All right, why don't we get started? It's 10:15 A.M. on my clock. So good morning, everyone. I'm Bryan Maher. I'm the Senior Analyst at B. Riley, covering Service Properties Trust and kind of everything RMR. This morning we have Todd Hargreaves, the President and CIO, and Brian Donley, the CFO of SVC, to go over the story. I'll start with some questions, and then feel free to raise your hand, ask any questions that you might have. Towards the end, we'll allot 5-10 minutes for that. So let's start with you know, the fact that most investors know SVC is a large owner of hotels. You used to have 300 and some hotels, now you're down to about 220. And we'll talk about that business in a minute.
But you also have a very large net lease portfolio, about $5.5 billion of investment, 749 properties. I think it's 44%-45% of your total real estate investments. Why don't we start talking about that portfolio first, then we'll shift to hotels. Starting with the TA and Petro Travel Centers, it's about $3.3 billion-ish investment. They performed very well during the pandemic. Last year, TA itself, the OpCo, was acquired by BP for about $1.3 billion. Maybe you can talk about what's going on with those assets and, then we'll shift to the other net lease properties.
Sure. Good morning, Brian. Good morning, everyone. Thank you for attending our, our panel here. Yeah, it is interesting 'cause we, you know, we started off as a predominantly a lodging REIT, and then bought the Travel Center assets in 2007, 2008, and then bought the, the other net lease in 2019. But it is—we, we, we like to remind people that about 45% of our portfolio is in the net lease, we're not just, just lodging. So, but like you point out, the TA assets are, you know, we like to think of it as our crown jewel. They're a very large part of our portfolio and a very secure and high-value part of the portfolio as well.
We have about 175 Travel Center assets across the country. They're under five portfolio leases with TravelCenters of America, represents about 30% of our total investment and generates about $250 million of annual rent in our portfolio. So again, a very stable cash flow stream for the portfolio. Last year, as you point out, TA was sold to BP, so we saw a significant credit enhancement in a very large part of our portfolio, those leases are now guaranteed by an investment-grade subsidiary of BP. And, you know, BP has said publicly they are going to invest significant capital in those assets. Those leases run for 10 years, and then there's 50 years of renewal options.
All of those leases have contractual 2% escalators through 2033 in all of the renewal options. So again, a very strong part of the portfolio and something we're very excited about.
So let's move on to the other net lease assets. I think movie theaters you had, restaurants, quick service, retail. You know, how did those perform during the pandemic? How they're performing now? How do you view that aspect of the portfolio?
Sure. So, as just like the TravelCenters assets, those throw off about $110 million or so of annual net rents. Again, similar to the TA assets, it's a very... It's very different than the hotel portfolio. Hotels are just generally more cyclical in nature. Obviously, those cash flows are gonna have lower lows and higher highs. But, really coming out of the pandemic, having that concentration in net lease, really, I think we'd be in a completely different position now if we were just 100% hotels. It really kind of helped us cover our interest expense, cover our overhead. You know, we had some hiccups with the net lease portfolio. Right coming out of the pandemic, you saw a lot more of the experiential type properties, like movie theaters.
Those didn't do as well coming out, but since then, we've, you know, we had very few. You know, like a lot of the other net lease companies, we had to give some concessions, did some rent deferrals, but quickly got back to those tenants paying 100% rents. And we've seen the coverage, the rent coverage at those properties really improve every quarter since then. And if you look at that portfolio now, we're about 3.5x coverage for the non-Travel Center assets, so very healthy unit-level coverage at those assets. Our heaviest concentrations are in quick-service restaurants, full-service restaurants. We have grocery stores, medical-related retail, auto-related retail.
We do have some exposure to movie theaters and fitness centers, which again, had some challenges at the beginning of the pandemic, but have really since come out of that. The overall movie industry has kind of gotten back to close to where it was in 2019. So, again, a very stable part of the portfolio, and just like with our Travel Centers, gives us a good counterbalance to the more cyclical nature of the hotel assets we own.
No Red Lobsters?
No Red Lobsters. Good question.
You sold a couple of net lease assets over the last few years, and they're small, kind of non-core. You know, what are your thought processes there with, you know, how much more you might sell over the next couple of years, and what type of assets might you be unloading?
Sure. So most of what we've been selling over the past couple of years has been vacant net lease assets that have come back, and we haven't been successful at leasing. They're few and far between. They're a lot smaller deals, where sometimes the best exit is to sell to developers and, if you can determine that you're unable to lease it. I think going forward, once we get back into acquiring more net lease assets, and that is the idea with that portfolio, is to grow that over time. Over the past few years, there's been different, different strategies with allocating capital across the portfolio, that the only areas we've been actively buying assets is really in hotels, and we've only really bought one hotel.
We've been more net sellers to address some of our debt maturities coming due and kind of, conserve capital, as we've addressed some of the maturities in, in our portfolio. But ideally, as a portfolio, we want to grow over time. So I think, I think you'll see us get into more of a, a typical capital recycling strategy, where we may sell some lower cap rate properties. We may take advantage of the liquidity in the market, may sell some... We'll do a lease and then sell a property where we think the value has been maximized, and then roll that into some, some higher cap rate properties and industries that we like, where we think the returns are appropriate.
So rent coverage is, like, almost 2.4, 8.7-year WAL, 90%+ occupancy. You know, kind of closing the loop on our net lease discussion, you know, where do you see in the next couple of years, you know, what sectors do you lighten up on? You know, you talked about you might add. You know, where is your bias towards adding?
Right. I think what we've done, we've— So the properties we have sold have been in some of the industries that we've looked to reduce our exposure to, like the movie theater, movie theaters. But right now, if you look at our concentration again, we're mostly... Our heaviest concentrations are in the restaurant spaces, which we like. So I don't think we're necessarily gonna shift the concentration across the industries necessarily. I think you just may see a shift within those industries, like I pointed out before. There's a lot of liquidity in the space right now to sell quick service restaurants, and you can get pretty attractive cap rates, especially given where interest rates are today.
You can still get all-cash buyers to buy some of these smaller QSRs for, you know, cap rates in the 5% range. So I think you can, with some of the more established brands, some of the larger operators, some of the larger franchisees, you can still take advantage of that liquidity, take advantage of the good cap rates, and then maybe invest that capital into the same industry, but maybe smaller operators, lesser-known brands, but areas where you can find properties that still have very good store-level performance, very good store-level coverage, and just kind of shift the return profile.
Okay, we're going to shift gears to the hotel component. Does anybody have any questions on the net lease assets before we shift gears over to the hotels?
Yeah. I mean, given the what you're paying for your implicit capital costs, why not sell it, buy back your debt that's trading at 10%-13%?
Sure. Go ahead, Brian.
Sure. No, we've been balancing liquidity, we've been balancing covenants, we've been balancing different things in our capital strategy. The stabilization of our EBITDA levels has been anchored by those net lease properties, you know, so the TA assets specifically. You know, there is a strategy as far as you know, potentially selling some of those net lease assets and utilizing for different reasons. You know, we have looked at buying back some of the debt. Yeah, but there's been a need to focus on the hotel portfolio, deploy capital there. So we're balancing a few different things. So we don't have any plans to sell large swaths at this stage, but it's something we do think about.
Anybody else on net lease? All right, so shifting gears to the hotel component, it's about 55% of the portfolio. Maybe you can start off by talking about what types of hotels you have, what kind of markets they're in, and how they've been performing since the pandemic.
Sure, yeah. We have a very, very diverse portfolio of hotels. We own 220 hotels today. We have approximately 50 full-service hotels. We have about 100 extended stay hotels, and the balance are select service hotels. We're also diversified by chain scale. We have hotels in the mid-scale, all the way to upper upscale, which is our Royal Sonesta branded hotels. We have a lot of high-quality hotels in leisure markets like San Juan, Puerto Rico, Kauai, Hawaii. We have hotels in Hilton Head, Fort Lauderdale, a lot of strong urban markets as well. And then, so we have Sonesta-branded hotels, and we also have relationships with Hyatt and Radisson, which manage hotels under portfolio management agreements with us.
The one unique thing about SVC relative to some of our peers is that we do have a 34% ownership stake in Sonesta, which manages about 90% of our hotels. So there's a unique brand-owner alignment there, which again, I think makes us unique amongst our peers. Results are coming out of the pandemic. You know, I'd say for the most part, we're seeing the best performance in our Royal Sonesta upper upscale branded hotels. I think we've seen those really take advantage really over the last couple of years, over the return of leisure travel and the ability to push rates. I think recently we've seen that performance come down a little bit just because rates are getting back to more normalized levels.
And then, the extended stay actually was one of the first areas to really come back, coming out of the pandemic because they were in drive-to markets. They kinda leaned more towards the ability to social distance. You didn't have to interact with other guests or other hotel employees, so that was actually the first area to come back before our leisure travel came back. The area that's still trailing where we were pre-pandemic is our select service portfolio, which really, really depends more on that business traveler, and overall, we just haven't seen the business travel come back to where it was before the pandemic. So that's the area that's really lagged the recovery in our portfolio, which I think is consistent with the industry.
So I think a lot of people know that during the pandemic, in the third quarter of 2020, Marriott and InterContinental defaulted on over 200 hotels that you had in the portfolio, and you made the conversion to convert those to the Sonesta brand. You know, how has that gone? What were kind of the big challenges there? Any regrets to that? And has RevPAR kind of lived up to what you thought it might when you made the conversion, you know, with the pros and cons of doing something like that?
Sure. I mean, it's been a learning process. I think a lot of things went according to how we expected, but we've learned a lot of things along the way, and things happened that were unexpected. I think the transition, I mean, transitioning 200 hotels is a very large project, and I think we did that effectively. I think there's a lot of hotels that are performing as well or better than we expected and better than where we were in 2019. And again, that is consistent with, you know, the Royal Sonesta branded hotels, some of the Sonesta full-service hotels, some of the extended stay hotels.
I think what we may not have appreciated fully at the time of the transition is the impact that some of these these loyalty programs from some of the bigger brands had on really keeping market share, and we've really seen that in the select service portfolio, which really is dependent upon the business traveler and the rewards and loyalty program. So that's the area where we really haven't seen RevPAR get back to where it was. But like you point out, there's a trade-off, too. It's one of the reasons that you know, our manager purchased Sonesta over a decade ago, was to give us that flexibility to be able to manage manage our hotels with an affiliated company. You're really seeing that kind of with the renovation program we're doing now.
We have the ability to do the PIPs that we think are appropriate, put money in when and at the levels that we think is appropriate at our hotels. So there's trade-offs to having Sonesta in there and some of the previous brands. But, you know, I think as Sonesta continues to gain that brand recognition, I think we'll continue to see them close that gap and take back more market share in the areas where we're still trailing in RevPAR.
So maybe shifting to the cost side. I mean, has staffing levels gotten back to the pre-pandemic levels? Can you run the properties more efficiently with things that you did during the pandemic? And then maybe talk a little bit about inflation and pressures from, you know, insurance costs and other things that are impacting margins.
I would say for the most part, if you look at percentage of filled positions, I think we're right back to where we were across all of our operators relative to 2019. Just with the high turnover with some of these positions, you're kind of always in that low 90% of positions filled, and we're right back approaching those levels now. In terms of where we have been able to get more efficiencies, and you know, I think you've seen us reduce, if you look at it on a same store basis, reduce overall headcount. You know, I think all of our operators have learned to operate more efficiently. You know, for example, there's...
You know, we own over, again, over 200 hotels, so there's hotels in clusters or areas where we're able to get operating efficiencies, not just through vendors, but we've learned that, you know, maybe you don't need a GM at two extended stay hotels 15 miles apart. You can have a GM at one property and a director of sales at the other. So we've learned to reduce overall headcount and manage labor that way. That being said, overall labor costs are just up overall. I think overall, pay wages, especially for housekeepers and front desk and food and beverage staff, has increased.
I think you're seeing those types of positions now, you're having to spend a lot more money on retention and recruitment and just overall benefits and bonuses you're paying to the- that level of employee. So I think it's a permanent shift in terms of what that overall line item is now. And the other area where we're seeing it is insurance, and just seeing overall premiums and deductibles increase. And again, that just like labor, that's a permanent shift that's gonna impact margins permanently. I think it has been moderating recently, but it's again, it's up significantly to where it was in 2019.
Given that you have a brand like Sonesta, which maybe everybody's not familiar with, like Marriott and Hilton and-
Right
... Hyatt, and what have you, how do you weigh, you know, pricing your rooms versus maintaining the level of occupancy that you want to be at? It's a little bit more nuanced than what some of the bigger brands are going through.
Right. I think, you know, and, and I think Sonesta is, they're growing into their size. They went from, you know, back in 2019, there were 60 hotels, and then we transitioned 200 of our, of our owned hotels, to Sonesta. We've since, we've since sold some hotels, but then they bought, a company called Red Lion Hotels in 2021, and to get into 2022, to get into the franchising space. So they've really grown almost overnight to, from 60 hotels to the 8th largest hotel company in North America. So they're still kinda they're still We have to remind ourselves sometimes that they're still a relatively new company, but they are growing into their size. They're really gaining that brand recognition.
So I'm not sure our pricing strategies are that much different than some of the other brands that we compete against. But you know, there's always that balance between occupancy and rate that you're trying to really look at for each of the different hotels. I would say, in terms of our select service hotels, where we're really having a challenge, kind of that midweek business travel, that midweek occupancy, we're doing everything we can to get occupancy. If that means reducing rates, if that means relying on more of the OTAs to book those rooms, we're doing everything we can to maintain occupancy, as a lot of that will flow through to the bottom line.
Whereas on some of our higher-end hotels where we've been able to push rate, we've pushed rate, and we don't. You know, once you get to a certain rate, you're hesitant to reduce that as well. But where we can push rate, we're doing that as well.
You own 34% of Sonesta. I think that's the max you can own-
Right
as a REIT. What's the long-term strategy there? And if memory serves me, I think a year or two ago, Sonesta bought four or five properties in Manhattan. Is it their long-term strategy to own those themselves, or could we see a day where SVC ends up owning those properties outright? What are the thoughts there?
Right. So the long-term strategy with Sonesta is to grow through franchising. We'll continue to evaluate and own and buy properties in our portfolio, more on the full-service side, that we want them to manage for us. The real opportunity and the real value proposition is through growth and franchising. Right now, with the Red Lion acquisition, most of what they purchased were the franchise contracts associated with economy-branded hotels. But once they bought that, they really bought that for the infrastructure to start franchising Sonesta-branded hotels. Now, I think they have about 100 in the system, but if you look at some of the brands they compete against, they have 50 times that amount, right? They have 6,000 plus franchised hotels in the system.
So there's, just in the U.S. alone, there's significant room to grow franchising, and it's just a much higher margin business than the management business is. You should be able to get to 40% net margins in that business. So every franchisee and every new franchise they can bring into the system is gonna be very profitable. So they're very focused on that. That's where we see the growth. That's where we get excited about owning 34% of Sonesta today. We get asked a lot, "What are you gonna do with Sonesta? Are you gonna monetize it? Can you monetize it?" Sure, we could, but we look at this, you know, I think looking back in three, five, longer time horizon, we think this company is gonna be worth a lot more.
We think there's a lot of room to grow, just in the U.S., but internationally as well. And again, that's not gonna cost us any money. We're just gonna benefit from that through our ownership share. But also, the more they grow, the more brand recognition they get, the more franchises they get, and more dots on the map they get, will just benefit our managed hotels as well. And then, to your question, New York, yeah, they bought a portfolio in New York, at a very good time, right when New York was starting, the New York hotel market was starting to really recover. They bought 900 keys across four hotels in Manhattan, with at a very good basis. So you're right, they have very limited number of hotels on the balance sheet.
So there is a scenario where SVC could potentially purchase those, but there's no immediate plans to do so.
So you have a big CapEx budget this year and next, I think $300 million+, maybe for Brian. You know, how's that money being deployed? What type of returns are you expecting? How much of that is kind of regular maintenance CapEx, and how much is ROI projects? I think that there might be some misconceptions in the market when people try and calculate the dividend coverage ratio, and they back out your elevated CapEx, and they say, "Oh, your dividend's not covered." But if it's a, you look at a regular CapEx number, it is. I mean, what, what are your thoughts there on the CapEx? And, and maybe we'll just do the, the dividend discussion at the same time.
Sure. Yeah, so we announced that we're gonna spend roughly $300 million this year on different hotels. $100 million of that, we'll call maintenance CapEx, just routine stuff to keep things in good order. But, you know, the repositioning of certain hotels, you know, our Hyatt Place portfolio, for example, 17 hotels are almost complete. We have various Sonesta hotels across different chain scales that are being repositioned and renovated, you know, with five full-service hotels, about a dozen select, and the rest extended stay. We expect to complete about 33 hotels in the calendar year 2024. So there's gonna be a lot of choppiness over the next few quarters for SVC and into next year as we continue this program. We're gonna continue to evaluate the success of these projects.
You know, we target a high single-digit return on what we call discretionary CapEx. Some hotels will perform better than that, you know, some will be lower than that average. But how we measure it is, you know, stabilized period before we start the project, and then, you know, give the hotel time to ramp up and measure success, you know, after a stabilization period. But we look forward to showcasing some of the before and afters in the coming quarters as we get a little more volume completed this year. Yeah, but so far, early successes in the few that we have finished at the end of 2023 have proven to the case study.
You know, as far as the dividend coverage, yes, the CapEx is elevated, but the, you know, we, we feel comfortable with the dividend level today. You know, as far as our capital allocation strategy, it's a, it's a part of, that overall story of SVC. You know, again, the CapEx, we're gonna utilize, so we utilized some of the cash on hand we had at the beginning of the year from the TA transaction. We'll, we'll use some of the cash from the asset sales, to cover some of that CapEx. So net-net, you know, we, we think we're covering the CapEx program this year, and again, we, we keep an eye on the dividend. You know, the board meets regularly, quarterly, discusses it, but, you know, we feel comfortable at the level we wanted to set.
When we reinstated the dividend at the current level, we wanted to set it at a level we believe we could maintain it over the long term and not have to scale it back. Obviously, it's a lever if things get worse, as we've shown during, you know, coming out of the pandemic, but we feel comfortable today.
So last for me, and then we'll ask the audience for some questions. But you've been pretty active in the financing market over the past, let's say, eight or nine months. What's going on there? Have you taken out everything you need to take care of for 2024, 2025? What's the big picture strategy? And maybe just touch upon the TA transaction you did last fall, which was kind of a big deal.
Sure. You know, we were in 2023, if we roll the clock back, staring down $1 billion of maturities in 2024 and $1 billion in 2025, and that was one of the most common questions we received was: How are you gonna deal with that, those large bullets? So last fall, we decided to launch a secured bond offering backed by two of our five lease pools with TA. That transaction went very well. It showed another avenue of ability to raise capital and refinance debt maturities. You know, the deal we announced more recently was unsecured notes with subsidiary guarantees. So, you know, we're trying to migrate back to the strategy we had pre-pandemic, which was pure unsecured corporate debt.
We've been balancing the desire for a lower cost of capital, utilizing assets and secured debt, versus getting back to the more regular way structure that we've enjoyed over the last, you know, decade or so. You know, so that's our strategy. That was our strategy with the most recent deal, was to sort of balance cost of capital with getting back to more regular way unsecured offerings, saving those properties for a rainy day.
Yeah, we have three or four minutes. Anybody have any questions? Sure.
So I'm still not understanding how you can justify a high single-digits return when you're borrowing at 8 7/8s. So that gives you, like, no margin, and you're paying a dividend that's, I think, yielding, like, 15% right now. So isn't your target for these investments way too low? I mean, are you, are you, I mean, are you really using high single digits when your cost of capital is your cost of debt is actually very high single digits, so your cost and your cost of equity is much higher? Doesn't that make sense? Can you explain that?
Yeah, I'll put the price of the stock price aside and the dividend yield aside for a second. But you know, the options of doing the CapEx program and not doing the CapEx program could actually yield a much worse result if we don't. Some of it is defensive, some of it is you know, revenue opportunities. But you know, letting a hotel age and worn out, you're gonna continue to lose market share. So some of it's by necessity. You know, the yield, the high single-digit returns we target is an average. Some will yield better, some will not. But not doing it is a worse alternative for hotels.
But I understand your point as far as the, the cost of capital, that it's just a facet of the market we're in today, where our credit stack is. You know, we've been chipping away at our debt levels and our principal levels, you know, utilizing the TA transaction. You know, we were able to pay back some principal, and we'll continue to find ways to do that, to try to delever. I think deleveraging for us and, and lowering our cost of capital is going to come more from the results of the hotel portfolio, which these CapEx investments is integral to achieve in the future.
Any thoughts of splitting the company? Would that even be possible? Because you have one section or one portion that can finance itself at a much lower cost than another portion. Is that, you know, a possible consideration?
It is something we've talked about in the past. Anything is possible, right? But we, you know, when we bought the net lease retail portfolio in 2019, it's something we considered very seriously. But at the end of the day, we thought the larger scale and the combined company would be better than the sum of the parts of the two separate entities, two smaller entities with high concentrations of tenants. Yeah, so that's where we landed. Anything's possible, though.
Yeah. Back to add on to, back to the cost of capital question, I mean, there's other ways, right? We, like Brian pointed out, he's right, is that, that our number one priority is investing back into these hotels, putting CapEx into these hotels that need it. There's other ways that we can address leverage, and we're doing that now. We've sold 68 Sonesta brand hotels over the past three years. We have another 22 in the market. These are negative cash flow hotels that we're not putting that capital into because we don't think we're gonna get even the 8% return on that capital, and it's negative cash flow. We're gonna sell those hotels, so that will help us delever as well. So there's other areas to do it, but holding back on the CapEx is not the answer.
And to your point on the two different parts of the company, one of the things that's frustrated me, as a sell-side analyst covering the stock, is you look at where the shares are trading, they're trading at about 10.8x EBITDA, which is in line with lodging REITs, but it's only 55% lodging, and it's 45% net lease. And net lease REITs on average trade at about 14.9x EBITDA. So you kind of do a weighted average, and you know, SVC should be trading more like 12.5x EBITDA, not where it's currently trading.
And so I think that the market looks at these guys, because maybe the history, I don't know, is, "Hey, it's a lodging REIT," when in fact, it's got this other component, which you could say that they should maybe divest or split off, but it's the component that really held them up through the pandemic, when lodging, for all lodging companies, suffered immensely, right? Just like senior housing suffered immensely at DHC, but it was buoyed by its medical office building and life science component. So I hear what you're saying, but there's a very viable counterargument to keeping them together.
Yeah, I have one more second. When you sell the Sonestas, do they have to keep the brand, and are they becoming franchisees or, or they opt out of the brand, and they become something else?
It's a mix. They do not—they're not required to keep the brand, but we offer them with the option to enter into a new franchise agreement. And most of what, 50 of the 68 we sold kept the brand under new franchise agreements, and the majority of what we're in a market to sell with today will likely stay Sonesta branded as well.
And the franchisee fees are comparable with Marriott, Hilton, and Hyatt?
Yes. Yeah. Yeah, 5%, typically, royalty, and then a 3.5% marketing fee is typical.
Any other questions? We're about out of time. Back there.
Yeah, just a general question on hotel occupancy and RevPAR. How is that looking today and looking for the rest of the year compared to 2019?
In terms of, in terms of overall RevPAR, we're probably. And it's a mix, depending on which part of the portfolio you're looking at. We're probably high 80% in terms of where we are today, RevPAR, versus where we were in 2019. So, you know, our select service portfolio, like we've been talking about throughout this presentation, that's, you know, that's a much lower percentage, whereas our Royal Sonesta and upper upscale are probably closer to that 100%.
All right. We are way out of time. Thank you very much. Appreciate it.
Thank you, everyone. Thank you, Bryan.