Why LaSalle Hotel Properties (LHO) is a solid long-term investment for income investors
Ever since the Federal Reserve lowered the fed funds rate to nearly zero in December 2008, income investors have struggled to obtain meaningful yields in savings or fixed income products without taking undue risks. E.g. relatively high yields have attracted more than $100 billion in investors’ capital into the U.S. MLP industry in recent years, with much of it coming from unsophisticated investors who did not understand the potential downside risks (U.S. MLPs are down about 25% this year).
Furthermore, the Federal Reserve’s reluctance to rise rates, along with ongoing monetary policy easing from the European Central Bank, has continued to pressure interest rates lower. As I write, the U.S. ten-year yield sits at around 2.0%, the German 10-year at 0.5%, and the Swiss 10-year at -0.3%. As I discussed in an earlier article on Tanger Outlets, however there are still pockets of value in real estate investment trusts (REITs). In particular, I like LaSalle Hotel Properties (LHO) due to: 1) its high and sustainable dividend yield, 2) its ability to increase cash flows when inflation is rising, as three-quarters of its revenues are tied to daily market rates, and 3) the promise of long-term demand growth in “gateway cities” where it operates, such as New York, Los Angeles, Seattle, and Washington D.C.
LHO has a market value of $3.3 billion and a dividend yield of 6.2%. Over the last 12 months, LHO is down by 20%. Here are three reasons why I like the stock.
1. Highly favorable industry structure for established incumbents
The hotel REIT industry has high barriers to entry. Notwithstanding the rise of Airbnb (which I will cover below), incumbents are protected from new competition because: a) incumbents typically own hotels in unique, highly desirable locations, b) only incumbents have the experience and resources to build and operate new hotels effectively (e.g. the luxurious Taj Hotels chain has struggled to gain a foothold in the U.S.), and c) hotels are only in the business of filling rooms and are not subject to fashion or technological risks.
LaSalle Hotel Properties owns 47 hotels in highly desirable locations within the U.S. urban, resort and convention markets. The firm focuses on owning luxury and upscale hotels in the central business districts (CBDs) within those top markets, with the vast majority of its earnings coming from 8 target urban markets: Seattle, San Francisco, Los Angeles, San Diego, Chicago, Washington D.C., New York City, and Boston. New competitors cannot replicate LaSalle’s hotel portfolio as these 8 urban markets impose high regulatory hurdles while lacking new and desirable locations for new hotel construction. This ensure LaSalle’s long-term pricing power and steady earnings growth.
2. Long-term favorable supply and demand dynamics within the firm’s 8 target urban markets
The weakness in LHO’s stock price over the last 12 months is due to: a) greater-than-expected hotel room supply growth from three of LHO’s core markets, i.e. New York, Washington D.C., and San Francisco, b) concerns about the adverse impact of Airbnb on hotel occupancy and room rates, and c) weakness in international travelers’ spending stemming from a strong U.S. dollar.
While these trends are worrisome, I believe they are transient in nature. Core, gateway cities such as New York have historically experienced higher-than-average room rate and demand growth than other urban areas, and even more than suburban areas. Moreover—while Uber and other companies associated with the “sharing economy” have hurt other regulated services industries such as the taxi industry—it is a stretch to assume this will extend into the lodging industry. The main reason: Most travelers expect a consistent lodging experience with certain levels of luxury; Uber provides a relatively consistent experience because the ride-sharing experience is quite short and has less variables. By contrast, travelers spend one day or more at a hotel and expect a wide range of amenities; because of this, it is difficult for Airbnb to provide a consistent, pleasant experience that will lure a significant number of travelers to its system (the hotel industry also has more resources to push for more regulations targeting the Airbnb model).
Finally, I expect international travel to the U.S. to not just recover, but to grow on a structural basis as it benefits from the long-term growth in Asian consumer and travel spending. In particular, LaSalle’s 16 hotels in San Francisco, Los Angeles, and New York will benefit from the ongoing influx of wealthy Chinese visitors, the latter of which is up 20% year-over-year.
3. A conservative management team with a strong track record
Over the last 15 years, LaSalle’s stock (7.6% annual return) has outperformed both the average stock in the hotel & motel REIT industry (6.7% annual return), as well as the S&P 500 (4.8% annual return). LaSalle’s hotel portfolio also has the highest earnings before interest, taxes, depreciation, and amortization (EBITDA) margins out of 7 other U.S. hotel REITs in the industry (33% vs. an industry average of 29%), while maintaining the second-lowest leverage ratio. This is a testament to the efficiency and prudency of the firm’s management.
LaSalle’s unique hotel portfolio, strong management team, and favorable industry dynamics should propel the firm’s earnings growth for years to come. I expect LHO to return 10%-15% annually over the next 2-3 years.
Disclosure: Neither I nor does my firm, CB Capital Partners hold any shares in LHO.
Henry To, CFA, CAIA, FRM is Partner & Chief Investment Officer at CB Capital Partners. Established in 2001, CB Capital Partners is a global financial advisory and investment firm headquartered in Newport Beach, California, with an office in Shanghai, China and an affiliate office in Mumbai, India. Visit http://www.cbcapital.com and http://www.cbcapitalresearch.com for more information.
