Investing in Hotel REITs
How Real Estate Investment Trusts Work for Hotels
Investing in hotels can be an exciting way to own real estate. If you are wealthy, you can franchise a hotel concept directly from one of the major hospitality companies. To buy a business-class hotel could cost $15 million. Luxury hotels can easily require $30 to $60 million or more. Although most such purchases are traditionally financed with debt, the down payment required is still far beyond reach for most investors.
However, there is another way to invest in hotels: You can purchase hotel REITs in your brokerage account the same way you buy stocks, bonds, or mutual funds. Learn more about hotel REITs and how to invest in them.
What Are Hotel REITs?
A real estate investment trust (REIT) is a special type of corporation focused on acquiring and managing real estate and real estate-related assets. One of the things that differentiate REITs from ordinary corporations is that they are exempt from corporate taxes, provided several strict conditions are met. For instance, they're required to distribute at least 90% of all of the profits in the form of cash dividends to stockholders.
This makes REITs highly sensitive to interest rate movements, but it also means they tend to offer much larger dividend yields than their blue-chip stock counterparts.
The downside? REIT distributions are not "qualified dividends" under the tax code, meaning you'll be taxed as if they were ordinary income—not at the lower, more attractive dividend tax rates.
How Hotel REITs Differ From Other REITS
Just as stocks in different industries and sectors have different risk characteristics, REITs vary significantly depending on the type of real estate project in which they specialize.
For example, a commercial office REIT might experience cyclical lease rates as it follows boom and bust cycles. In contrast, an industrial warehouse REIT might be far more steady, as overcapacity can be shut down with minimal maintenance costs, and much more quickly than is possible with an apartment building.
Then there is the hotel REIT. Hotel REITs focus on developing, managing, acquiring, or financing hotels and hospitality-related properties. These can range from budget inns located on the side of forgotten highways to five-star prestige resorts.
Hotel REITs can involve developing and owning the property, in which case a third-party management team is hired to handle the actual running of the hotel in exchange for a share of the revenue. Or, hotel REITs can focus mostly on managing other people's hotel properties for a cut of the revenue.
They can also involve financing hotel projects, in which case they act more like quasi-fixed-income investments.
Risks and Benefits of Investing in Hotel REITs
Whatever the nature of the REIT you're interested in, you must understand what it is you own or you risk losing your capital.
Hotel REITs are notoriously volatile because hotel occupancy correlates with general economic conditions, making them highly sensitive to expansion and contraction.
When a recession—or a pandemic—hits, hotels are almost immediately affected. Businesses slash travel budgets, opting for video conferencing or telephone calls instead. Families and organizations postpone vacations, staying closer to home.
For a hotel REIT, this frequently means cash flows dry up at the same time yields are rising, so you get dramatic declines in the value of the units or shares.
On the plus side, when things turn around, cash flow sometimes explodes through the roof, delivering skyrocketing payouts and market values. You must understand the ebb and flow of hotels as an industry if you want to invest in them successfully.
How a Hotel REIT Works
Let's look at a real-world illustration to demonstrate how an actual hotel REIT works.
Service Properties Trust is a hospitality-focused REIT with 1,109 properties in 47 states, Puerto Rico, and Canada.
The REIT was formerly named Hospitality Properties Trust; it acquired Spirit MTA REIT in 2019 and changed its name to Service Properties Trust.
In the boom years before the real estate collapse tanked the economy in 2008, Hospitality Properties Trust generated distributions for owners. In 2007, for example, they generated $3.03 cash per share.
When the financial world fell apart in 2008, though, hotel bookings fell off a cliff. Business conferences were canceled and cash distributions were decimated, dropping to $0.77 per share, a staggering decline of 75%. If you were relying on that income to pay your bills, you suddenly found it had evaporated at the moment you needed it most.
Investors who understood the nature of hotel REIT ownership waited it out, however, as the economy eventually rebounded. These investors saw distributions slowly increase again and share prices climb once more.
And for its part, Hospitality Properties Trust made calculated acquisitions, diversified its brands to span 23 industries, required its tenants to pay fixed minimum rents, and strategically located its properties to protect cash flows. The lessons of the 2008 collapse did not go unheeded.
Ways to Invest in Hotel REITs
There are four major ways you can strategically approach acquiring hotel REITs if you want to own them.
- Buy cheap: Consider only buying blocks of hotel REITs during stock market crashes. The lower your cost basis, the faster you can extract your purchase price in cash dividends if you plan on investing that money somewhere else.
- Dollar-cost average: Steadily buy into hotel REITs in a dollar-cost average strategy. Sometimes, you're going to be buying at the worst possible moment, but other times, you'll get a bargain. Combined with reinvested dividends, this strategy should average everything out for a satisfactory total return. For most people, this is probably the better approach, reducing stock market risk when combined with diversification.
- Speculate: When the hotel industry is in collapse, you could buy hotel REITs until the boom years return, then dump them. However, the odds of long-term success are not great unless you understand the hotel industry in great detail and treat the REIT acquisition the same way you would if you were to buy a property outright.
- Buy via an index fund: Throw in the towel on buying REITs directly and buy an index fund which mixes lots of different REITs, including hotel REITs, as part of a diversified portfolio. This technique has a much lower dividend yield, but if you think the reduced risk is worth that trade-off, it might be your wisest course of action.
Hotel REITs are not the faint of heart. If you don't know what you are doing, tread lightly.
The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.