Chatham Housing Fund: Low double-digit return opportunity

introduction

Chatham Lodging Trust (New York Stock Exchange: CLDT) is one of the weakest-performing REITs so far in 2024, with a negative 18% return well below the 5% decline in the Vanguard Real Estate Index Fund ETF (VNQ).):

I think the company is very cheap, offering a 10.3% cap ratio and strong operating performance, despite the risks associated with its revenue growth engines and expensive debt.

Company overview

You can access all of the company’s results here. Chatham Lodging Trust is a real estate investment trust focused on extended stay lodging as well as select service hotels with premium brands. In fact, extended-stay rooms account for about 63% of all 5,883 rooms at the REIT’s 39 hotels.

From a market perspective, the company operates in 17 states and D.C., with particularly large exposure To California – The state represents approximately 28% of Chatham Lodging’s EBITDA in the trailing 12 months:

From a brand perspective, Residence Inn accounted for 46% of EBITDA in the last 12 months:

Operations overview

On June 3, Chatham Lodging provided a dedicated business update on its operations in April and May of 2024. The REIT increased its revenue per available room, or RevPAR, by 5% year-over-year in both April and May. This is significantly higher than the 1.5% annual growth recorded in the first quarter of 2024.

The increase in RevPAR in April and May was mainly driven by higher occupancy, which is clearly not a sustainable driver of RevPAR since you can only increase occupancy so much (occupancy was 83% and 82% in April and May, respectively). On a more optimistic note, CEO Jeffrey Fisher noted:

As occupancy rates rise, the growth rate should accelerate, which is very encouraging as we enter the busiest time of the year.

With adjusted FFO numbers not being provided with the April/May business update, I will highlight the results achieved in Q1 2024, with the growth trend definitely picking up in Q2. In the first quarter, adjusted FFO was $0.16 per share, flat year over year, with revenue growth offset by higher interest and operating expenses. For reference, adjusted FFO was $1.18 per share in 2023.

2024 forecast

Chatham Lodging was initially targeting a 2.5-4% RevPAR increase in Q2 2024. With the latest update, it’s clear that the REIT will exceed the upper range of its guidance, which is very encouraging. Furthermore, with growth accelerating in the REIT’s busiest season, 2024 is set to be a year of strong RevPAR growth for Chatham Lodging. For reference, RevPAR grew 2.5% in 2023.

Capital structure

Chatham Lodging finished the first quarter of 2024 with net debt of $412 million, which rose to about $450 million in the second quarter after Hilton Phoenix Downtown acquired Home2 Suites for $43 million. Additionally, the Company has $120 million of preferred shares outstanding in Series Preferred Stock. This implies that net debt currently represents 45% of enterprise value, while preferred stock funds represent 12% of the capital structure (I conservatively chose preferred stock with a par value of $25 instead of the current market price of $21.15).

The company plans to address maturities in July 2024 with additional borrowing of $140 million on its revolving facility carrying an interest rate of approximately 7% (secured overnight financing rate, or SOFR, plus a 1.5-2.25% margin). The remaining maturities are fixed, but unfortunately interest rates are fixed at very high rates, just above 7%, which will clearly create headwinds for the company starting in July 2024. For reference, interest rates on expiring debt are around 4.6%.

Implied market cap rate

I estimate that Chatham Lodging should generate approximately $104 million of net operating income on a run-rate basis, driven by 2% year-over-year investment income growth compared to 2023 levels and a contribution from the recently acquired Phoenix Hotel. For an enterprise value of $1 billion, this represents an implied market cap rate of 10.3%, which is very attractive.

The company’s capital investment budget for 2024 is $37 million, which means an after-capex cap rate of 6.7%, which is also very attractive. Finally, I estimate general and administrative expenses to be about $12 million in 2024, or a 1.2% administrative burden on enterprise value, which is a bit high, but generally what you’d expect from a small REIT like Chatham Lodging.

Class A preferred stock.

The Series A preferred stock currently offers a yield of 7.8%, 2.5% below the NOI level at which the company trades, but still an attractive amount considering it also trades at a discount to par. At market prices, the preferred shares are currently worth about $102 million, which implies that they are covered by more than four times the market value of the common shares.

The preferred dividend of $2 million per year is also covered by adjusted FFO 4x.

Risks

Operationally, Chatham Lodging Trust is performing very well, with RevPAR growing 5% year-on-year in April and May. The key going forward will be whether the company is able to sustain RevPAR growth above inflation through increases in average daily rate, or ADR, rather than occupancy gains. So far in Q2, ADRs are down 1% y/y in April and up 1% y/y in May, which is very disappointing. If this trend continues, the company will see its RevPAR growth evaporate as occupancy cannot be increased indefinitely.

The other risk facing Chatham Lodging is the very high average cost of debt, which I estimate at around 7% once the July 2024 maturity is addressed. It is true that nearly a third of the debt will be at a floating interest rate after repayment in July 2024, and therefore will benefit from rate cuts. Interest from the Fed, but unlike the vast majority of other REITs, the company doesn’t have cheap financing locked up for the long term. condition. Instead, maturities in the 2030s carry an interest rate of about 7%, which is very high, and in a few years this debt will likely trade above par as maturity approaches and interest rates decline.

Conclusion

Chatham Lodging Trust’s business update for April and May indicates the company is easily beating Q2 guidance. The key point to pay attention to in the future is whether occupancy growth translates into ADR growth. With a market cap ratio of 10.3% and a growing pipeline, Chatham Lodging looks very cheap and could easily deliver a low double-digit return to enterprise value. Of course, if you are risk averse, Series A preferred stock is well covered by both dividends and market value. To me, the common stock is clearly undervalued given the excellent operating performance, hence I rate it as a buy.

thank you for reading.