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Investing into operating hotels – The Next Big Thing?

by maria
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The UK, EU and US property investors’ investment in operating hotels has steadily increased in popularity over the past c. 10 years, owing largely to the Global Financial Crisis of 2007-2008. Interest rates in these three geographies crashed to 0%, and in some cases, even moved into negative territory.  This resulted in property investment yields dropping to historically low figures, roughly halving from their peak yields prior to the crisis.

The majority of investors seek out yield when making their investment, and while buying a piece of real estate yielding 4% might be acceptable for the annuity funds, it is generally not interesting for the more active investor who will be seeking an annual compound return of c. 10%, or higher; hence they have had to move up the risk curve.

Subsequently, over the past c. 10 years, property investors have started buying hotels to manage them because (a) they still own the underlying real estate and there should be a natural floor to the value of the investment if something was to go wrong; (b) at the same time, the profit from the hotel should be a higher than the rent they would get if they let the property to a hotel manager; and (c) there are a lot of good white label hotel operators in the market an owner of a hotel can use to help them – in fact, the majority of Hilton, Marriott, IHG etc hotels are not run by the hotel companies anymore, they are run by a hotel operator under a franchise agreement with the hotel brand.  Therefore, the risk-adjusted return from owning and running a hotel should give a better return on your investment vs letting the hotel to an operator.

What is Hotel Property investment?

Hotel property investment is buying a hotel real estate asset in exchange for either (a) an annual rent; or (b) an operating yield.  Drawing comparison between the two at this moment in time (August 2021) in the UK for example, if an investor were to purchase a leased Premier Inn hotel (a limited-service hotel run and managed by Whitbread plc), the price you would need to pay would mean you would generate a c. 4% yield.  Whereas, if an investor were to purchase a similar hotel such as a Hampton by Hilton, or a Courtyard by Marriott or a Holiday Inn Express, appointing a manager to run the hotel under a franchise agreement, you would probably generate a c. 7% yield.

Unsurprisingly the higher yield comes at a higher risk. The investors return is linked to the performance of the hotel, and as we have seen during the Covid pandemic, hotels can be loss-making, whereas a tenant must keep paying their rent obligations regardless of the performance of the underlying hotel trade.

However, in normal times, the advantage hotels have over other types of leased property investment is their response rate. They can change their prices almost daily to match external factors, which can work heavily in their favour.  If demand is high, they can increase prices to maximise profit, and if demand is low, they can lower prices and use promotions to generate more interest. This makes them highly adaptable.

In order to deliver the results, like any other trading business, you must have a good manager running the hotel.

Hotel Managers

If you are going to invest in an operating hotel, one of the key decisions that will have to be taken is choosing who is going to manage the hotel.  The big brands do manage hotels but they have moved away from running hotels as their core business to being brand companies.  At the time of writing, Hilton has 18 different hotel brands, IHG 16, Marriot 30 and Accor a massive 35 different hotel brands.

Further, a lot of owners are of the view that a brand managing a hotel puts them into a conflict of interest.  This is because a white-label operator will be employed to maximise the profit from the hotel while remaining compliant with the brand standard.  Whereas the brand owner managing the hotel will also be interested in maximising the value of their brand and hence may do something which does not maximise the profit of the hotel but enhances the value of the brand.

It is of course possible to manage the hotel yourself, but unless you are going to invest in a number of operating hotels, it probably does not make economic sense to recruit your own management platform.

Other factors to consider

In addition to who is going to manage your hotel, other factors to consider are:

  1. In addition to hotel management, other factors to consider are:-
  2. Is the location a year-round location or seasonal?
  3. Is the hotel going to focus on rooms, or will it offer other services such as bars, restaurants, gym, spa, golf, meeting and events etc?
  4. What brand, if any, are you going to put on to the hotel?  Do they have many other similar branded properties in the location?
  5. Who is your target market and is the hotel going to be a full-service luxury, limited service budget, extended stay or something in between?
  6. What competition is already in your market?  Can the market take another property in that location?
  7. Availability of labour?
  8. Any tax benefits?

To Summarise

Investing in operating hotels vs. leased hotels does significantly increase the risk of your investment as you are investing in a trading business without the certainty of regular cash flow available through a lease.  The current pandemic has shown that no matter how much you prepare for uncertainty, something can come along and turn the business into a loss making business and it is expensive to keep a hotel shut.  However, as we adapt, grow and learn from the pandemic, well-managed hotels that focus on the risks and put inadequate protections against these risks should start to generate a greater yield than if the hotel was let to an operator.

If you are thinking of investing in operating hotels, you must consider the points listed above; managing these risks upfront will help protect the value of your investment.

And enjoy yourself, there is a reason why the sector is called hospitality… because everyone working in it is very hospitable.

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