Service Properties Trust — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Dollar amounts are in millions unless stated otherwise. Service Properties Trust (SVC) is a REIT owning hotels and service-focused retail properties. At quarter-end it owned 221 hotels and 763 net lease properties.
Financial performance and position
| Metric | Q2 2023 | Q2 2022 | Six months 2023 | Six months 2022 |
|---|---|---|---|---|
| Total revenue | $503.8 | $515.8 | $933.0 | $909.5 |
| Net income (loss) | $(11.3) | $11.4 | $14.7 | $(108.5) |
| Net income (loss) per share | $(0.07) | $0.07 | $0.09 | $(0.66) |
| Normalized FFO per share | $0.58 | $0.54 | $0.80 | $0.52 |
| Operating cash flow | Not separately provided for Q2 | $328.5 | $59.3 |
Q2 hotel operating revenue was $404.3 million and hotel operating expenses were $309.1 million, leaving a hotel operating spread of $95.2 million, or approximately 23.6% of hotel revenue, versus approximately 22.4% a year earlier. This is a simple revenue-less-expense measure, not a company-reported margin. Q2 rental income was $99.5 million. Six-month interest expense was $164.1 million, down from $182.2 million.
- Liquidity: Cash and cash equivalents were $434.9 million; restricted cash was $15.8 million. Combined cash and restricted cash were $450.6 million at June 30, compared with $45.4 million at year-end 2022.
- Debt: Principal debt was approximately $5.81 billion: $5.20 billion of senior unsecured notes and $609.5 million of net lease mortgage notes. No revolver borrowings were outstanding. Balance-sheet carrying amounts were $5.16 billion for senior notes and $554.1 million for mortgage notes, net of discounts, premiums and issuance costs.
- Debt maturity profile: $1.175 billion of senior notes mature in 2024 and $1.15 billion in 2025; mortgage notes of $609.5 million mature in 2028. The new $650 million secured revolving facility matures in June 2027, with two conditional six-month extensions.
- Distributions: SVC paid $0.20 per share in each of the first two quarters. A further $0.20 distribution was declared in July, payable in August.
Changes versus prior comparable periods
- Q2 revenue declined 2.3%, primarily because hotel sales reduced hotel revenue; higher hotel rates and RevPAR partly offset the decrease. Six-month revenue increased 2.6%, as hotel demand and pricing gains outweighed property dispositions.
- Comparable hotel RevPAR rose 2.8% in Q2 and 10.5% for the first half. Q2 comparable occupancy increased 0.3 percentage points and ADR rose 2.4%. Across all hotels, Q2 RevPAR increased 2.4% year over year.
- Q2 GAAP results shifted to a loss from income. The quarter included a $9.0 million impairment charge, a $5.2 million income tax expense and lower equity-method earnings. Q2 2022 had a $38.9 million real estate sale gain, versus no material sale gain in Q2 2023.
- First-half GAAP income improved from a $108.5 million loss to $14.7 million income, including a $48.8 million gain on TA shares and $41.8 million in real estate sale gains. Normalized FFO, a non-GAAP measure, increased to $132.3 million from $85.7 million.
- Operating cash flow rose to $328.5 million from $59.3 million, partly reflecting $188.0 million of prepaid TA rent, higher hotel returns and changes in operating liabilities. Investing cash flow was $104.0 million, including TA-related proceeds, property sales and a hotel acquisition; financing cash outflow was $27.3 million.
Transactions, outlook and risks
- TA transaction: BP acquired TravelCenters of America on May 15, 2023. SVC received approximately $379.3 million in cash, including $188.0 million of prepaid rent, $101.9 million for its TA shares and $89.4 million for TA-related tradenames and trademarks. The amended leases cover 176 travel centers, require $254 million of annual minimum rent with 2% annual increases, and expire in 2033 before extension options. TA receives $25 million of annual rent credits over the initial 10-year term; BP guarantees lease payments subject to an initial aggregate cap of approximately $3.04 billion. TA accounted for 67.6% of net lease annual minimum rent, making tenant concentration a key exposure.
- Portfolio and capital spending: Net lease occupancy was 96.1%; weighted average remaining lease term was 9.3 years. Management expected to fund $160 million of hotel capital improvements over the next 12 months using cash on hand. SVC acquired a 250-room Miami Beach hotel for $165.4 million and sold 20 properties in the first half.
- Funding and outlook: Management stated that operating cash flows, cash on hand, the revolver and potential asset or security sales are expected to meet obligations, capital needs and distributions. This is subject to economic and capital-market conditions; management cautioned that recession, higher rates, inflation or weaker tenant and hotel-manager performance could reduce cash flows, constrain financing and require a distribution reduction.
- Credit and refinancing: SVC reported compliance with debt covenants. Senior-note tests included total debt to adjusted assets of 53.1% against a 60% maximum and debt-service coverage of 1.97x against a 1.50x minimum. The filing identifies substantial 2024–2025 maturities and refinancing costs as risks. A 1-percentage-point increase in refinancing rates would add approximately $58.1 million to annual interest cost if the stated debt were refinanced at rates 1 percentage point higher.
- Other notable matters: SVC recorded a $9.0 million impairment on 16 net lease properties. It had $11.2 million of reserves for uncollectable rents, up from $7.7 million at year-end. SVC is externally managed by RMR and disclosed related-party relationships involving RMR and Sonesta; Sonesta managed 195 hotels and SVC owned approximately 34% of Sonesta. Management identified economic weakness, labor and cost inflation, hotel demand, tenant payment capacity, financing access and related-party conflicts among the risks.
Investor verification priorities
- Assess whether TA rent collection and the BP guarantee, including its cap and rent-credit mechanics, adequately mitigate the concentration in travel centers.
- Review liquidity and refinancing plans for the $1.175 billion due in 2024 and $1.15 billion due in 2025, including potential borrowing costs and covenant headroom.
- Reconcile GAAP earnings with FFO and Normalized FFO, especially the effects of TA-share valuation, asset-sale gains, impairments and other exclusions.
- Monitor hotel operating trends, capital expenditure requirements and the ability of managers and tenants to meet contractual returns and rents.
- Evaluate the sustainability of the $0.20 quarterly distribution against recurring cash generation, debt service and planned capital spending.