Hotel REITs or Hotel Rooms: The Correct Place to Make a Bad Decision
Occasionally, it’s a great idea to pay top dollar for a hotel room… But it’s almost never a great idea to pay top dollar for a hotel REIT.
“Real estate investment trusts are still priced at bubble valuations,” insists Dan Amoss, the analytical mind behind the Strategic Short Report. “These valuations bear little connection to economic reality.
“2009 was the year that the REIT sector bought itself some time by selling lots of bonds and stock to the public as the financial markets recovered,” Amoss explains. “Investment bankers worked overtime to promote these deals to their institutional clients. Robert W. Baird’s real estate research team estimates that REITs raised $17 billion in equity from secondary market offerings in 2009. But that wasn’t enough capital for the most highly levered REITs, which remain at risk of bankruptcy in a double-dip economy.
“These levered REITs still need much more capital to repair their balance sheets,” says Amoss. “Baird estimates that another $26 billion in new equity needs to be raised over the next few years. But it’s doubtful that REITs will be able to raise that kind of money anywhere near current prices…or at any prices. So 2010 may be the year that REIT promoters run out of greater fools to buy secondary stock offerings at bubble valuations.”
REIT valuations are stretched, Amoss argues, even though fundamental trends in commercial real estate are grim. “Deflationary forces in commercial real estate will continue to weigh on REIT valuations in 2010,” Amoss predicts. “In cases where lenders can no longer ‘extend and pretend,’ we’ll see properties repossessed and sold at fire-sale prices to vulture buyers. Supply will far exceed demand in most geographies and property types, so rents and REIT profits will remain under pressure.”
Net-net, if you are going to be any kind of fool at all, Amoss advises, be the kind of fool who buys a crazy-expensive hotel room for a night, rather than the kind of fool who buys a crazy-expensive hotel REIT.
Admittedly, no automatic correlation exists between the price of a hotel room and the delights that hotel room nourishes. For example, the one-star Jolly Roger Motel in Santa Monica, California could easily produce a 5-star memory. (In fact, it did). On the other hand, the upscale Casa Del Mar Hotel that sits right on the sands of Santa Monica beach could easily produce a 5-star nightmare. (In fact, it did).
Let’s not blame the Casa Del Mar; but your editor would have preferred a night in a cardboard box anywhere outside the hotel to the “getaway” he experienced inside the hotel. An oceanfront balcony and 800-thread-count Egyptian cotton sheets are simply no match for an enraged lover with a wine glass full of pricey cabernet.
And so what? Even in the worst of outcomes, the overpaying hotel guest would have dropped $600 for a miserable night and a great breakfast buffet. There are worse things in life.
The pricey hotel room, like a call option, never costs more than the initial “premium.” But like a call option, the hotel room merely offers the promise of potential reward…not a guarantee. So if things go wrong, blame your companion…not the Egyptian cotton sheets.