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Rob Carrick

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Heartbreak Hotel

Rob Carrick


OTTAWA (GlobeinvestorGOLD) — Welcome to heartbreak hotel.

It's not a place, but rather a real estate investment trust called Royal Host REIT. While travel-related companies and income trusts of all sorts have made spirited recoveries from the woes of the past year or more, Royal Host is an ongoing disappointment.

Royal is one of a couple of TSX-listed hotel REITs with a presence in the mid-market and budget side of the hospitality business. While Legacy Hotels has properties like the Chateau Frontenac in Quebec City and the Royal York in Toronto, Royal Host offers Travelodge and Country Hearth Inn. It's an honourable market niche that Royal Host occupies, one that caters to families and small business people who need a reliably clean place to spend a night or two.

The problem is, no one's resting easy if they own Royal Host units. A year ago, before the outbreak of SARS and a summer of forest fires in the West and the big power blackout in Ontario, Royal Host was priced in the $6 range. These days, after bottoming at $3.90, the units are scuffling along around $5 range. Given that other travel-related companies have rebounded more solidly, you have to wonder whether Royal Host if one of the few pure turnaround plays left in the sector.

First, some background. Royal Host owns 39 hotels, manages 77 properties and has 115 franchise locations. It's the master franchiser for the Travelodge name in Canada, and it also operates under such banners as Super 8, Holiday Inn, Chimo, Ramada and Country Hearth. These locations are well diversified geographically, with properties in seven provinces and the Northwest Territories. In terms of market capitalization, Royal Host is by far the smallest of the four TSX-listed hotel REITs at just $124-million (Legacy is tops at $750-million).

Why check out this pint-sized laggard? Certainly, there's the potential for price appreciation if and when Royal Host restores its monthly distribution to what it was before its current troubles began. The payout was cut to 2 cents per unit from 6 cents last summer, and to 6 cents from 8 cents after Sept. 11. The current distribution yields 4.8 per cent annually, which isn't enough on its own to justify owning this REIT. A return to 6 cents would result in a much more attractive yield, which in turn would send the unit price higher. A return to the 10-cent per unit distribution of 1999 seems out of the question.

Of course, there's also the risk that the distribution could be suspended altogether, as with Legacy Hotels. In a report dated Oct. 31, which is after the most recent distribution cut at Royal Host, Dominion Bond Rating Service said this REIT's "payout ratios based on cash income and cash available for distributions are high and, unless operating conditions improve, are unsustainable." Royal Host has yet to issue its fourth-quarter financial statements, so a more up to date analysis isn't yet possible. DBRS has assigned Royal Host a stability rating of STA-5 (low), which is lowest among the four hotel REITs it covers (that's on a scale where STA-1 is best and STA-7 is worst).

The hotel REIT most comparable to Royal Host is InnVest Real Estate Investment Trust, which rates an STA-4 (low), the same as Legacy and Canadian Hotel Income Properties. InnVest's recent success is in striking contrast to Royal Host. With its own portfolio of budget and mid-market hotels, InnVest has rallied about 28 per cent in the past year and now yields 9.8 per cent. And while InnVest's unit price fell last year, it never wavered on its monthly distribution of 9.375 cents.

InnVest's no bargain right now, but it offers the more comfortable stay for the typical income-seeking trust investor. For those of a more speculative bent, there's Royal Host, the heartbreak hotel of hotel REITs.

Rob Carrick has been writing about personal finance, business and economics for more than 12 years.

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