Category: REIT

Board Engagement Critical for Risk Management, Data Center REIT Executive Says

Oliver Schmidt, chief audit executive at QTS Realty Trust, Inc. (NYSE:QTS), joined REIT.com for a video interview at REITWise 2017: NAREIT’s Law, Accounting & Finance Conference in La Quinta, California.

Schmidt participated in a REITWise panel on risk management issues.

Schmidt explained that when it comes to risk management, the audit executive plays an advisory, communication and assessor role.

Schmidt also stressed the importance of engaging with the management board to ensure alignment around what are perceived to be the key enterprise risks. The management board can provide guidance on those issues, and sometimes it will need to step in and make course corrections, Schmidt said.

As far as cybersecurity risks, Schmidt encouraged REIT executives to come up with common sense, layman’s terms to better understand technology. He also noted that executives can take advantage of many existing security frameworks that foster a good baseline for a company’s cybersecurity program.

(Why?)

Published at Thu, 30 Mar 2017 13:03:56 +0000

REITWise Panel Explores Drivers of REIT Shareholder Activism

Mark Parrell, executive vice president and chief financial officer with Equity Residential (NYSE: EQR), joined REIT.com for a video interview at REITWise 2017: NAREIT’s Law, Accounting & Finance Conference in La Quinta, California.

Parrell moderated a REITWise panel on investor activism.

Some of the key points to emerge from the session included the need for REIT management boards to be “their own best critics”and to communicate regularly with investors, Parrell said. He noted that the REIT industry is already ahead of other sectors when it comes to communication.

“In the REIT industry generally, you have a pretty good pulse on what a lot of your investors are thinking,” Parrell said.

Parrell also commented that in the past, activism in the REIT sector was restricted due to the size of the industry and its tax rules.

“That’s changed. That trend is certainly upward in terms of activism in our area,” he said.

Meanwhile, Parrell stressed the need for “direct, candid and positive conversation” with activists, both in public and in private. He added that REITs should also try to determine whether activist viewpoints are shared by a broader swath of the company’s investor base.

(Why?)

Published at Wed, 29 Mar 2017 19:46:49 +0000

Real Estate Industry Showing Early Signs of Optimism About Trump

In the latest episode of The REIT Report: NAREIT’s Weekly Podcast, FTI Consulting Managing Director Michael Hedden what economic indicators are suggesting about the direction of the real estate market.

According to Hedden, property markets showed resilience in response to the economic challenges posed in the last year. He said capital sources are still showing interested in investing in real estate.

“The United States has been a very attractive market for those investment dollars,” Hedden observed.

Hedden also offered his thoughts on how real estate investors view President Donald J. Trump’s policy agenda. Although he cautioned that it’s too soon to come to conclusions since in the two months since Trump’s inauguration, early signs suggest there is some optimism in the real estate markets, according to Hedden. He noted that regulatory reform appears to be popular with real estate professionals, as is the possibility of tax reform.

Despite the signs of optimism, Hedden warned that any changes would come at “glacial speed.”

“It’s not going to be overnight in terms of the impact on the market,” he said.

For the rest of 2017, Hedden said he will be watching to see if—or how—political issues affect the market. Trends in the health care, retail and lodging sectors still bear watching, according to Hedden.

(Subscribe to the NAREIT Podcast via iTunes.)

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Published at Tue, 28 Mar 2017 20:19:22 +0000

Gladstone Land Benefitting from Demand for Organic Produce

According to Gladstone Land Corp. (NASDAQ: LAND), the expanding organic produce section in your local supermarket is a positive sign for the farmland REIT’s long-term health.

The company expects increased consumer demand for organic fruits and vegetables will continue to bolster the value of farmland in its portfolio for the next decade and beyond. Currently, more than 35 percent of the company’s fresh produce acreage is either organic or in transition to become organic.

“The high-value side of farmland is going to continue to have tremendous appreciation,” says David Gladstone, founder, president and CEO of Gladstone Land, in an interview with REIT.com.

Organics “Going Gangbusters”

Gladstone Land, the country’s first publicly traded farmland REIT, leases land to farmers on a triple-net basis. It owns 59 farms located in California, Oregon, Arizona, Colorado, Michigan, Nebraska and Florida. All farms are 100 percent leased. The company concentrates on acreage with on-site water sources that can support fresh produce and annual row crops, as well as permanent crops such as almonds, blueberries and pistachios.

 “Organics are going gangbusters,” Gladstone says. Many of Gladstone Land’s tenant farmers want to convert their farms over to organic, “which we’re delighted to do,” he adds. The process of conversion takes three years to complete. Crop yields during that time are lower because no fertilizers can be used, but Gladstone says that hasn’t deterred farmers from making the switch.

In addition to converting existing farmland, Gladstone Land has also been actively purchasing properties already concentrating on organic crops.

Last year, the REIT paid approximately $26 million to purchase farmland in Colorado specializing in organic potatoes. In January, the company spent $54 million on approximately 3,750 acres of organic farmland in southern Florida, the largest acquisition in the company’s history.

“We see Gladstone Land’s external growth potential looking more attractive than ever, particularly if its increased scale can result in higher investment spreads and more chunky transactions going forward,” says John Massocca, analyst at Ladenburg Thalmann & Co., Inc.

He adds that on average, rent increases on lease renewals during the last four years have exceeded 17 percent. That indicates the company’s portfolio still possesses inherent rent growth potential, according to Massocca.

Scarcity of Land

At the same time that demand for high-value crops is thriving, the land where they are grown is becoming scarcer.

For example, about 100,000 acres are going out of production on an annual basis in California, according to Gladstone. Gladstone Land cites data showing that the value of irrigated cropland in California has increased 119 percent in the past 15 years. Prime coastal cropland, mainly used to grow crops such as strawberries, has appreciated 83 percent since 2000, according to the company. Most of Gladstone Land’s farms in California are located along the coast.

Moving Away from the Family Farm

As it pursues new acreage, Gladstone Land’s transactions are often carried out on a personal level.

“Every time we buy a farm that’s been owned for several generations, it’s like tearing their heart out,” Gladstone says. On the other hand, he adds, once the children and grandchildren of farming families are exposed to non-farming careers, many of them are reluctant to stay on the land. The significant tax consequences of passing a family farm from one generation to the next can also make farmers more willing to sell.

The company’s target purchase price for a farm is typically in a range of up to $50 million. Gladstone explains that the REIT can offer prospective sellers either cash or a tax-deferred exchange of shares in the company. Since its initial public offering in 2013, the REIT has purchased more than $350 million of new farm assets.

“There are going to be great opportunities for us. We have money, and people want to sell. Owning the dirt is a strong place to be for the next 10, 15 years,” Gladstone says.

(Why?)

Published at Tue, 28 Mar 2017 12:36:15 +0000

Self-Storage REITS Remain Appealing

Following a banner year in 2015, self-storage REITs cooled off in 2016. Returns for the sector were down 8.14 percent for the year, compared with an increase of 9.3 percent overall for the FTSE NAREIT All REIT Index.

However, executives and analysts point out that the underlying fundamentals of this recession-resistant sector remain appealing.

“Self-storage REITs likely had as good a year, if not better, in 2016 than the preceding two or three years in terms of average occupancy rates, same store sales, net operating income (NOI) and funds from operations per share,” says Christopher Marr, CEO of CubeSmart (NYSE: CUBE). “However, our share prices had the worst performance in as long as I can remember. Our previously outstanding rates of internal growth started to slow during the second half of the year, and that deceleration worried investors.”

In spite of market jitters, self-storage remains one of the best real estate businesses in the long run, says Ryan Burke, an analyst with Green Street Advisors. He points out that demand for self-storage space comes from the movement of people, which doesn’t discriminate between a good or bad economy.

“The big advantage to self-storage is that it requires low capital expenditures,” Burke says. “Owners have to put fewer dollars back into the business to keep it competitive over time: only about 5 percent of NOI, compared to an average of 15 percent in other property sectors.”

In fact, the sector has turned into a hotbed for new investment, according to Joe Margolis, CEO of Extra Space Storage (NYSE: EXR). “The secret of self-storage is out, and now there is more equity chasing deals,” he says.

Victims of Their Own Success

So what led to the self-storage stock slowdown? The biggest culprit is comparisons to previous years, when self-storage was beating every sector in top-line growth, says David Rogers, CEO of Life Storage, Inc. (NYSE: LSI). He notes that the sector enjoyed rent growth between 8 and 10 percent in 2014 and 2015.

Sector Stats

Sector: Self-Storage
Constituents: 5
One-year Return: -3.77%
Three-Year Return: 15.55%
Five-Year Return: 15.33%
Dividend Yield: 3.86%
Market Cap ($M): 50,243
Avg. Daily Volume (Shares): 702.7
(Data as of Feb. 13, 2017)

“Average occupancy rates of 88 percent used to be the peak for self-storage because customers move in and out so frequently,” Rogers says. “Now the average occupancy rate is 94 percent.”

Margolis says the performance metrics of 2009 through 2015 reflected a lack of new supply, increasing demand and product awareness, and the availability of technology to increase efficiency. All helped produce outsized growth, he says.

“We’ve seen a consistent increase in demand since 1998, and now 9 percent of U.S. households rent a self-storage space,” Margolis says. “You can feel it with our high occupancy levels and the quick lease-up of any new product. Not only is there consistent demand, but people keep their space for longer and longer time periods.”

Strong demand meant that storage facility owners didn’t need to offer discounts or incentives such as one month’s free rent to achieve high occupancy rates, according to Marr. Rent increases were also consistent. Now, self-storage customers are experiencing “rent fatigue,” says George Hoglund, a vice president and REIT analyst with Jefferies.

“Over the past few years, we’ve seen double-digit rent increases in some markets, and some tenants are starting to think maybe it’s not worth it to keep storing stuff,” Hoglund says.

What Now?

The consensus among analysts and executives seems to be that the self-storage sector is coming off a period of extraordinary, albeit unsustainable, growth. Expectations of normal growth are affecting how self-storage companies are planning for the future.

Marr says CubeSmart is focusing on “less stressful and more intuitive” experiences for customers.

“We’re learning as much as we can about our customers to maximize revenue,” he says. “We can determine whether the offer of a free truck for two hours is more valuable than one month of free rent.”

Meanwhile, Life Storage intends to use high-tech revenue management systems to determine which stores will be busy at different times to manage incentives and rates, according to Rogers. He also says the company will continue to leverage the scale advantages of being a REIT in a business flooded with mom-and-pop shops.

“With 650 stores, we can afford a team of people to manage and develop our marketing and revenue management platforms,” Rogers says. “We recently had a guy in Norfolk ask us to manage his facility because he’d poured $52,000 in one year into web ads, but all he saw were ads for our storage facilities. We pay about $11,000 per store for marketing.”

Margolis says a big advantage of scale in self-storage is that with 60,000 customers moving in and out each month, his company has access to a massive database to look at customer behavior and optimize operations.

Another area of interest for self-storage REITs is third-party management. Marr notes that CubeSmart’s third-party management of some self-storage facilities provides income from fees, the benefit of branding and future acquisition opportunities. Similarly, Life Storage expects to provide more third-party management and to enter into joint ventures to own 15 to 20 percent of facilities it manages and may eventually buy. 

Looking Ahead

Rising real estate taxes and increasing wages from a stronger job market are among the pressures now facing the self-storage sector. Still, industry leaders insist that the property sector continues to see strong fundamentals, particularly on the demand side.

“While 2017 won’t be like the glory days for self-storage, we’re still strong and will still see consistent growth,” Rogers says. “Typically we’re at least 2 percent to 2.5 percent above inflation, and all the growth we’ve seen over the past few years has been in the face of virtually no inflation.”

“Don’t forget that regardless of the absolute level of shares, self-storage outperforms other investments,” Marr says. “Everyone needs to relax a little bit and adjust their expectations.” 

Supply Side Challenges 

Until 2016, the supply of new self-storage facilities was nearly nonexistent. “We started to see some new supply in 2016, which we think will probably peak  in 2018,” CubeSmart CEO Christopher Marr says. “It’s not a lot of supply, but it’s a sharp ramp-up compared to zero.”

Burke says more self-storage facilities are being built in Denver, Phoenix, Miami, Charlotte and Texas. The uptick in new stores includes “third-generation” facilities that look like apartments or offices and include climate control, according to Rogers.

CubeSmart has a pipeline of facilities under construction in New York City this year. Marr says the company will cautiously continue to target urban areas with strong population and household income growth.

(Why?)

Published at Fri, 24 Mar 2017 15:04:08 +0000

ESH Hospitality Expanding Footprint in Extended-Stay Market

ESH Hospitality, Inc. (NYSE: STAY), the owner of more than 620 hotels in North America, is looking to build its presence in the extended-stay hotel business by taking a “deliberative” approach to growth in the coming years.

ESH is the REIT subsidiary of Extended Stay America (ESA), Inc. ESH and ESA shares trade as a single unit.

The company’s brand, Extended Stay America, serves the mid-priced, extended-stay hotel segment. The average length of stay for one of the company’s customers is around 26 days.

In an interview with REIT.com, ESH President and CEO Gerry Lopez said the company expects to expand its market share by focusing on individual assets and markets, rather than acting on a portfolio-wide basis, he explains.

The five-year plan, dubbed ESA 2.0, involves the selling, building and franchising of assets. It reflects a return to an earlier, successful strategy of unit growth, according to Lopez. In contrast, ESA 1.0, which ran from 2011 to 2016, involved renovating the entire portfolio, installing a revenue management system and organizing a sales force to target the extended-stay market.

Return to Unit Growth

During the last 14 months, ESH has sold or placed under contract 57 hotels. Lopez says the process of shedding what it views as non-strategic assets is just getting started. The list includes ESH’s hotels in Canada. Located in three separate provinces, the hotels don’t make sense from an efficiency perspective because of the great distances between them, he says.  

Going forward, ESH will look to develop new hotels in those markets where it already has a presence and anticipates continued growth. Lately, the markets that most appeal to ESH are those located in the Southeast that have benefitted from a surge in auto manufacturing and the related business travel.

“We see those markets doing really well into the future; that will be a prime area for us,” according to Lopez.

Looking ahead, the company expects to build 70 to 80 new hotels by 2021, with an even split between assets owned and franchised. “Our unsolicited franchise inquiries, driven by our brand equity, [signal] a pent-up demand for this brand. However we want to initially concentrate on owners who will commit to multiple locations,” Lopez says.

Chad Beynon, analyst at Macquarie Capital (USA) Inc., says the ESA 2.0 plan “is gaining traction” and should result in unit growth starting in 2019.

“With 70 percent of profits from the coasts and 75 percent of properties in suburban markets, we believe STAY is well positioned, given current industry trends,” Beynon adds.

Michael Bellisario, analyst at Robert W. Baird & Co., says the Extended Stay America portfolio should produce revenue per available room (RevPAR) growth above its peer competitors throughout 2017 as it continues to reap the benefits from its extensive renovation and repositioning program.

Business Versus Leisure

Business travelers account for about 60 percent of ESH’s revenues. Lopez points out that growth in business travel hasn’t been as dramatic in the last couple of quarters as it was a year ago, when growth was in the double-digits. Nowadays, double-digit growth is coming from the leisure segment, according to Lopez.

For ESH, online travel agencies (OTAs) are key to attracting leisure travelers and unofficially serve as a marketing and distribution channel for the company.

“Even after paying the OTA commission, the rate we get is higher than our average daily rate,” Lopez explains. OTA guests, who typically stay two to three nights, fill ESH’s schedule when there is not enough extended-stay demand, Lopez says. “It allows us to control demand at each hotel much more effectively than we otherwise could.”

Restrained Supply

As it undertakes its strategy of deliberative growth, Lopez points out that new hotel supply does not pose a threat at this time.

He explains that the vast majority of announced new supply consists of upscale and upper-upscale chain properties. “In the economy segment, there are virtually no projects announced, certainly none by the majors,” Lopez says.

Revenue per available room (RevPAR) in 2016 was just under 4 percent, and ESH’s most recent guidance calls for RevPAR growth of 1 percent to 3 percent in 2017. “It’s not that we’re any less confident about the business, it’s just that there is more uncertainty,” Lopez says.

Lopez adds that he is cautiously optimistic about the overall macroeconomic environment for the next few years, due in part to the potential for lower corporate taxes. If President Donald J. Trump’s infrastructure spending program comes to fruition, “that would be great. All those guys will be staying with us.”

(Why?)

Published at Thu, 23 Mar 2017 15:24:12 +0000

Keeping Retail Relevant

When people started plugging into the World Wide Web in the early 1990s, the vast universe of potential applications for online technology became clear—even if we weren’t exactly sure what form they would eventually take. Hooking up the modem to chat with Yankees fans or car collectors around the world was a sign of cool things to come; yet, our digital lives essentially ended there.

Two decades later, consumer behavior continues to change, and the options to procure goods and services have mirrored those behavioral changes. Today, an online presence is vital to participate in our global system of commerce. That applies to both buyers and sellers. Websites and apps provide more than just information or channels of communication. 

The Department of Commerce estimated that in the third quarter of 2016, U.S. e-commerce retail sales totaled $101.3 billion. That marked an increase of 4 percent from the previous quarter and a gain of nearly 16 percent from the same period in 2015. E-commerce as a selection tool and distribution system will continue to play a larger and larger role in the business plans of nearly all retailers (and vice versa – bricks-and-mortar alternatives will play a larger role in companies that previously had no such option). Whereas the Commerce Department data show that e-commerce sales accounted for roughly 2.5 percent of all retail sales at the start of 2006, that share had climbed to approximately 8.5 percent as of the third quarter of 2016—hardly the end of shopping as we know it, but critical to address and incorporate into every business plan.

The effect of changing consumer behavior on the business of retail continues to grow and shows no signs of slowing. Experience is more important than ever before, demands for continually higher service levels that weren’t even possible some years back are vital for shopping center owners to consider, and retailers of all types search for the magic formula to identify and then satisfy increasingly fickle customers.

Some major brands have disappeared. Others are still working to figure out exactly where they fit in the new landscape. A few have settled on business plans that work particularly well, and that’s encouraging.

Like all bricks-and-mortar retail companies, Federal Realty Investment Trust (NYSE: FRT) is committed to adapting along with those retailers. The right location still works as the best hedge in creating demand that exceeds supply. Not an easy feat today. There is far more retail leasable space per capita in the United States than in nearly every major country. Particular real estate locations need to be compelling.

But it’s more than that. Flexibility in format and in the merchandising of shopping centers through a relevant tenant mix are factors that are more important than ever, particularly in a macro environment where supply arguably exceeds demand and where retailers are experimenting with the perfect number, size and shape of their bricks-and-mortar offerings.

The changing landscape in the retail industry will reward the retail real estate companies that identify and court tenants positioning themselves for relevance in their vision of 2020 and 2025, not the 1990s. Retail real estate companies that thrive in this omnichannel environment will recognize that the investments they are making right now—in terms of both time and capital—will determine whether they’ll be able to grow their rents in the decades to come.

Don Wood is president and CEO of retail REIT Federal Realty Investment Trust. He was the 2012 NAREIT Chair.

(Why?)

Published at Thu, 23 Mar 2017 14:23:09 +0000

MIT’s David Geltner on the Data Revolution in Real Estate

A revolution is coming in real estate investment, according to MIT professor David Geltner. “Rules of thumb” and “conventional wisdom” are out, he says. Empirical data and analytics are in.

“This is an industry that has always needed to use a lot of numbers, but it is an industry that never had real data,” Geltner says. In a wide-ranging interview with REIT magazine, 

Geltner discussed how the influx of data-driven millennials is changing the culture of the real estate business, what buildings and people have in common and more.

REIT: You’re a major proponent of transactions-based approaches to real estate valuations. Can you explain the advantages of this method?

David Geltner: Transaction prices are the fundamental datum for real asset valuation wherever there is a well-functioning market for the assets. Economists define values on the basis of “opportunity cost,” and opportunity cost is what you can sell for in the market.

There is also a venerable and abiding role for appraisals in various aspects of the real estate industry. We often need to value properties more frequently than they are transacted. And we often need an outside independent expert opinion about value, sometimes even when there is also an associated transaction price. Appraisals can also be quite useful for constructing real estate investment performance indices and benchmarks.

There is also an important role for stock market-based indications of property values at an aggregate level. REIT share prices reflect the way the stock market values commercial property assets. The stock market is the most efficient information aggregator about property values, and its valuations represent liquid opportunity costs available on a daily basis and based on a wealth of publicly-available information.

In general, empirically, we tend to find that stock market-based valuations of property assets move first in response to relevant news; followed by average private property market transaction prices, which on average reflect market values; and finally then appraisal-based indices tend to move last. But ultimately all these types and sources of property valuation information tend to end up in the same place.

REIT: Where do you think the real estate market is now in its typical cycle?

Geltner: Actually, I’m real good at telling you when the cycle has turned, after it has clearly turned. As of last year, I thought we had reached a plateau and that if the plateau held for a while, we might avoid a major downturn in commercial property pricing. But then the market turned up again.

I guess I wouldn’t want to bet against some sort of pretty broad and non-trivial downturn happening between now and 2020. Hopefully, just a correction, rather than a crash, but that may depend on how much higher commercial property prices rise before they fall.

REIT: Some of your more recent work has focused on real estate depreciation. Tell us a little bit about your findings.

Geltner: I think it’s pretty cool! We find that buildings are like people. Commercial structures in the U.S. seem to exhibit an average lifetime of about a century, maybe a bit less, especially in the case of multifamily apartment buildings.

The buildings live on average nearly a century before being demolished, but they pass through three rather distinct “stages of life.” Youth is from about zero to 30 years old and is characterized by a sharp drop in value as the structure loses its luster as a “new building.”

But once in middle age, roughly 30-65 years, there is relatively little differentiation of value by age. A 40-year-old building is not perceived much differently from a 60-year-old building as far as the age of the structure is concerned: Of course, middle-age buildings may absorb more capex in order to keep up their status.

Finally, in old age, over about 65 years, the building value begins to decline pretty rapidly again toward essentially zero, just the land value of the property remaining. As the building approaches its life expectancy, it may become less worthwhile to spend money to try to keep it up.

Our study is also the first academic study to combine estimates of routine capital improvement expenditures with the above-described estimates of “net depreciation,” which is the decline in value associated with age. We find that capex is approximately equal to net depreciation. In other words, for example, typically routine capex averages around 3.5 percent of the remaining structure value per year, and net depreciation is also about that much. Thus, “gross depreciation” or “capital consumption” is around 7 percent per year of the remaining structure value.

This is substantially more depreciation than is typically assumed in the real estate investment industry, in U.S. income tax policy, and in the official U.S. economic statistics.

REIT: Real estate derivatives seemed promising before the 2008-09 downturn, but then never seemed to get off the ground. Why?

Geltner: The tough nut to crack for commercial property derivatives has always been the short positions, at least regarding price index-based derivatives that would enable synthetic investment. There are probably plenty of investors who would like to invest synthetically in the long side of real estate indices. But the demand for the short side is more narrowly based on entities with exposure to particular property markets that they want to hedge specifically.

One strength of REIT-based products such as ETFs is that they are based on funded, liquidly traded shares, which therefore do not require matching long and short positions.

REIT: As an academic, what are some of the subjects in real estate that are lacking in rigorous analysis or in need of more attention?

Geltner: There is relatively little rigorous, economics-based focus on commercial real estate development: the actual process of capital formation, where and how financial capital is converted into the physical capital that greatly impacts cities, society, the environment and the economy.

A very exciting frontier is to link the economic and financial perspective of real estate development to the physical perspective of the architects and urban designers. We could use development of both theory and empirics.

This is an industry that has always needed to use a lot of numbers. But it is an industry that never had real data. This could change now because we do now have much more and better data, and getting more and better all the time. And we now have computational power that can make use of this data.

There is the potential for a major cultural shift in how the real estate investment industry does business. It may not happen, but real estate programs in higher education have an opportunity and an important responsibility to try to help it to happen.

REIT: What about improving real estate as a field of study in higher education? 

Geltner: Honestly, there has been over the past few decades quite a blossoming of academic real estate centers and programs. I think the field has grown and matured and improved considerably, certainly over the 30 or so years I’ve been in it. And I would say this growth is accelerating.

When I started out there were just faculty members and Ph.D. students. Today post-docs and research scientists have added major new human capital to the equation, making the academic real estate research scene much more exciting. =

About David Geltner

David Geltner is a professor of real estate finance in the MIT Department of Urban Studies & Planning and associate research director of the MIT Center for Real Estate. He is the lead author of the widely cited textbook “Commercial Real Estate Analysis & Investments.” He received the Graaskamp Award in 2011 for excellence and influence in real estate investment research from the U.S. Pension Real Estate Association.

(Why?)

Published at Thu, 23 Mar 2017 14:07:41 +0000

New REIT Park Hotels & Resorts Aims High in the Lodging Marketplace

For many real estate companies, growth is a slow, methodical process. Just ask Thomas J. Baltimore Jr., who spent more than a decade growing the venerable RLJ Lodging Trust (NYSE: RLJ) one deal at a time. 

Today, Baltimore—who co-founded RLJ in 2000 with entrepreneur Robert L. Johnson of BET fame—sits at the helm of a new hotel REIT, Park Hotels & Resorts (NYSE: PK), which in January became the second-largest player in its sector in one fell swoop following its Jan. 3 spinoff. 

Based in McLean, Virginia, the company was formed when Hilton Worldwide, where Baltimore once held management positions, spun off most of its owned real estate into a separate public REIT. Park Hotels is the latest entrant into a sector long dominated by Host Hotels & Resorts Inc. (NYSE: HST), which still dwarfs all other stock exchange-listed hotel REITs in terms of size. Park Hotels had a market capitalization of nearly $5.3 billion in early February, while Host’s market cap was more than $13 billion at the time. 

At A Glance

Address: 1600 Tysons Blvd., Suite 1000
McLean, VA 22102
Phone: 703.584.7441
Website: pkhotelsandresorts.com
Management Team:
Thomas Baltimore, Jr., Chairman, President & CEO
Sean Dell’Orto, EVP, CFO & Treasurer
Matthew Sparks, EVP & Chief Investment Officer
Robert D. Tanenbaum, EVP, Asset Management

“Your typical hotel REIT tends to have a market capitalization of anywhere from $1 billion to $2 billion,” said Patrick Scholes, a lodging analyst at SunTrust Robinson Humphrey Inc. Prior to the formation of Park Hotels, “if you were a large-cap investor who needed liquidity, there was only one name in which you could invest, Host,” he added. 

Baltimore describes his departure from RLJ last May as “bittersweet,” but says the opportunity to serve as chairman, president and CEO of Park Hotels was too compelling to pass up. As the longtime CEO of RLJ, he earned a reputation on Wall Street as a straight shooter and savvy hotel-property investor and asset manager. Baltimore also had a loyal following within the company, where he presided over a senior team of men and women that had very little turnover over the course of more than 15 years. 

“When [Hilton CEO Christopher J.] Nassetta called me about the opportunity and spinning out Hilton’s owned real estate, it was the one opportunity that I found too compelling to pass up,” said Baltimore, who had first-hand knowledge of Hilton’s portfolio from his time at the company.

Quality and Quantity 

Park Hotels owns a $9 billion portfolio of 67 large-scale, high-end hotels, including iconic properties stretching from coast to coast. Its trophy properties include the New York Hilton, which spans an entire city block in Midtown Manhattan; the landmark, 1,544-room Hilton Chicago Downtown, boasting nearly 200,000 square feet of meeting space; and the oceanfront, 2,860-room Hilton Hawaiian Village in Honolulu. 

Stock Synopsis

Ticker: PK (Spun off Jan. 3, 2017)
Equity Market Cap: $5.4B
Share Price: $26.25
Yield: 6.6%
Volume: 4.0M
(three-month avg.)
(*Data as of March 9, 2017)

“You start with a portfolio with heft and scale. It’s truly an iconic portfolio that would be really difficult to replicate in this environment,” Baltimore said.

Baltimore not only sees upside potential in the 35,000-room portfolio of upper-upscale and luxury hotels, but plans to grow Park Hotels through acquisitions of like properties in leading hotel and resort markets. The company already has holdings in 14 of the top 25 U.S. hotel markets. Baltimore also believes the fragmented lodging REIT sector is ripe for consolidation and that Park Hotels will be able to acquire smaller competitors over time.

In his new role, he is taking nothing for granted and aiming high. “The real goal and vision,” explained Baltimore, “is that we want to build credibility over time and be the preeminent lodging REIT” by generating superior long-term returns for investors.

Heavyweights at the Helm

When Baltimore returned to Hilton prior to the spinoff, he quickly got to work assembling a team of seasoned executives to lead the future Park Hotels. “Job one was hiring an experienced team with aligned interests and shared values,” said Baltimore, who recruited a number of professionals from Hilton. 

The company’s newly formed management team not only includes hotel-industry veterans, but well-known executives within the REIT world, said Lukas Hartwich, a senior analyst at Green Street Advisors. 

Like Baltimore, Sean M. Dell’Orto, Park Hotels’ executive vice president and chief financial officer, is also a Hilton veteran. Most recently, Dell’Orto was Hilton’s treasurer and a senior vice president. 

Park Hotels’ senior leadership team also includes Executive Vice President of Asset Management Robert D. Tanenbaum, the former chief operating officer and executive vice president of asset management at DiamondRock Hospitality Co. (NYSE: DRH), and Senior Vice President of Design and Construction W. Guy Lindsey, a 13-year veteran of Sunstone Hotel Investors Inc. (NYSE: SHO).

“When a company comes public, you often have a management team that people [within the REIT industry] aren’t too familiar with. With Park Hotels, people essentially know what they are getting. It’s a good team,” Green Street’s Hartwich said. 

Zeroing in on High-Growth Markets 

A major priority for Baltimore and his team is to grow the company’s presence in the top 25 U.S. hotel markets and leading resort destinations. That goal rests in part on a plan to selectively sell holdings in slower-growth markets and reinvest in markets that are expected to benefit disproportionately from the anticipated uptick in international travel to the United States over the next several years. 

From 2000 to 2016, inbound international arrivals to the United States grew at a compound annual rate of nearly 3 percent, according to Baltimore. Through 2020, that rate is expected to climb to about 4 percent. Much of that growth, he said, will be concentrated in a handful of markets, including Hawaii, San Francisco, Los Angeles, Chicago and New York.

“You have a growing middle class in Asia and other parts of the world. Where do they want to come when they visit the United States? There are a half dozen markets they are focused on visiting,” said Baltimore, adding that Park Hotels already has a strong presence in most of those markets and is poised to become an even bigger player. 

“We want assets of scale, typically greater than $100 million [in value],” he said, adding such properties often trade “off-market” and attract a limited number of bidders. “Our scale gives us a real advantage to be able to purse and acquire assets like that.” 

Through acquisitions, Baltimore also hopes to bring greater brand diversity to the company’s holdings. Its lack of brand diversity is among the factors that have weighed on Park Hotels’ stock post-spinoff, according to analysts. 

“We are one-brand concentrated right now,” Baltimore said. “We seek brand and operator diversity over time.” This is similar to what happened in 1993 after Marriott International spun off what is now Host Hotels.

A Portfolio with Room to Run  

Baltimore believes there’s still plenty of upside in the company’s existing portfolio. To free up “embedded ROI [return on investment],” he and his team are mulling various options, such as value-add projects. 

“Hilton was focused on an asset-light strategy,” explained Baltimore, alluding to Hilton’s primary focus on managing and franchising hotels. “We will look at developing, selling, partnering,” in other words opportunities to “activate the real estate,” he explained. 

While Hilton will continue to manage the vast majority of properties it spun off, oversight of operations under Park Hotels creates a system of checks and balances that should eventually translate into higher profits, said Ryan Meliker, an analyst at Canaccord Genuity Inc.

Meliker says that Baltimore and his team can take some relatively simple steps to improve profit margins, such as adding resort fees, eliminating room service at certain properties or doing time-motion studies to keep a tighter lid on labor costs.

To boost revenue per available room, the company might consider ratcheting up group business, which now accounts for 29 percent of the company’s revenue mix. That shift, according to Meliker, would reduce the supply of rooms available to so-called transient travelers. That should, in turn, give the company’s hotels more pricing power and allow them to book less business through online travel agencies, which tend to charge hefty commissions to hotels.

“Hilton, like most brand owners, doesn’t have corporate oversight of property-level management to make sure they are maximizing profits for the owner. There is not that system of checks and balances,” Meliker said.

Optimism Out of the Gate

As he looks ahead, Baltimore concedes that there are a few big-picture issues that give him pause, but says that he’s generally optimistic about the hotel sector’s outlook. “Trade wars or any extensive restrictions on immigration that negatively impact travel are always a concern,” he said. “But I try not to worry about things I can’t control. I’m an optimist. We live in a great country, a resilient country.”

Indeed, he’s hopeful that the pro-business environment the stock market has been anticipating since election day will materialize and, over time, translate into stronger hotel demand. There is a high correlation, he notes, between business investment and hotel demand. 

According to Green Street, weak corporate profits have weighed on business travel, which accounts for 75 percent of demand for the higher-quality hotels that REITs tend to own. But corporate earnings growth turned positive late last year, which Green Street says could presage an increase in hotel demand. Meanwhile, leisure travel is holding up relatively well thanks to a healthier job market and higher incomes, according to Green Street. 

“Business sentiment is beginning to turn a little more positive, and that could serve as a real catalyst toward extending the cycle,” said Baltimore, whose career has also included stints in management at the former Marriott Corp. and at Host. 

Baltimore may be a veteran of the hotel real estate sector, but he hasn’t lost his enthusiasm for the business and is clearly up for a new challenge. “I really enjoy the journey. I love the industry: no two days are alike, and I love building and leading teams,” he said.

(Why?)

Published at Wed, 22 Mar 2017 13:49:49 +0000

Well-Capitalized REITs Positioned Well in 2017

When it comes to mergers and acquisitions for REITs, opportunism will likely remain the key theme of 2017.

Look no further than Ventas Inc. (NYSE: VTR) as an example. The health care REIT last year purchased most of the life science and medical real estate assets of Wexford Science & Technology from affiliates of Blackstone Real Estate Partners for $1.5 billion in cash. The deal further diversified Ventas’ portfolio with reliable income from 23 operating properties representing 4.1 million square feet leased by top universities, academic medical centers and research companies. The portfolio was 97 percent leased, and the projected 2017 cash yield was 6.8 percent.

As prices for commercial real estate continue to rise, selective deals like this are most likely to continue for well-capitalized REITs, which have the financial might and the ability to quickly finance purchases.

“You never know what the future will hold,” says Debra Cafaro, Ventas’ chairman and chief executive officer. “We are always ready. We can be very nimble in approaching opportunities that present themselves. Our speed, sophistication and experience enable us to win transactions that will benefit shareholders.”

Coming off a solid year, REIT M&A is likely to continue at a steady pace in various forms, including public-to-public and public-to-private deals and portfolio transactions, once uncertainty about interest rates dissipates and policy initiatives out of Washington become clearer. Spinoffs have and will also likely continue to be an attractive way for REITs to provide pure-play trades for investors, while initial public offerings might come back if the REIT market resumes an upward trend in terms of stock valuations.

All in all, REITs will pick their spots in 2017.

“Transactional activity for REITs should remain healthy, but episodic,” says Neil Wolitzer, a managing director in real estate investment banking at Goldman Sachs Group Inc. “Companies are constantly looking for ways to create value in both their businesses and through strategic activity, such as M&A and other large-scale transactions.”

“Interest rates are the biggest wildcard in the discussion,” says Vivek Seth, vice chairman of investment banking at Raymond James. “To really establish a trajectory and trend, it will take the first half of this year to see how it goes with the next few Fed meetings and how the world macro environment reacts to all of this. Only then we’ll know whether we have a major or minor tightening cycle.”

If inflation resumes, rates on 10-year Treasury bonds will likely keep rising this year. Buyers could swoop in and buy up assets or REITs that are in sectors with shorter leaseholds, such as lodging and apartment REITs, notes Gil Menna, co-chair of the REITs and real estate M&A practice at Goodwin Proctor. Combine that with a healthy appetite for yield by private equity and sovereign wealth funds, and deals could start flowing.

“There is going to be private capital chasing public REITs, either with portfolio or whole-company transactions,” Menna says. “Buyers will want to get in on the act on increasing cash flows on short-duration leaseholds if inflation starts to kick in.”

The direction of interest rates should be clearer in the second half of the year, leading to an acceleration of deal-making, particularly in a market where property prices are rising. While REITs have been selective in adding assets to their portfolios, they face a tougher market in terms of prices, which rose to nearly 28 percent above their pre-recession high last November, according CoStar’s value-weighted U.S. Composite Index. This makes it harder to buy class-A assets with a high enough capitalization rate to justify the purchase. The higher prices mean REITs could be more pressed to look at transactions in order to grow, says Larry Gellerstedt, president and chief executive officer of Cousins Properties Inc. (NYSE: CUZ).

“Looking forward, REITs, in general will continue to look at corporate transactions because we are late in the cycle relative to development and pricing of assets in the private market today is pretty frothy for REITs,” Gellerstedt says. “We have seen REITs do a whole lot of buying, so when you are in that position and looking to improve your company, you obviously look at transactions.”

Transactions of REITs being taken out by other REITs or private companies seem likely to continue once market clarity returns.

“There is a lot of interested capital out there to look at opportunities that perhaps don’t belong in the public markets or don’t have the skill to be in the public markets,” Seth says. “The also-rans, the weaker sisters, are definitely getting a lot more interest than at any point prior in this particular cycle.”

Wolitzer adds that getting a deal done requires meeting three conditions: It has to make strategic sense, the numbers have to work and the social issues of meshing two management teams must make sense. “Sometimes two of the three of those things can make sense, but what makes it so episodic is that it has to be all three.”

REITs below $1 billion in market capitalization also will be motivated to somehow work towards that level, which is viewed as a key threshold to attract institutional investors and obtain better financing terms.

“Bigger is definitely better as a theme,” Seth says. “You will see a lot more of that variety than mergers of equals. The reality is you need to have the size, attendant liquidity and investor following to be able to capitalize on industry trends and raise the money you need to continue to grow.”

Spinoffs Du Jour

Outside of normal M&A activity, spinoffs have been a common tool by REITs and likely will continue, given investor appetite for pure-play companies. Hilton Worldwide Holdings (NYSE: HLT) did so recently with the bulk of its hotel real estate holdings, creating Park Hotels & Resorts (NYSE: PK). Ventas spun off the bulk of its skilled nursing facilities in 2015, creating the REIT Care Capital Properties Inc. (NYSE: CCP). Vornado Realty Trust (NYSE: VNO) in 2015 offloaded the bulk of its retail holdings into Urban Edge Properties (NYSE: UE). Last October, Vornado also announced that it would spin off its Washington, D.C., portfolio into a combined company with JBG Cos. The new publicly traded REIT, to be called JBG Smith Properties, is expected to begin trading by the end of the second quarter.

Similarly, Cousins Properties spun off Parkway Inc. (NYSE: PKY) after buying Parkway Properties Inc. in October in a stock transaction worth about $3.5 billion. The overlap of the two companies’ Houston office portfolios spurred the structure of the deal, Gellerstedt notes. The fallout from a 60 percent drop in oil prices during 2014 and 2015 put a damper on both companies’ stock prices. By merging the two companies and spinning off the Houston assets, the resulting company could realize its value and separate out the more-volatile Houston portfolio.

Two weeks before the deal was signed in April 2016, Cousins traded at 18 percent below NAV, according to Green Street 

Advisors. In January, the merged Cousins traded at a 2.4 percent discount to NAV. 

The combination of Cousins and the original Parkway highlights how it still makes sense for REITs to combine if the price is right. The portfolios of both companies also overlapped in high-quality submarkets, such as Atlanta, Charlotte, and Austin, Texas.

“One thing in the office space that does help you from a results standpoint is if you have concentrations in high-barrier submarkets,” Gellerstedt says. “That brings you the ability to bring multiple options to a customer and also get operating leverage in that market.” 

On Their Terms

Of course, the larger REITs can call their own shots.

One route is to stay the course and eschew big deals, instead buying and selling assets. Duke Realty Corp. (NYSE: DRE) has taken that approach with its industrial and medical office building portfolios.

“Most companies have enough critical mass to not do anything,” says Jim Connor, Duke Realty’s CEO. “The real estate is pretty good. The markets are pretty good, particularly for our two product types. So if I don’t do anything and just run my company well, I should be able to report really good growth, grow the dividend and keep my investors happy. When you balance that against going out, doing a deal and paying a huge premium, it’s really hard to believe you can justify that.”

Regardless, REITs will continue be selective when it comes to acquisitions. Ventas’ Cafaro sums up the industry’s prudence: “We are bidding on assets where we have unique opportunity or the assets have some significant upside or unique characteristics we think will create value.” 

Never Say Never for IPOs

While REIT M&A activity was steady, IPOs slowed to a trickle in 2016. Three deals worth a total of $1.5 billion were announced during the year, far from the recent peak of 19 IPOs in 2013, representing $5.7 billion.

In early 2017, the single-family rental REIT Invitation Homes Inc. (NYSE: INVH) raised nearly $2 billion via its IPO. It is unclear, though, if that signals the start of any significant acceleration in REITs going public.

“You need a discernible, upwardly mobile trend for investors to bank on,” Seth says. “Anytime you have seen a big wave of IPOs, it’s occurred after some move of stock prices has clearly been established, rather than trading in a range.”

Private players looking to go public will also want to see more stability with interest rates and more clarity on what will happen with tax reform in Congress.

“In a world where you have a 15 percent corporate rate and you end up in an environment with no depreciation deduction and no interest expense, that’s a very different world for investors,” Seth says.

(Why?)

Published at Wed, 22 Mar 2017 15:03:18 +0000