Sunstone Hotel Investors: Should You Buy The 2.76% Commons Dividend Yield? (NYSE:SHO)

Who is buying the common shares of Sunstone Hotel Investors (NYSE:SHO)? The hotel REIT last declared a quarterly cash dividend of $0.07 per share, unchanged sequentially, for a 2.76% annualized forward dividend yield. The REIT also declared a $0.06 per share supplemental for the fourth quarter, an incremental yield of roughly 60 basis points. SHO gutted its dividend in the aftermath of pandemic stay-at-home orders, but the distribution has since recovered to outperform the 5 cents per share pre-pandemic payout. Critically, the aggregate dividend yield at 3.36% is 239 basis points lower than CDs, which currently offer rates of up to 5.75%.

advance, SHO is currently trading at 11x its price to annualized adjusted forward funds from operations. Third quarter AFFO was $0.23 per share, $0.92 per share annualized. This isn’t exactly cheap, with its peers trading at substantially lower multiples. For example, RLJ Lodging (RLJ) is trading at 6.7x its annualized third-quarter AFFO with Pebblebrook Hotel Trust (PEB) trading at 5.45x its annualized third-quarter AFFO. SHO owned 14 hotels and 6,675 rooms at the end of its third quarter, with these split between resort, convention, and urban hotels. The REIT also has roughly 16% of its hotels on leasehold ownership.

AFFO, Comparable RevPAR, Occupancy, And Debt Maturities

SHO recorded fiscal 2023 third-quarter revenue of $247.7 million, up 1.4% from its year-ago comp and a beat of $6.81 million on analyst consensus. The REIT recorded revenue per available room of $222.54, flat versus the prior year with occupancy at 72.8%, up 140 basis points versus 71.4% in the year-ago period. SHO’s average daily rate at $305.69 was also down $5.93 from its year-ago comp. AFFO at $0.23 decreased 4.2% versus its year-ago figure but outperformed by 2 cents the top range of initial guidance of AFFO to be $0.18 to $0.21 per share.

The REIT is paying out around 30.4% of AFFO as a dividend, an incredibly low payout ratio and far below the 90% requirement for REITs. However, SHO has been buying back shares heavily, with its diluted weighted average shares outstanding of 205,782,000 at the end of the third quarter down 2.61% over its year-ago period. SHO has repurchased $38 million of its shares year-to-date at a blended price of $9.26 per share. The REIT’s debt maturities are also somewhat decent, with just $74.6 million from a mortgage loan tied to its JW Mariott New Orleans property coming due in December 2024.

The Chicago Mercantile Exchange’s 30-Day Fed Funds futures pricing data is currently pricing in a majority 29.8% probability that the Fed funds rate, currently at 5.25% to 5.50%, would have been cut by at least 125 basis points by this time. Whilst this should make refinancing easier, SHO has also been actively disposing of some assets and held cash and equivalents of $113.8 million at the end of the third quarter. The REIT disposed of its 1,060-room Boston Park Plaza for $370 million in October, roughly $350,000 per key and at a 7.1% cap rate.

NAV And The Preferreds

SHO’s GAAP net asset value at the end of the third quarter came in at $1.8 billion, around $8.79 per share, and up from $8.61 per share in the year-ago period. The commons are currently trading hands for $10 per share, around a 14.4% premium to NAV per share. The overall trajectory of NAV over the last 5 years has also been down which when considered against the constrained dividend profile heavily reduces the appeal of the common shares.

The preferreds form the better consideration here from a total return perspective. SHO has two outstanding preferreds; Series H (NYSE:SHO.PR.H) and Series I (NYSE:SHO.PR.I). The H series is currently swapping hands for $21.19 per share, around a 15% discount on its $25 par value. It comes with a 7.2% yield on cost and has roughly two and a half years left until it comes up for redemption on 24 May 2026.

The combination of a double-digit discount to par value and a dividend yield that is far in excess of the commons renders the preferreds a better consideration. The commons are not exactly cheap at 11x its price to annualized AFFO and the 14.4% premium to third quarter NAV per share. The strong dividend coverage does infer a possible raise next year, but this is not a certainty with SHO likely to prioritize dividend buybacks in the near term. I’m rating the common shares a hold.