The global coronavirus pandemic threw the world's economy into a tailspin, upending businesses across the spectrum. Two sectors that saw a dramatic negative impact were retail and hospitality. Now that the world is starting to get back to growth, which of these recovering property types is worth putting money into for real estate investment trust (REIT) investors? It's complicated, but here are some things to consider as you look for deals.
A little backstory
The hospitality real estate investment trust (REIT) space is largely about hotels, with some variety underneath that big-picture grouping. For example, some hotels focus on business travel, while others handle more vacationers. There's also names focused on resorts and convention spaces. The key, however, is providing a bed for people staying away from their homes.
At its core, the retail REIT space provides space for stores. However, there is a huge amount of variety here, from grocery stores to nail salons to clothing retailers to car dealers to restaurants. And that just touches the surface. Retail REITs generally focus on one major property type, such as malls, shopping centers, or freestanding single-tenant buildings. Between retail and hospitality, retail probably has the more varied footprint.
The problem in 2020 was people were asked to avoid each other in an attempt to slow the spread of the coronavirus. People stopped traveling and only went to stores when they absolutely had to. With effective vaccinations, people have started to get back to their normal lives again. However, there are changes that will likely linger.
For example, online shopping has grown in popularity, and conducting business via video conferencing has proven both cheap and effective. Both sectors are, thus, still dealing with material change. But retail looks more attractive today. Here's why.
1. A more resilient model
The effective lease length of a hotel is one single night, since travelers can change their plans with little to no cost. That means that economic downturns tend to hit results very quickly. To put a number on that, Host Hotels & Resorts (NYSE: HST) saw its revenues decline a massive 93% in the second quarter of 2020.
Compare that to National Retail Properties (NYSE: NNN), where revenues dropped less than 1% in the same quarter. One of the key factors in that difference is that the average lease length is much longer in the retail sector. In National Retail Properties' case, its average lease is over 10 years. That gives retail REITs more staying power in the face of adversity.
2. Dividend sustainability
Plenty of retail REITs cut their dividends in 2020, but there were many that managed through the period while still increasing their payouts. Net lease landlord National Retail Properties was one, but it was hardly alone, with other leading names like shopping center owner Federal Realty also achieving the feat.
And many of the retail landlords that ended up cutting have since gotten back on the growth track, including mall giant Simon Property Group. A lot of hotel REITs were facing such a severe drop in demand that they simply eliminated their dividends. The last dividend from Host Hotels & Resorts, for example, was paid in April of 2020. That's not at all unusual. To be fair, given the backdrop, the REITs made the right call here, but dividend investors certainly weren't pleased to see the dividend suspensions.
3. A cleaner road back
If having a better business model and more resilient dividends aren't enough to push you to the retail space, then you should also consider the path to a recovery. In the case of retail, while some niches will be better-positioned than others, our social natures are highly likely to get us back out and about again. And since shopping is both a necessity (think groceries) and a pastime (visiting the mall with friends and family), it doesn't require much to see how things get back to normal.
When it comes to hotels, on the other hand, it effectively means travel has to pick up materially. That's likely to happen over time, of course, but there are areas where things may never return to normal, like business travel. And even vacations are a stressful affair, given the different variants of the coronavirus that keep popping up. It's much easier to justify going to the mall for a family outing than getting on a plane for a few hours and then staying at a hotel for a week, even if you really want to "get away." This is clearly subjective, but hospitality's recovery path just doesn't seem as simple.
Go big or go home
All in, the retail REIT sector just stacks up better than the hospitality sector today because of its long-term fundamentals and its recovery prospects. That said, not all REITs are created equal, so investors looking at the retail space should probably stick with the biggest and best names, which includes bellwethers like net lease landlord National Retail Properties, shopping center owner Federal Realty, and mall giant Simon Property Group. All of these retail REITs continue to deal with the impact of the pandemic, but they are in a much better position than most hotel owners are today.