Good morning. Thanks for joining us. I'm Jack Armstrong. I cover Service Properties Trust at Wells Fargo, and this morning I'm joined with Chris Bilotto, President and CEO, and Brian Donley, Treasurer and CFO. Brian and Chris are going to start with some opening remarks, and then we'll jump right into Q&A.
Thank you for having us, and Jack, thanks for hosting the panel. I think, big picture for those that aren't familiar with SVC, the company has been largely in a transition mode over the last several years. Collectively, the portfolio consists of net lease and lodging. About 70% of our business from an NOI standpoint comes from the net lease side of the portfolio, which is a pretty big change from where we were over the last several years.
Really, I would say even more near term, we've been principally focused on several additional initiatives, primarily to help improve our overall balance sheet, and the outlook for the story as we look at improving performance across the hotel portfolio, in addition to other opportunistic endeavors with respect to the net lease portfolio and continuing to procure better names and opportunities to, again, for that particular side of the business to serve as a catalyst for the overall growth as we continue to position ourself more towards net lease. As you may have seen, whether it's in our presentations or different press releases, we've done about $1.6 billion in capital markets activity over the last year and a half through the form of different financings.
We did a large equity raise in the last month, again, all in preparation to really position this company to be more on the front end of opportunistic growth, which is going to be heavily driven by our hotel portfolio, and consideration of a broader kind of strategy as we continue to pare that down and, again, shift more towards net lease. We're excited about where we're at today, just given the work we've done. We feel good about year to date where we've seen performance on the portfolio, and we'll be talking about that a little bit today. We provide a full year guidance in 2026 for the first time. I think there's a lot of steps and a lot of things and actions we're taking that are very supportive of the narrative and where we're going with the story.
Can you talk a little bit about how both your lodging and net lease portfolios compare to your peers in terms of quality, geographic exposure, chain scales?
Yeah, I think broadly speaking, if you bifurcate the two, we'll start with the net lease portfolio. The net lease consists of a mix of tenants across the spectrum. Our largest tenant is with TravelCenters of America. That represents close to 70% of our ABR, and there's a story with respect over the last 15 + years as we've entered that space and continued to transition that portfolio over time. Absent of that, the lion's share of our portfolio resides within QSR casual dining and other opportunistic type endeavors with retail and something that we've continued to grow more specifically over the last one and a half years outside of the TravelCenters.
I think when you look at the net lease side of the business, it's on sure footing with respect to good rent coverage, long-term WALTs, and things consistent with what we would expect as we continue to grow that portfolio going forward. On the lodging side, that's been the biggest transition for the portfolio. Last year we sold close to $1 billion worth of hotels, primarily on the focus service level. What that has really done is transition the portfolio heavily tilted towards full service. That's a function of resort type destinations, leisure, urban settings, and then a much smaller footprint across our suburban portfolio. That's a step one in the strategy.
We also have roughly 15 properties that we're selling this year as a continuum of that endeavor to pare back hotels where we think we don't have the right opportunity to grow performance, and continuing to position the portfolio to be in better markets and in a better setting. We expect a lot of those transactions to come to fruition later on this year, and again, that's something that we'll talk about in more detail.
Yeah. Can we just jump right in there, and in terms of what you expect to sell for the rest of this year, and then how you're thinking about future hotel sales once you get this next block done?
Yeah, I think just as a little bit of color, with respect to the hotel portfolio, we've got 93 hotels. When you look at the overall performance of the hotels, these hotels are operating in the mid-teens margins. I think by any standard, I think the view is that given the quality, locations, and type of these hotels, the overall margin for the portfolio should be north of 20%. As we think about the bogey and where performance needs to be, that's the benchmark number that we're thinking about. There's going to be varying opportunities to get there. One is the dispositions that we have in the market today. These dispositions are assets. Half of them are focused service, the other half is full service. Collectively, they produce a negative EBITDA drag of close to $13 million.
This is addition by subtraction, selling those hotels, getting proceeds in the neighborhood of $130 million is an opportunity for us to improve the overall performance of the hotel portfolio, and use proceeds to continue to delever, and help with our overall kind of EBITDA growth as well. Where we stand today in that process is, we've awarded 14 of the 15 hotels, and are under in various stage of the contracts. Half of them are under purchase and sale agreement, the other half are going through the process to get there. In most cases, deposits are hard on the front end with respect to those purchase and sale agreements.
I think from a timing standpoint, we would expect that the closing and the transactions would occur, I think, commencing as early as Q3 and into Q4, with the goal of being out of all 15 of those hotels by year-end.
Sticking with the lodging side of the business, what have you been seeing 2Q to date in terms of performance by chain scale and across service levels?
Yeah, in general, we've seen solid RevPAR growth. We printed Q1 earnings with 6.5% RevPAR growth, and that's trending through April. May is also meeting our expectations with that growth pattern. Some of it's based on comps, based on renovation we had under hotels we had under renovation last year, so some easy comps, but also just strong Q1, some good citywides on the West Coast, whether it be from the Super Bowl with some of the JP Morgan conference and things of that nature in California. We're seeing some strong trends. It's still TBD as far as the World Cup impact, which I'm sure is on your question list, which is upcoming, and we have 40% of our keys in host cities across the country. We're seeing good demand.
Booking windows are still short, but we're still seeing solid trends as far as how we've been pacing and accelerating above the industry over the last four months plus.
To your point, pretty strong RevPAR growth in Q1, you had margins that were still in the single digits. What's the game plan to improving margin, and how should we be thinking about that for the balance of the year?
Yeah, there's a lot of initiatives underway to improve margin. That margin drag is also encumbered by the hotels we're selling. We've got negative EBITDA coming out of those, that by nature will just improve margins. More specifically, there's a couple things. We have four operators. Our largest operator is Sonesta Hotels, which represents about 70% of the portfolio. On that side of the business, there's a new executive leadership team that started in April, we're looking forward to the work that they plan to do to help drive performance at the hotels that they manage. Not indifferent from our other relationships with IHG, Radisson, and the Hyatt, similar endeavors underway with our asset management team and working with the operators directly.
I think the thing for us over the last couple of years, we've been investing heavily in the portfolio, to the tune of about $750 million over the last three years. Specifically for our portfolio, there's just been a lot of impairment in performance, just given the heavily weighted construction as we implement new brand standards and just do regular way routine CapEx. That in itself has been a negative driver for performance while those hotels have largely been out of service. That's not indifferent from where we were in Q1, taking on some larger renovations across the portfolio, and the general impact that that's having on overall margins. Look, the biggest catalysts for performance improvement from an expense side are going to be on the labor side. We've got opportunities within insurance.
Labor represents the lion's share of the expense. We're working closely with our operators at creative ways to help reduce labor costs. There's varying different aspects in how we might be able to achieve and what we can do to ensure that that comes to fruition. The other big thing for us outside of just routine, regular way occupancy growth and other initiatives is our revenue mix is heavily tilted towards the OTAs. With that particular segment of revenue, it's a very expensive acquisitions cost. We're spending a lot more time focused with our operators on finding ways to convert a lot of that business to brand.com and other initiatives, which that'll help with the overall flow-through of margin.
In addition, there's a lot of initiatives underway with the global sales teams in driving additional performance and bookings through group and transient or group and contract business, things that are underway. I think that's become more evident over the first four months of the year for the information we provided with an outsized amount of business coming from that side. Some of that is supported just by having newly renovated hotels. It's allowed us to get back into booking events more long-dated now that we have those hotels in the inventory to do so. Those are a handful of the initiatives we're focused on to drive margin.
Yeah, obviously a lot of moving pieces there. We're thinking about the timeline over the next couple of years, if you look at a trailing 12, you've got a 15+ point margin spread to your select service peers in the public markets. How quickly can we expect you to capture on some of that gain?
It's going to be incremental. I think we've given guidance, and we've talked about a couple hundred basis points of margin improvement. That guidance doesn't include the sales of the hotels. That'll have an immediate impact, and it'll be more staggered over the year. Look, we're laser-focused on it. To give a timeframe, I'd like to think that as we enter 2027, we'll see more material incremental benefits, especially as a lot of hotels that had been under renovation and aren't necessarily up to performance with where they should be because of the ramp. I think that that's just going to be a catalyst that's more of a hockey stick approach than just more traditional way improvement of the business.
I think we should start seeing more incremental growth as we get into 2027, just given we've had a material amount of moving pieces going through 2025 and even early 2026, which has just created a lot of noise in the portfolio. Having that cleaned up will make a meaningful difference.
As you mentioned, we're nearing the end of your multi-year CapEx program. Can you talk a little bit about the cash-on-cash returns that you're seeing from that spend? Then as we end the program, what's a good stabilized CapEx run rate?
Sure. I think Chris noted earlier that we've spent a significant amount of capital at various hotels to the tune of $750 million over the last few years. We've substantially reduced our CapEx spend as we've gotten through a lot of major larger box renovations, full on public space, guest rooms, different capital initiatives. This year, we're projected to spend $120 million-$140 million of capital, which is down from close to $300 million. Some of the returns that we're seeing and some of the results we're seeing at various projects have been at different ends of the scale. We've had some good results in hotels, such as our airport hotels in Miami. We did a full-service renovation at our White Plains, New York hotel, not too far from here, we have Simply Suites in New Jersey.
They've produced pretty good returns outsized of our expectations in double-digit return on actual investment when you look at EBITDA pre-renovation, post-renovation. We're also seeing slower growth in some of the other projects. It's been mixed. It's not always just, say, pin a number on it. Our Hyatt Place portfolio, we did full renovations to brand standard for that portfolio to the tune of $90 million, and growth still lagging our expectations. There's still work to do on hitting our target investment returns on some of that CapEx. Some of it's defensive in nature, but to maintain market share or be able to grow rate. This year, we have a significant project in Miami going on our South Beach hotel, the Nautilus, run by Sonesta, is a big deal for us.
That hotel, we're going to put roughly $40 million-$50 million into it to reposition it. Again, we expect outsized returns. We'll be able to command a much larger rate. There's a lot of activity in that market, and we're excited about that. That's going to be completed by the fall. From a CapEx run rate standpoint, the guide for this year is $120 million-$140 million. We expect for the next couple of years that to continue to be in that range, $100 million-$120 million. It could ebb and flow a little bit, and we've bifurcated in our materials, $80 million-$90 million of that's maintenance CapEx. The rest would be discretionary renovations as we look to continue to improve the portfolio, the quality of the portfolio, and continue to drive results.
As we're thinking about the lodging business strategically, do you see SVC as a long-term lodging owner? Five, 10 years from now, do you want to still be in the lodging business, or is the goal to dispose of all of your retained hotels?
Yeah, I think long term, the goal is just to continue to pare back on the hotel portfolio. I think it's definitely a multi-year journey, and with a lot of the execution on the broader business plans that we took on over the last four months, I think that's continued to be the message. Given what we did last year and what we're doing this year is kind of a big jumpstart and a catalyst in support of that. No, I think, look, we recognize the value proposition of the goal to re-rate the company as a net lease company. We understand the strong demand that comes with that re-rating and the multiple applied to that business. We have a solid footing with the portfolio on the net lease side. We feel good around what that can bear long term.
I think with the hotel side, the story for the company is really around you've got a solid footing with the net lease side. We've got a clean balance sheet just given the work that we've done with, I think, a well-laddered maturity schedule allowing us to really focus on driving performance for the hotels. The goal is that as we continue to drive performance for the hotels, position those to be in a scenario where there's the right capital markets environment and the right valuation, just given the work and the growth we would expect coming out of that, to then divest accordingly.
Again, it's a multi-year journey, but nonetheless, I think that investors today will benefit from the outsized EBITDA upside that would come from that portfolio, just bridging the gap to where the benchmarks are in addition to the stability of the cash flow that comes from the net lease side of the business.
Switching over to the net lease side of the house, can you talk a little bit about your tenant watch list right now and how your credit losses have trended versus your expectations when you set the guide at the start of the year?
Sure. As Chris outlined at the beginning of the conversation, TravelCenters of America is our largest tenant, the lion's share of the portfolio. It's backed by a credit with British Petroleum. The rest of the portfolio is more granular in nature with a lot of franchisees of different brands across the spectrum of what we refer to as necessity-based retail, e-commerce resistant properties, in the QSR space, auto repairs, and the like. Credit losses have been pretty steady for this portfolio. We acquired the non-TA assets in 2019, and during COVID, it was all about rent deferrals. There wasn't really any sort of pressure on credit losses. As the dust settled after all that, we've seen 25 basis points, 50 basis points of credit losses from tenants either having to restructure or bankruptcies here and there for small franchisees throughout the country.
Q1, we had a little bit of a hit with a couple of master lease tenants that went bankrupt. We took $3 million-$4 million of charges in the first quarter. It still remains to be seen. Those are strong performing properties. There might be some recoveries throughout the year on some of that. The credit losses have been pretty immaterial overall to the whole $380+ million of rents we have annually. Again, we're talking about less than half a point.
Can you talk a little bit about why you shifted to net neutral net lease acquisitions, and what we would need to see in terms of improvement on the balance sheet or to leverage before you might turn those back on?
Yeah. I think kind of broadly speaking, coming into the year, we recognize that our focus is to de-lever, and we want to kind of be smart around where we allocate our capital. Rolling into a capital recycling, kind of neutral growth strategy, we felt like was the right kind of outcome in support of that. We do feel there's a lot of benefits to continue to refresh that net lease portfolio, grow it incrementally. We've seen a lot of success over the year. We have an ABS instrument within that portfolio where we just did a follow-on earlier this year, and kind of seeing the success and where the rates trend on that instrument, and that's something that I think we feel like we can continue to use long term.
This year, like I said, we're kind of acquiring $25 million all through the form of capital recycling. That could flex, right, if we find other opportunities in the portfolio to reposition out of certain brands or opportunities, we would do so and kind of reinvest in additional net lease to kind of keep it neutral. I think as we monitor leverage, some of that's going to be a little bit more organic, right, as we grow EBITDA in the hotel portfolio. That's going to naturally organically reduce leverage. I think as we start to kind of see our leverage targets come in the seven handle and things of that nature, I think that'll give us more comfort to be more acquisitive or consider other alternatives outside of the work we're doing in the lodging portfolio more broadly.
Even as you have net neutral net lease acquisitions right now, how are you thinking about reshaping the portfolio, and are you happy with the amount of your portfolio that's exposed to TravelC enters? Is that something you want to lower over time?
I think gradually, we would want to lower it over time. We have a lot of conviction in kind of the TA portfolio more specifically and just kind of the business. There's a lot of benefits that we see coming. For our particular leases with TA, as Brian noted, they're backed by BP, so we have IG credit backing the leases, and so obviously we feel good about the stability. That's a company that continues to invest in TravelC enters. We're just a portion of their portfolio more broadly. There's a lot of initiatives underway in supporting kind of the continued improvement and growth of that portfolio. I think kind of more broadly speaking around TravelC enters, a lot of these locations, if not all of them, are just irreplaceable.
It can be very hard to continue to develop and build new TravelC enters, and so entrants into the space are obviously in the form of M&A versus adding new supply. I think that gives us a good positioning and kind of a defense mechanism for continuing to own those long term. I don't think we'll spend our time growing in TravelCe nters. It's a good base, and good credit, but I think the goal would be to kind of grow the portfolio outside of TravelCenters more specifically, I think as we move forward. Certainly, reducing exposure from that 70% today to something less, I think would be advantageous. Again, with a solid footing coming from the TravelCenters itself.
We're a long ways out from those leases coming due, but can you walk us through how you think about those negotiations and then maybe what the latest you're hearing from BP?
Yeah. I think big picture, just for everyone's benefit, we have five master leases with the TravelCenters. Each of those leases are well balanced by geography and number of properties. BP, it's kind of the same guarantee, and kind of an IG across all five of those, and there are five 10-year renewal options in support of those. Those renewal options can be exercised from the tenant or from BP, give or take two years out from expiration. So kind of normal runway, that would be kind of the normal course. I think what's important is those are by master lease, all or nothing renewals. The timing of that, we're seven years out. We have a lot of time.
We just completed that transaction in 2023. I think for us, it's continuing to monitor BP and their investment in the business and how they want to kind of continue to grow EBITDA performance. We've seen kind of the coverage come down over the last couple of years. Some just being that I think that transaction occurred at the peak, which is great. At the same time, that coverage has come down, I think more just from the ingestion of the portfolio into their ecosystem, and kind of them as an organization continuing to try to work through the broader business plan and strategy going forward. We spend, I think, a reasonable amount of time talking to BP. They just brought on a new executive leadership team at the end of last year, kind of industry experts in support of the overall growth.
They've kind of talked about a one to two year plan as they think about how they're going to continue to execute on varying strategies supporting the TravelCenters. I think that the short answer is one, it could be a scenario where they want to wait towards the renewal right. I think in practicality, which is not indifferent from other large tenants across our portfolio, we have a seat at the table. We're having active dialogue. I think we want to be constructive, and so we'll kind of wait and see and be there to have that dialogue with them and help inform their business plan, and I think that'll give us more inroads into the timing of when they think it's prudent to exercise that renewal option. All conversations today are supportive of them being committed to TravelCenters.
Can we spend a little time talking about the balance sheet and how you're thinking about addressing the maturities you have over the next couple of years?
Sure. Yeah. We've done a lot of work in the last couple of quarters. Chris talked about the equity offering we did and some of the refinancings we've done to clear out debt maturities. All our unsecured notes through 2026 were redeemed in the last few months.
As we look ahead, our next maturity is our zero coupon notes that we issued last fall. They were two-year notes. They mature in September of 2027. Behind that, we have another $400 million of unsecured notes. That's our focus in the nearer term. The zeros are backed by one of our TravelC enters pools, so there's very strong collateral, which gives us some flexibility. Couple that with the amount of work we've done to reduce our interest expense. We've reduced interest expense by $60 million annually based on the refinancing we did with the net lease portfolio, as well as the equity deal with just retiring debt, extinguishing debt. As we look ahead, we have to balance the fact that the zero coupons, which are not as common around the industry, the fact that we took the accreted value and essentially prepaid that interest.
Retiring those early versus waiting too long to refi and market risk, that's something we're actively discussing, and we'll look to as we get closer to 2027. Whether or not we apply proceeds from dispositions to delever further and chip away at some of that stuff as part of our active dialogue as a team, as part of our business strategy. The 15 sales that we have in flight plus potentially others that we may consider bringing to market will be a part of the holistic strategy to address those debt maturities.
You provided a bridge in your most recent deck to free cash flow. How should we be thinking about what the highest and best use of that free cash flow is? How much flexibility do you have before you need to turn the dividend back on?
Sure. It's been a highlight for us in our story. I mentioned earlier the CapEx spend has been clearly outsized, again, reinvesting into our properties has been a key focus the last few years to put us in a good position operationally. From a cash flow story, we've gone from burning close to $200+ million to, on a normalized basis, $50 million-$75 million of free cash flow before discretionary CapEx. For us, as I just mentioned, we're focused on debt maturities and our leverage profile. There's no tax issues regarding the dividend that would force us to raise the dividend, we're going to be mindful around use of cash flow. For the next few quarters, it's all about strategy around the balance sheet and the debt maturities we've talked about.
The board will talk about the dividend ongoing, as it always does, and whether or not we'll see that next year or not.
Can you talk a little bit about the feedback you received following the equity raise and maybe an update, if you have one, on your search for a new board member?
Yeah, I think the feedback has been very supportive. I think that's a testament of just the success of the equity raise and kind of having that come to fruition. I think, look, the genesis for that equity raise was largely driven by the fact that we had strong fundamentals across the portfolio, and we're really kind of looking at our overall covenants for the balance sheet, which kind of remained tight, and not necessarily giving us the runway we felt like was necessary to help improve the overall portfolio and extract the value that we feel confident with. I think in addition to that, I think the overall stock price at the time had a cap on it, just knowing that we had a chunky maturity wall with our debt.
Again, a hotel portfolio that continued to need some level of CapEx, in addition to time to continue to improve that. The combination of being able to do a successful equity offering and provide that breathing room was welcomed. We have a lot of dialogue with our investors, legacy investors and new investors, and everyone is supported and excited about the story. I guess, what was the second part of your question?
The search for a new board member.
Got it. The search for a new board member is ongoing. I think, as Jack is referring to, with the equity offering, we announced that we would also add a new independent board director, and so that process is ongoing.
As we're coming up on time here, what's the one thing that you think public markets are getting wrong about SVC?
Yeah, look, we've spent a lot of time over the last year, and even more so several months, just given a lot of the initiatives out there, really articulating the story. Look, I think what is important in our view for everyone to understand is, one, the hotel portfolio itself. I think one of the challenges that we hear and do the best we can to dialogue is that given the level of transactions we've done in our hotel portfolio over the last year, plus selling hotels at give or take $60,000 a key, I think that there's an assumption that that is the portfolio that we own and overall valuation.
It's our job to get out there and continue to highlight that what we're left with today, even the retained portfolio after the sales this year, is a highly sought-out collective of hotels, both resort destinations, leisure travel, and other kind of hotels in solid markets. I think we've talked about owning hotels in Miami, South Beach, Kauai, San Juan, Cambridge, several airport destinations. I think it's really our job to make sure the investment world understands the quality of the portfolio because that's a catalyst for driving overall value improvement over the near term. I think as you've seen in our prints, we're outpacing the market when we think about RevPAR growth and some of the other catalysts, that's a testament to the portfolio and the work we've done.
I think continuing to tell that narrative and supported by having good prints each quarter is all part of the messaging that we need to continue to highlight.
Really helpful stuff. Thanks for making the time for us.
All right. Thank you.