The COVID-19 outbreak had a significant impact on the hospitality sector. Many hotels closed their doors in the spring of 2020 due to the pandemic's impact on business and leisure travel as many governments imposed restrictions to slow the spread of the virus. While most properties reopened along with the economy as travel rebounded, occupancy levels remained at or below breakeven levels for many hotels throughout the year. That put significant pressure on sector profitability. On a more positive note, a string of good data on vaccines towards the end of 2020 suggests that 2021 could be much better for hotels.
This backdrop is vital to understanding what's ahead for real estate investment trusts (REITs) that own hotels like DiamondRock Hospitality (NYSE: DRH). Here's a closer look at the company and how the pandemic might affect its long-term outlook.
DiamondRock Hospitality Company profile
DiamondRock Hospitality is a hospitality REIT. As of late 2020, the company owned 31 premium hotels and resorts containing more than 10,000 rooms. About two-thirds of its properties are in gateway cities like New York, Boston, Chicago, and San Francisco. The other third are in vacation destinations like Key West, St. Thomas, and Fort Lauderdale.
The company partners with high-quality brands Marriott (NASDAQ: MAR), Hilton (NYSE: HLT), and Intercontinental Hotel Group (NYSE: IHG) and independent operators to manage its hotels. Roughly 55% of its 2019 EBITDA came from Marriott-branded hotels, 11% from Hilton, and the other 34% from lifestyle brands, which includes a mix of independent hotel operators and collection properties from Marriott and others.
Hospitality REITs like DiamondRock don't make money that same way as most other REITs. Instead of generating relatively stable rental income backed by long-term leases with tenants, most hotel REITs generate revenue via short-term room rentals, food and beverage sales, and other sources like spas, parking, and resort fees. In 2019, 70% of DiamondRock's revenue came from rooms, 23% from food and beverage, and 7% from other sources.
One of the company's strategies is to upgrade its hotels so that it can charge higher room rates. Recent and future projects include renovating and rebranding several hotels, a celebrity chef restaurant program to improve its restaurant offerings, and adding more guest rooms and event space. The company expects these projects to generate a high return on investment and produce incremental EBITDA.
DiamondRock Hospitality Company news
Like many hospitality REITs, DiamondRock endured a difficult 2020 due to the impact the COVID-19 outbreak had on the sector. The company initially suspended operations at 20 of its 30 operating hotels (one had previously closed due to hurricane-related damage). It reopened 12 during the second quarter and another five in the third quarter as governments lifted travel restrictions and demand started rebounding. The company expected that the three remaining properties -- all located in New York City -- would remain closed for the balance of 2020.
The pandemic had a significant impact on DiamondRock's financial results in 2020. Occupancy through the third quarter only averaged 28.7% compared to 79.7% in the same period of 2019. Meanwhile, total RevPAR plunged 65.8% to $91.41 in 2020. As a result, the REIT's AFFO per share was a negative $0.38 through the third quarter of 2020, compared to a positive $0.80 per share in the prior-year period.
With the company's hotels losing money, DiamondRock's focus in 2020 was on preserving its liquidity. In addition to closing some hotels, restaurants, and outlets, the company suspended its dividend, laid off staff, and canceled most of its capital projects. The company also completed a preferred stock offering to boost its liquidity and take some pressure off its balance sheet. Those moves helped reduce its cash burn rate and extend its liquidity. It anticipated ending 2020 with enough funding to last 22 to 23 months at its expected cash burn rate exiting the year. Though, further improvements in occupancy and RevPAR in 2021 should enable it to start generating positive free cash flow again.
Another notable accomplishment in 2020 was a new agreement with Marriott that modified several franchise and management contracts. The agreement converted five hotels from brand-managed to franchise with new terminable-at-will contracts with third-party hotel operators. The deal will also up-brand one hotel while giving it the option to up-brand another. Overall, the agreement significantly reduced its portfolio's long-term brand management contracts, giving it more flexibility.
Those moves position the REIT to emerge from the pandemic in a stronger position than it entered. The company believes that its enhanced liquidity will enable it to capitalize on potential distress opportunities that will likely emerge. Roughly $24 billion of loans backing hotels mature through 2023, which could enable the REIT to acquire hotels from financially stressed owners.
DiamondRock Hospitality Company stock price
DiamondRock has struggled to create shareholder value in recent years: