Lodging Fund REIT III Maps Strategic Growth

The hospitality-focused REIT outlines robust plans for diversification, while grappling with economic headwinds, operational hurdles, and an evolving exit strategy.

December 18, 2024

A Focused Growth Strategy

Lodging Fund REIT III, Inc., a hospitality-centric real estate investment trust, is carving its path in the midscale hotel market, with a focus on properties in America's Heartland. The Maryland-based REIT's annual report reveals its commitment to acquiring, managing, and eventually exiting a portfolio of high-quality hotel assets in promising U.S. markets. Operating primarily in metropolitan areas with populations exceeding 250,000, the firm targets properties under leading brands like Marriott, Hilton, and Hyatt, leveraging brand recognition for competitive advantage.

The REIT’s investment strategy is divided into three opportunity classes: Stabilized, Refresh, and Value properties. Stabilized properties are steady performers, while Refresh and Value properties require varying levels of rehabilitation to realize their full potential. The company emphasizes modest capital improvements and a balanced geographic and asset-class diversification to mitigate risks.

Financial and Operational Landscape

As of December 31, 2023, Lodging Fund REIT III owned 19 properties across diverse locations, including North Carolina, Texas, and Colorado. With an aggregate mortgage debt of $180.2 million, its leverage strategy maintains a loan-to-value ratio of approximately 57%, within its targeted range of 35% to 65%. Despite this calculated approach, the REIT faces several economic pressures, including inflationary cost increases, labor shortages, and heightened competition from vacation rental platforms.

Revenue generation hinges on hotel occupancy and average daily rates, both of which are sensitive to economic conditions. The report cites weak demand due to inflation, fluctuating interest rates, and a post-pandemic travel recovery as key risks. These factors are compounded by operational challenges, such as rising costs for property improvements and brand-mandated upgrades, which could affect profitability.

Regulatory and Legal Context

The report highlights the company’s reliance on its tax-advantaged REIT structure, which mandates distribution of at least 90% of taxable income to shareholders. However, maintaining this status comes with stringent compliance obligations, including limits on asset types and income sources.

Lodging Fund REIT III also faces scrutiny from the Securities and Exchange Commission (SEC). In a settlement finalized in August 2023, the company’s advisor agreed to pay significant penalties related to expense allocations. This has prompted tighter internal controls and the engagement of independent consultants to ensure regulatory compliance.

Exit Strategy and Forward Outlook

In May 2024, the REIT’s board authorized the pursuit of a sale or merger by 2025, contingent on favorable market conditions. This strategy includes optimizing its portfolio through acquisitions and disposals, aiming to maximize property-level profitability before executing the exit plan. However, the report cautions that factors such as rising interest rates and shifting buyer sentiment could influence the feasibility and timing of such a transaction.

While the company's near-term challenges are considerable, its diversified portfolio and adherence to top-tier hospitality brands position it well for future growth. Lodging Fund REIT III is actively navigating a complex landscape, with a clear strategy that balances risk management and growth opportunities.