Description

We believe that Sotherly Hotels (SOHO) is an attractive investment opportunity. SOHO is a hotel REIT that owns twelve hotels in the Mid-Atlantic and Southern region of the United States. At current prices, on a TTM basis, SOHO has an implied cap rate of 10.0% and a dividend yield of 5.2%. In addition, due to recent renovations and portfolio brand changes, SOHO’s operating results are likely to improve materially in the future. Using the low end of management’s guidance for 2016, SOHO is currently trading at an implied forward capitalization rate of 10.9% and an AFFO yield (after subtracting maintenance capital expenditures) of 13.6%.

In 2015, SOHO made significant capital expenditures and underwent major brand changes at several of their hotels that should lead to improved operating results.  

• At their hotel in Houston, SOHO has spent $3.3 million on a $4.9 million renovation project that will be completed in the spring of 2016. Once the project is complete, the hotel will become an independent hotel affiliated with the Preferred Hotels Group. The transition to an independent hotel should improve operating margins. Under a franchise agreement, a hotel typically pays around 5.0% of room revenue as a franchise fee plus 3.5% of room revenue as marketing and reservation fee.  Under their independent model, SOHO will only pay Preferred Group 3.0% of room revenues.

• At their hotel in Laurel, Maryland, SOHO has spent $3.9 million on converting the hotel from a Holiday Inn to DoubleTree. This conversion should lead to significantly higher room rates in the future.

• At their hotel in Jacksonville, Florida, SOHO spent $6.7 million converting its hotel from Crowne Plaza to DoubleTree. This upbranding was completed in September of 2015.

• In July of 2015, SOHO acquired the 75% of Crowne Plaza Hollywood that they didn’t already own for $26.3 million. To fund the purchase, SOHO issued 3.43 million shares at $7.11.

In total, for the nine months ending September 30, 2015, SOHO spent $15.7 million in capital expenditures in addition to the $26.3 million they spent to acquire all of  Crowne Plaza Hollywood. Although these capital expenditures are likely to have a positive impact in the future, they negatively affected SOHO’s stock price and operating results in 2015. In the 3rd quarter of 2015, management estimated that renovations reduced rooms available for service by 12,500 nights. In addition, the stock offering used to fund the purchase of Crowne Plaza Hollywood was negatively received by the market place. The stock price fell from $8.25 before the offering to $6.95 the day after the offering. We believe the stock price decline has created an attractive entry point for investors.

Valuation

If you consolidate the results of the recently acquired Crowne Plaza Hollywood Hotel for the last twelve months, SOHO currently has an implied capitalization rate of 10.0%.

Using the low end of management’s guidance for 2016, SOHO has an implied capitalization rate of 10.9% and an AFFO yield of 13.6%. For my AFFO calculation, I deducted management’s estimate of maintenance capital expenditures, which is 4% of total revenues.