Hotel REIT Looking to Turn Things Around
In periods of rising interest rates, real estate investment trust (REIT) instruments are impacted by the higher carrying costs that affect margins. But interest rates are finally heading lower, which will benefit REITs.
Take the case of Service Properties Trust (NASDAQ:SVC), a small-cap REIT with interests in two major asset classes: hotels and service-focused retail net lease properties.
At the end of June 30, 2024, Service Properties owned 220 hotels with 37,697 hotel rooms in the U.S., Puerto Rico, and Canada. The company also owned 749 retail service-focused net lease properties comprising over 13 million square feet. The net lease occupancy rate was an impressive 97.3% at the end of June. (Source: “About Us,” Service Properties Trust, last accessed October 15, 2024.)
But Service Properties stock has been under pressure, with the share price down 45.2% in 2024, which in turn has driven the forward yield to 17.32% as of October 15.
The REIT’s dividends were negatively impacted by the pandemic and subsequent closures in the hotel and retail segments, which were significant. Service Properties Trust made the decision to cut its quarterly dividend from $0.54 per share in the first quarter of 2020 to $0.01 per share in the second quarter of 2020.
But with the situation on the mend, Service Properties raised its quarterly dividend to the current $0.20 per share in the third quarter of 2022. SVC stock currently has a forward yield of 17.32% given the price deterioration.
Service Properties stock is well below its 52-week high of $8.72 and just above its range low of $4.26 on August 12. The stock traded at a five-year high of $26.28 in October 2019. The current price weakness presents a compelling opportunity for contrarian income investors. But be aware that the beta of 2.19 suggests that Service Properties stock suffers excess volatility.
Chart courtesy of StockCharts.com
Some Bright Spots in the Second Quarter
On an annual basis, Service Properties Trust delivered revenue growth in three straight years and nine of the last 10 years back to 2014. The pandemic year of 2020 was the only down year for revenues, but the next few years could see some slowing depending on the economy.
| Fiscal Year | Revenues (Billions) | Growth |
| 2019 | $2.32 | 0.9% |
| 2020 | $1.27 | -45.4% |
| 2021 | $1.50 | 18.2% |
| 2022 | $1.86 | 24.6% |
| 2023 | $1.87 | 0.6% |
(Source: “Service Properties Trust,” MarketWatch, last accessed October 15, 2024.)
Analysts estimate that Service Properties will report flat revenues of $1.88 billion in 2024 and $1.89 billion in 2025. (Source: “Service Properties Trust (SVC),” Yahoo! Finance, last accessed October 15, 2024.)
The second quarter saw revenues edge up to $512.9 million, compared to $503.8 million in the same quarter in 2023. The company’s revenues in the six months to June 30 hit $949.2 million, versus $933.0 million in the first half of 2023. (Source: “Service Properties Trust Second Quarter 2024 Financial Results and Supplemental Information,” Service Properties Trust, August 6, 2024.)
Moving to the bottom line, the REIT has yet to return to the generally accepted accounting principles (GAAP) profitability that was the norm prior to the pandemic. However, the significant narrowing of the loss in 2022 and 2023 was an encouraging sign.
| Fiscal Year | GAAP-Diluted EPS | Growth |
| 2019 | $1.58 | 39.8% |
| 2020 | -$1.90 | -219.8% |
| 2021 | -$3.31 | -74.7% |
| 2022 | -$0.80 | 75.7% |
| 2023 | $-0.20 | 75.3% |
(Source: MarketWatch, op. cit.)
Analysts expect Service Properties to continue to lose money. The loss is expected to rise to -$1.13 per diluted share in 2024 prior to dropping to -$0.92 per diluted share in 2025. (Source: Yahoo! Finance, op. cit.)
With REITs, one considers the normalized funds from operations (FFO) rather than the GAAP presentation. On this basis, Service Properties Trust reported normalized FFO of $73.8 million, or $0.45 per share, versus $0.13 per share in the first quarter and $0.30 per share in the fourth quarter of 2023. (Source: Service Properties Trust, op. cit.)
A major risk for Service Properties is the $5.55 billion in total debt on the balance sheet at the end of June. However, it is typical of REITs to carry high debt balances. (Source: Yahoo! Finance, op. cit.)
A look at the Piotroski score, an indicator of a company’s balance sheet, profitability, and operational efficiency, shows a weak reading of 3.0, which is below the midpoint of the 1.0 to 9.0 range. The interest coverage ratio of 0.6 times in 2023 also demands attention.
Service Properties Stock: Strong FFO Suggests Safe Dividends
Service Properties’ annual dividend of $0.80 per share represents a forward high yield of 17.32%. With a normalized FFO of $0.45 per share in the second quarter, the payout ratio is reasonable at 0.44% based on the quarterly dividend of $0.20 per share.
Free cash flow (FCF) has been positive in five straight years, including a four-year best of $284.7 million in 2023. As long as FCF remain positive, I expect the dividend payment to remain intact and extend past the current 30-year payment streak. (Source: MarketWatch, op. cit.)
| Metric | Value |
| Dividend Streak | 30 years |
| Dividend 7-Year CAGR | -12.5% |
| 10-Year Average Dividend Yield | 7.6% |
| Dividend Coverage Ratio | 1.5X |
The Lowdown on Service Properties Stock
SVC stock has strong institutional support, with 336 institutions holding 79.3% of the outstanding shares. Around 34% of the REIT’s shares are held by BlackRock, Inc. (18.6% stake) and Vanguard Group Inc (15.95%). (Source: Yahoo! Finance, op. cit.)
In my view, Service Properties stock is worth a look for the contrarian income investor who wants a high dividend yield and the potential for price appreciation.