Expanding horizons

REITs as an alternative source of hospitality liquidity – part 2

by KEN PATEL

This is the conclusion of a two-part look at this subject. Be sure to check out the first part of the series in the here.

In this first half of this article, (linked here), we looked at a few means by which property owners can secure liquidity and salvage under-performing properties given the challenging economic times in which we find ourselves, and we’ll conclude this series here. A topic as nuanced and complex as this could probably fill a Tolkien-sized book, but – rather than take the deepest dive possible – we’re concluding here with the hope that readers will use the information in this series to have a larger conversation with a financial expert to determine next steps.

THE REIT LIQUIDITY OPTION
By contributing their hotel assets to REITs, hotel owners can defer capital gains taxes, convert their fixed assets into marketable securities, and gain access to a much-needed influx of cash. This provides a more attractive value proposition than selling properties at a discount, getting diluted by issuing additional equity or issuing a substantially higher cost of capital, which could further compromise the already-dwindling revenue streams of hotel.

Moreover, by converting hotel properties into REITs, hoteliers can gain access to a wider pool of investors, whose investment contributions can provide a significant boost to the hotel’s financial reserves. This enables hotels to weather the ongoing perfect storm of issues, by diversifying their revenue streams and expanding their financial horizons.

All in all, the hotel industry’s decision to roll up into REITs highlights the innovative strategies being adopted by hotels to stay afloat in the face of the many challenges posed by the pandemic. By exploring new and unconventional avenues, hoteliers are emerging as resilient leaders in the face of adversity and uncertainty.

REAL ESTATE INVESTMENT TRUSTS
A REIT, or real estate investment trust, is modeled after mutual funds. They give everyday Americans the chance to invest in income-producing real estate that owns, operates, or finances income-producing assets across a range of sectors. These assets would otherwise likely be financially out of reach to the majority of Americans, by allowing them to buy and sell REIT shares like other stocks or mutual funds.

Congress created REITs in 1960 to give all Americans the chance to invest in large-scale, income-producing real estate beyond just their homes. In fact, the primary intention of Congress in authorizing the use of REITs was to provide a means “whereby small investors can secure advantages normally available only to those with larger resources,” in connection with real estate investment.

In short, everyone deserves the opportunity to invest in real estate. REITs historically have delivered to investors the benefits of commercial real estate investment along with the advantages of investing in a publicly traded stock.

In addition, REITs are total return investments. REITs are required to distribute at least 90% of their taxable income to shareholders annually in the form of dividends. However, most REITs typically distribute 100% of their taxable income and, as a result, pay no corporate-level income tax. Historically, they’ve provided high dividends plus the potential for moderate, long-term capital appreciation.

The Benefits of Contributing Your Hospitality Assets to a REIT

While Multi-Faceted And Complex, This Can Be Broken Down Into Six Components:

1. Dig into the data

Because REITs were intended to be passive investors of real estate – not active managers – all REITs are subject to a complicated and detailed tax regulatory structure, with many demands by the SEC for transparency and frequent reporting. However, many REITS will allow you as the owner-manager, to continue to manage your property, subject to the REIT’s corporate governance. After all, nobody knows your assets better than you.

2. The importance of outside counsel

You aren’t selling your asset, therefore there would be no capital gains on the property’s appreciation resulting from the transaction. Of course, you will need to secure your own legal and tax advice, yet most contributions are conducted in an environment devoid of any current tax impact as your investment basis won’t change.

3. Strength in numbers

Hotels that join REITs benefit from balance sheet strength in numbers. By pooling their assets and becoming part of a publicly traded REIT, hotels can gain access to a much larger pool of resources and investors. This can enable them to strengthen their balance sheet, secure liquidity, and weather economic downturns much more effectively.

4. Demanding diversification

Contributing hotel assets to REITs diversifies the owner’s portfolios. By converting a portion of their assets into marketable securities, hotel owners can spread their investments over multiple assets, reducing overall risk of concentration, and gaining ownership interests in different markets and product segments.

5. Pause for preparation

Conversion of fixed assets into marketable securities on your personal balance sheet can create an opportunity of market liquidity in less-favorable economic conditions. Needless to say, banks and other financial institutions like seeing a balance sheet from a sponsor with freely tradable, marketable securities, instead of a non-fungible fixed asset.

6. Bucking trends

Traditionally, selling property assets in times of low demand or a tough economic climate leads to a drop in value due to a buyer’s market. As a non-traditional approach, conversion into REITs can lead to a different set of investors and additional investor capital.

Lastly, joining REITs provides your remaining hotel portfolio with access to liquidity. The assets of the contributed hotels can be transformed into liquid, marketable securities without having to sell the properties. Property owners can increase cash reserves and utilize the funds to improve infrastructure, refurbish, or expand on properties, as well as repay debts or simply improve the bottom line.

In short, the pandemic and other economic factors have resulted in unprecedented challenges for the global hotel industry. However, innovative hotel owners can adopt this unique strategy to secure liquidity and stay afloat by rolling up into REITs. Contributing to REITs can offer various benefits, including balance sheet strength, diversification, deferred taxes, access to liquidity, and market liquidity. Therefore, a contribution into a REIT, can be an often-overlooked alternative to securing liquidity.