, this REIT leverage goes in the opposite and wrong direction for investors.

A Look At Hersha’s Hotels

According to a statement by management during their latest conference call, their historic guest breakdown is 50{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} business/50{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} leisure, but their latest breakdown is 75{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} leisure because there just isn’t much business travel. I just don’t see much return to normal business travel in the near future because of Omicron, but Hersha’s resorts seem to be doing very well. People feel the need to get away from Covid-19 anxiety.

The problem with using general statements about hotels is that detailed specifics, both positive and negative, are overlooked by investors. While I do not personally have detailed insight on all Hersha’s properties, I think it might be helpful to explain the following information to at least get some color on part of their hotel portfolio:

Hilton Garden Inn Tribeca (151 rooms): At first glance on a map this hotel’s location is excellent because it is in trendy Tribeca and a block away from SOHO. Actually it is in a terrible location. It is in the center of some of the noisiest traffic intersections in Manhattan. Traffic headed to and from the Holland Tunnel on Canal St. intersects with traffic going north on Church St. Constant horns. Plus, there is a fire station and two police stations within two blocks that have frequent vehicles with sirens blaring going past the hotel.

Holiday Inn Express Chelsea (228 rooms): First, it is on 29th St. and not really in popular Chelsea. The closest attractions are Madison Square Garden (4 blocks away), Macy’s (5 blocks away) and the Empire State Building (7 blocks away). There are other hotels closer to these attractions and there is an on-going major construction project right next to the hotel that will not be completed for a few years.

Hilton Garden Inn Manhattan Midtown East (206 rooms): A perfect location for a business traveler hotel on E.52nd St. It is within walking distance of midtown office buildings and interesting restaurants/bars on 2nd Ave where actual New Yorkers eat.

The Winter Haven Hotel Miami Beach (70 rooms) on Ocean Dr. and The Blue Moon Hotel (75 rooms) on Collins Ave. Both hotels are in South Beach within the strict building code Art Deco Historic District. Their 10-K states “2013 as the year opened” for both. This is extremely misleading because the Winter Haven was completed in 1939 and the Blue Moon was completed in 1934. Both have been through many reconstructions over the years. A major problem facing both is there has been increasing violence each year during various holidays and spring break periods. (Disclosure note: I used to have financial interests in multiple nearby properties, but those interests were sold years ago.)

Cadillac Hotel and Beach Club (357 rooms) on Collins Ave. It is north of the tourist area of South Beach in the traditional Orthodox Jewish neighborhood of Miami Beach. Again their 10-K is misleading because the hotel was actually built in 1940. It had some recent major reconstruction and looks great. A nice resort to get away from everything, but it is also a taxi ride away from popular restaurant/bar activity.

Parrot Key Hotel and Villas (148 rooms) in Key West. The hotel had to be rebuilt after Hurricane Irma. It is a stunning property. A great place to get away from everything, especially Covid-19 anxiety.

Fewer Hotels In Their Portfolio

Hersha in 2016 sold 70{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} interests in seven Manhattan hotels (1,087 total rooms) to Cindat Capital for $571.4 million and kept the remaining 30{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} interest. Those hotels were negatively impacted so badly by the plunge in demand for New York hotel rooms because of the pandemic that the 30{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} interest, with an implied 2016 value of $244.9 million, effectively became worthless when the mezzanine lender took ownership in early 2021. The implied $816.3 million equity value in 2016 was $751K per room, but became worth $0.00 as losses were charged against the equity value.

During 2021, Hersha sold five hotels for $196.5 million with a total gain of $48.3 million :

*Courtyard San Diego $64.5 million (245 rooms) $263K per room

*The Capitol Hill Hotel Washington, DC $51 million (153 room) $333K per room

*Holiday Inn Express Cambridge, MA $32 million (112 rooms) $286K per room

*Residence Inn Miami Coconut Grove $31 million (140 rooms) $221K per room

*Duane Street Hotel, NY $18 million (43 rooms) $419K per room

Hotel Room Valuation

Adding $1.0445 billion 3Q total net debt ($180K per room) and $367.6 million total preferred liquidation preference ($63K per room), the total financing per the 5,802 rooms is $243K. The current HT equity capitalization value per room is $65K using the latest HT price of $9.52. The problem, of course, is using average figures because the actual hotel room values vary greatly from one property to the next, but they do give some ballpark estimates when determining a value for HT stock. The current total capital per room is $308K ($180K+$63K+$65K). Without seeming too simplistic, if an investor thinks the average value per room is above $308K, buy HT. If the value is thought to be below $308K, sell HT.

Management stated that the average replacement cost is $525K-$575K per key (I use the word “room”). The problem is that the cost to build in many urban areas has soared much faster over the years than the ability to increase room rates. I value the properties on income not on replacement numbers.

Third Quarter 2021 Results

Traditional REIT metrics really do not currently reflect an accurate value, in my opinion, of the proper value of Hersha Trust because the hotel industry is still not close to getting back to near normal and the current HT stock price reflects improved future results-not current results. Since the nine months 2021 FFO was a negative $0.74 per share, you can’t really do the traditional metric of stock price/FFO. Even using the nine months 2021 adjusted EBITDA of $41.15 million ($47.57 million using the hotel EBITDA method), standard multiples to stock price and to debt result in distorted numbers.

While operations continue to improve, they are still far from normal and management is still keeping a strict control on the use of cash. CAPEX in the first nine months of 2021 was only a little under $8 million compared to $48.9 million for twelve months in 2019. To conserve cash, Hersha also paid $4.365 million in PIK interest payments last year instead of cash and they are expecting to also use the PIK feature in March 2022.

My estimates for 2022 from my model have such high standard deviations that make them useless in trying to give readers fair projections. My average estimates are somewhat lower than those shown for 2022 on Bloomberg Terminals of $412 million revenue and $0.95 FFO per share. Bloomberg also has a total 2022 dividend projection of $0.08 per share. Bloomberg’s revenue of $412 million implies a $195 RevPAR-revenue per available room, which I feel is too high because I expect fairly weak business travel for much of 2022. The average $195 RevPAR number for 2022 is also significantly higher than the latest $146.2 shown for November in Hersha’s December presentation. Using Bloomberg’s $0.95 FFO number and the latest stock price of $9.52, results in a multiple of 10x.

Some REIT investors like to look at equity per share using the reported balance sheet figures compared to the current stock price. As of September 30, total equity was $617.4 million. After subtracting the $367.6 million liquidation preference for the preferred stock, the equity for common stock was $249.8 million or $6.35 per HT share. The balance sheet numbers are based on the asset purchase price, plus capital investments, less total depreciation and any writedowns. With HT currently trading at $9.52, the market values the assets much higher than their book value.

Highly Leveraged REIT

This REIT was able to do some refinancing of their debt last year that included some covenant modifications, but they face $337.3 million in debt maturities this August that need to be rolled over or partially paid down by another round of asset sales. Management has also stated that they are expected to be in violation of some of their credit agreement covenants this year and will need new waivers to avoid default. In addition, in the latest quarterly report it was reported that they were in a covenant violation for one of their property mortgages.

The credit markets have been accommodating to low quality borrowers , but if that changes, Harsha could be in serious trouble in 2022. This REIT has too much borrowing of a combination of debt and preferred stock compared to the current value of their assets as indicated by the figures per hotel room earlier in this article. If they were to sell additional hotels to raise cash to partially pay down debt, I would expect it to be hotels that are not part of the group of 23 hotels listed on page 27 of their 3Q 10-Q as collateral securing their credit agreements.

Hotel REIT Eagle Hospitality Ch.11 Bankruptcy

While I do not think in the near future Hersha will file for bankruptcy, they looked like they were close to be putting their toe into the bankruptcy court in spring of 2020. It is, therefore, critical for hotel REIT investors to monitor actual Ch.11 bankruptcy cases for hotel REITs to get a feel for the bankruptcy process.

I was expecting to write a detailed blog article on hotel REIT Eagle Hospitality Trust’s Ch.11 case. Because U.S. investors can’t trade this Singapore traded REIT with hotel assets in the U.S., I knew that I could not get a regular Seeking Alpha article published. Since new blog posts are no longer part of Seeking Alpha’s business model, I am including an overview on this interesting hotel REIT bankruptcy in this article.

I will pass over the “soap opera” elements of Eagle’s bankruptcy such as the fact that the CEO and some board members were arrested in Singapore, that the administrative agent for the credit agreements filed a motion to dismiss the U.S. Ch.11 bankruptcy filing, the fact that U.S. bankruptcy Judge Sontchi has threatened to toss two individuals associated with Eagle into jail for fraudulent use of $2.4 million PPP money and just focus on three key points impacting REIT investors:

First, Eagle Hospitality is liquidating under U.S. Ch.11 bankruptcy-not under Ch.7 ( docket 1597). Liquidation in Ch.11 is often a more orderly sale of assets than Ch. 7. because Ch. 11 allows for DIP financing to raise cash to help preserve the value of assets during the selling process. Unlike some other REITs that have filed for Ch.11 during the pandemic such as CBL & Associates Properties (CBL) and Washington Prime Group and emerged from bankruptcy as operating entities after restructuring their finances, Eagle is liquidating completely and distributing cash to creditors under a Ch.11 reorganization plan.

It seems that DBS, their new REIT trustee, decided that a sale of the hotel assets would result in higher recoveries for creditors instead of continuing operations after doing some type of financial restructuring in Ch.11 with expectation of eventually getting higher recoveries for creditors over the next few years. In my opinion, this is an interesting approach and says a lot about what DBS, the largest bank in Singapore, thought about the future for the hotel industry in early 2021.

Second, the sale of the hotel asset was somewhat different from what often happens in asset sales in Ch.11. Madison Phoenix, who was also the $100 million DIP lender, was the $470 million stalking horse bidder for the hotels. Other potential bidders could bid for all the hotels, but there was an interesting bidding modification that designated six hotels that could be bid individually. Portions of $470 million stalking horse were allocated to each of these six hotels. Five hotels received collectively $24.8 million in higher bids than the original total stalking horse bids.

I personally really like being able to pick a specific REIT asset to bid on without being forced into bidding collectively on all the assets because you can bid just on the “diamonds” and do not have to also bid on the “dogs”.

Third, liquidation of all assets means that only cash is being distributed to various claim holders. Distributing cash is a relatively much easier process than distributing some recovery package of new equity, new debt, and/or warrants to claim holders. This also usually means that the lower classes, such as REIT equity holders, get no recovery.

Eagle equity holders are getting only interests in a liquidating trust, which in reality means they will get $0.00 because higher priority classes are getting less than full recovery. Under both CBL and Washington Prime Ch.11 reorganization plans, equity holders did get some token recoveries if the classes voted for the reorganization plan. They were thrown a “bone” so it would speed up the bankruptcy process to save on bankruptcy expenses. Eagle equity holders are not getting a “bone” and are not even allowed to vote.

Eagle is not doing an absolute waterfall recovery for the claim classes to expedite the process. Some lower creditor classes are getting a blended 56.1{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} recovery instead of 9.2{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90}, if the absolute priority rule was followed. Higher priority classes are accepting a small “haircut” to speed up the bankruptcy process. The Eagle case should be a warning to distressed REIT equity holders not to always expect a recovery-not even a token amount.

Conclusion

I was considering buying a hotel REIT as a hedge against inflation, but I decided that given the current economy, apartment REITs offer a better opportunity. I recommended Preferred Apartment Communities (APTS) and it has risen 47{352461131e134de422042936fefa1ec7b3be3957215d9cdd4e62cdd9b65caf90} since my October article.

While I am not expecting Hersha Hospitality Trust to file for bankruptcy, I think REIT investors need to follow the Eagle Hospitality Ch.11 case given the extremely uncertain economic times we are living in.

HT stock may be a great vehicle for those investors expecting a quick return to strong business travel and a continued high rate of inflation. For those of us who are rather pessimistic about business travel for the next few years, HT stock is not a bargain at current levels. HT is rated hold/neutral.

https://seekingalpha.com/article/4479966-hotel-reit-hersha-hospitality-trust-inflation-hedge

Next Post

Airlines scrap or change flights to U.S. over 5G dispute, despite rollout delays

Dubai, United Arab Emirates — Airlines across the world, including the long-haul carrier Emirates, rushed Wednesday to cancel or change flights heading to the U.S. over an ongoing dispute about the rollout of 5G mobile phone technology near American airports. The issue appeared to particularly impact the Boeing 777, a […]

Subscribe US Now