High Interest Rates: Impact on the Lodging REIT Sector

Impact on Financing Costs

High interest rates are increasing financing costs for lodging REITs, prompting strategies to manage debt structures, reduce weighted average cost of debt, and enhance balance sheet flexibility. Companies are also facing challenges in raising cost-effective capital due to macroeconomic pressures.

"We will continue making prudent capital allocation decisions to position our portfolio to drive results during the entire lodging cycle, while monitoring the financing markets to identify additional opportunities to improve the laddering of our maturities, reduce our weighted average cost of debt, and increase our overall balance sheet flexibility." --- (RLJ, earning call, 2024/Q1)

"In addition, the proportion of fixed-rate debt will decrease in 2024, as the Company had one interest rate swap in effect on $50.0 million of variable-rate debt mature in the first quarter of 2024 and has five interest rate swaps in effect on $235.0 million of variable-rate debt that mature during the remainder of 2024, resulting in a decrease in the amount of variable-rate debt that is fixed by interest rate swaps." --- (APLE, sec filing, 2024/Q1)

"We believe this strategy has resulted in a better cost of debt capital, allowing us to complete opportunistic investments and acquisitions and positioning us to manage potential declines in operations throughout the lodging cycle." --- (HST, sec filing, 2024/Q1)

"The net cash flow used in financing activities totaled $40.2 million for the three months ended March 31, 2023 primarily due to $94.0 million in repayment of Term Loans, $24.5 million paid to repurchase common shares under a share repurchase program, $14.4 million in distributions to shareholders and unitholders, $1.9 million paid to repurchase common shares to satisfy employee tax withholding requirements, and $0.3 million in deferred financing cost payments." --- (RLJ, sec filing, 2024/Q1)

"Macroeconomic pressures, including inflation, increases in interest rates and general market uncertainty, could impact the Company’s ability to raise debt or equity capital to fund long-term liquidity requirements in a cost-effective manner." --- (APLE, sec filing, 2024/Q1)

Refinancing Risks

Lodging REITs face significant refinancing risks in a high-interest-rate environment, as evidenced by Xenia Hotels & Resorts expensing $1.4 million in loan costs for refinancing and Apple Hospitality REIT planning to manage debt maturities through operations, credit facilities, and new financing.

"Additionally, during the first quarter of 2023, $1.4 million of loan costs were expensed in connection with the refinancing of the prior corporate credit facility." --- (XHR, sec filing, 2024/Q1)

"The Company plans to pay outstanding amounts and service payments due upon the upcoming debt maturity dates using funds from operations, borrowings under its Revolving Credit Facility and/or proceeds from new financing or refinancing the maturing debt." --- (APLE, sec filing, 2024/Q1)

Effect on Property Valuations

High interest rates have led to prohibitive debt costs, affecting property valuations negatively. Companies like Host Hotels & Resorts and Apple Hospitality REIT note reduced competition and market dynamics, while Xenia Hotels & Resorts highlights broader macroeconomic impacts on acquisitions and dispositions, all contributing to valuation challenges.

"Jim Risoleo: Chris, thanks for the question. Yes, we have explored disposition pricing recently and made a decision that really, given that we are under no pressure whatsoever to dispose off assets, and we will only do so if we believe that the pricing is fair relative to our hold value, the market dynamic just isn’t there today. The cost of debt is still prohibitive from a valuation perspective." --- (HST, earning call, 2024/Q2)

"I think, over and I talked about this a little bit on our last call, but over the past several months with the meaningful increase in interest rates and the pullback from many lenders, we found ourselves in a position to be very competitive around larger assets in some of these urban markets where ordinarily we would have seen very stiff competition, predominantly from private equity, but from a variety of potential buyers." --- (APLE, earning call, 2024/Q1)

"Statements in this Form 10-Q include, among others, statements about our plans, strategies and the impact of macroeconomic factors, including inflation, rising interest rates, a potential domestic and/or global recession, global conflicts, the evolving workforce and wage landscape, capital expenditures, the ability to consummate acquisitions and dispositions of hotel properties, liquidity and derivations thereof, financial performance and potential dividends, prospects or future events." --- (XHR, sec filing, 2024/Q1)

Occupancy Rates and Revenue Growth

Increased occupancy rates have driven revenue growth across the Lodging REIT sector, with notable contributions from specific markets and segments. Xenia Hotels & Resorts and RLJ Lodging Trust reported significant revenue increases due to higher occupancy and average daily rates, while Host Hotels & Resorts saw growth driven by key markets.

"Other revenues Other revenues increased $2.4 million, or 12.4%, to $21.6 million for the three months ended March 31, 2024 from $19.2 million for the three months ended March 31, 2023 primarily as a result of increased occupancy which was partially offset by renovation disruption." --- (XHR, sec filing, 2024/Q1)

"Revenue grew 8% in the second quarter, driven by 5% rate growth. Approximately half of the growth came from San Diego, Phoenix and Nashville with the balance coming from our other top markets. For full year 2024, we have approximately 4 million definite" --- (HST, earning call, 2024/Q2)

"From a segmentation perspective, our business transient revenues outpaced our other segments during the quarter, with BT achieving revenue growth of 13%, driven by a balanced contribution between occupancy and ADR." --- (RLJ, earning call, 2024/Q1)

"Bar remained strong at 33%, other discounts represented 28% of our occupancy mix, Group was 15% and the negotiated segment represented 18% of our mix in-line with the same period in 2023, which implies growth if adjusted for the Easter holiday shift, but it’s still nearly 200 basis points lower than 2019, which we believe represents opportunities for continued upside." --- (APLE, earning call, 2024/Q1)

"Notably, occupancy grew each month during the quarter. We are optimistic about the recovery in corporate and Group rates as we continue to achieve higher midweek occupancies across the portfolio, particularly on Tuesday and Wednesday nights, where these higher" --- (XHR, earning call, 2024/Q1)

Operational Adjustments and Cost Management

Lodging REITs are actively managing costs and making operational adjustments to navigate high interest rates. Host Hotels & Resorts and RLJ Lodging Trust adjust performance metrics like EBITDA and FFO for various expenses, while Apple Hospitality REIT employs a cash management process to advance or defer funds, optimizing financial flexibility.

"Management historically has made the adjustments detailed below in evaluating our performance, in our annual budget process and for our compensation programs." --- (HST, press release, 2024/05/01)

"We also present Adjusted EBITDA, which includes additional adjustments for items such as transaction costs, pre-opening costs, gains or losses on extinguishment of indebtedness, amortization of share-based compensation, derivative gains or losses in accumulated other comprehensive income reclassified to earnings, and certain other income or expenses that we consider" --- (RLJ, sec filing, 2024/Q1)

"Under the cash management process, each company may advance or defer up to $1 million at any time." --- (APLE, sec filing, 2024/Q1)

"Adjusted FFO per diluted share increased $0.05 to $0.60 for the first quarter, reflecting the increase in Adjusted EBITDA re, partially offset by an increase in interest expense (excluding debt extinguishment costs) which is included in Adjusted FFO per diluted share but not Adjusted EBITDA re . Outlook" --- (HST, sec filing, 2024/Q1)

"Adjustments to FFO and EBITDA The Company adjusts FFO, EBITDA, and EBITDAre for certain items that the Company considers outside the normal course of operations." --- (RLJ, press release, 2024/05/01)

Strategic Responses to High Interest Rates

Lodging REITs like Apple Hospitality REIT and Xenia Hotels & Resorts are strategically responding to high interest rates by leveraging competitive advantages in property acquisitions and adjusting return requirements to focus on un-levered double-digit returns.

"Chris Darling: Hey, thanks. Good morning. Justin, going back to the last question actually, you mentioned just higher interest rates in the past couple of months and that putting Apple really in a competitive position to have a competitive advantage in terms of acquiring properties." --- (APLE, earning call, 2024/Q1)

"Clearly, interest rates are higher than where they were previously, as everyone knows, so that's probably moved up the requirements a little bit on what kind of returns we're looking for, but we're certainly looking for that un-levered double-digit type returns." --- (XHR, earning call, 2024/Q1)

Investor Sentiment and Market Competition

Lodging REITs like APLE and HST are strategically positioned in markets with limited competition, securing high-quality assets and identifying compelling investments. Investor sentiment remains positive, with XHR noting potential for inbound business and RLJ emphasizing key financial metrics. Market growth and operational efficiency further bolster competitive positioning and investor confidence.

"Our discipline over the past several years positioned us to be active in a market with limited competition, where we were able to secure high-quality assets at pricing that met our internal underwriting criteria." --- (APLE, earning call, 2024/Q1)

"So, I think even despite kind of the move on the currency side, there's still sentiment that there's a lot more potential for inbound business." --- (XHR, earning call, 2024/Q1)

"The Company believes it is meaningful for the investor to understand FFO attributable to all common shares and OP units. EBITDA and EBITDAre" --- (RLJ, press release, 2024/05/01)

"Together with our dedicated team and partners, we continue to identify compelling strategic investments that deliver strong financial, environmental and social returns." --- (HST, press release, 2024/07/30)

"So, I think despite the hotel having been open for a period of time and ramping within the market, we see incremental opportunities both as the market continues to grow, bolstered by a strong convention calendar and increasingly a return of government workers to the city and improvement in our share and the efficiency of our property-level operations with the management transition. Austin Wurschmidt: Great. Thanks for the time. Justin Knight: Absolutely." --- (APLE, earning call, 2024/Q1)