Real estate investment trusts, or REITs, have been one of the worst-performing parts of the stock market in the COVID-19 pandemic, and not surprisingly, hotel REITs have been the worst-performing subsector with the Dow Jones U.S. Hotel & Lodging REITs Index down by 51% this year. Think about that for a second -- this means that as a group, hotel REITs are worth less than half of what they were on New Year's Day.
However, it's important for patient, long-term investors to remember that although this is a terrible and challenging situation, the pandemic is a temporary problem. At some point, the world will largely get back to life as it was. So, there could be tremendous value in hotel REITs for those who are willing to wait.
One particularly interesting stock is Apple Hospitality REIT (NYSE: APLE), which focuses on "select service" hotels. Here's why you might want to consider this hotel REIT for your portfolio and whether it might be the best hotel REIT to buy right now.
Apple Hospitality REIT -- the short version
If you aren't familiar, Apple Hospitality REIT owns a portfolio of 235 hotels in 34 states, most of which are so-called "select service" hotels. Just to give you an idea of what we're talking about, Courtyard by Marriott, Homewood Suites by Hilton, and Hilton Garden Inn are some of the brands most represented in the company's portfolio.
In short, a select service hotel is a somewhat upscale midsize property. They are generally rooms-focused, meaning that the bulk of hotel revenue comes from the rooms themselves, as opposed to dining venues, retail stores, spas, or other amenities you often find in larger-scale and luxury hotels.
The idea is that these types of hotels have a broad appeal to both leisure and business travel alike. Many of the properties are extended-stay or suite-focused, which makes them ideal choices for traveling families who want a quality product and good value. They are also generally located in business travel areas and provide an economical choice for companies.
The COVID-19 pandemic and Apple Hospitality REIT
Apple Hospitality REIT's business was hit hard by the COVID-19 pandemic, just like the rest of the industry. As the coronavirus outbreak developed, hotel occupancy rates fell to a fraction of normal levels and room rates plummeted. The company suspended its dividend and share repurchase plan, postponed all nonessential capital improvements, and reported an FFO loss in the second quarter.
Having said that, Apple Hospitality REIT is one of the lesser-affected hotel REITs and it's worth noting that the stock has significantly outperformed the hotel REIT index this year (a decline of 39% versus 51%). There are a couple of reasons for this.
First, the company's hotels are designed to broadly appeal to consumers, especially leisure travelers, which is an area of the hospitality industry that is rebounding relatively strongly. And more importantly, select service hotels are not very reliant on group events, unlike larger hotels. In fact, large groups made up just 14% of Apple Hospitality REIT's room nights in 2019. With hotel REITs focused on large-scale destination properties, this figure can be well over 50%.
In short, Apple Hospitality REIT's property occupancy has rebounded more strongly than most. Its estimated 45% July occupancy rate is far lower than normal but significantly higher than that of many rivals. As an example, group-focused hotel REIT Ryman Hospitality Properties (NYSE: RHP) reported just 18% occupancy for July.
Second, as a rooms-focused hotel operator, there are some effects of the pandemic that Apple Hospitality has largely avoided. For the most part, the company's hotels were unaffected by restaurant shutdown and reduced-capacity mandates, just to name one example. They also don't have revenue-generating convention space or luxury spas that are sitting idle.
Is it the best hotel REIT?
This is a tough question, as it depends on what you mean by "best." Some of the harder-hit hotel REITs (like Ryman) could have more upside potential than Apple Hospitality REIT as the economy normalizes, for example.
However, Apple Hospitality REIT is a nice combination of safety and growth potential that investors could find appealing. While it's still trading at a nice discount, the business has already rebounded to the point where it's likely to be profitable in the third quarter, and while the company may wait to reimplement the dividend, it's likely to become a solid income stock again sooner rather than later. In short, Apple Hospitality REIT could be a smart choice for investors who want exposure to the beaten-down hotel REIT subsector, but without the volatility and liquidity concerns that come with some of the more luxury- and group-focused companies.