Commercial real estate generally tends to be a good hedge against inflation and economic recessions. Hotels, as a sector within commercial real estate, are an operating business with a real estate component. What this means is that much of its value is derived from the proven ability to generate, and the potential to increase, income.
Hotels differ from other asset classes of commercial real estate, namely multi-family, retail, office, and industrial. This is because the operational component of a hotel adds potential risk and uncertainty, though it may also provide a wealth of additional benefits that make the investment much more attractive. Hotels also offer a way to diversify an investor’s portfolio with potential passive income.
Here are ten reasons why you should consider investing in hotels.
Hotels sell their rooms by the night. Thus, each night represents another opportunity to increase revenue. This includes the ability to mitigate inflation risk by consistently re-pricing room rates along with the ability to optimize net income for each additional room or night sold.
Sales and marketing help make hotels successful because both try targeting the right audience by strategically placing advertisements where they will receive a lot of traffic. Intangible advantages, such as loyalty to a brand, reward programs and property culture, also count toward building up a reliable revenue stream. The quality of the hotel or properties tends to spread through word of mouth, which is where an investor may expect to get the greatest value from a nightly lease.
Due to this model of leasing, hotels tend to recover quickly from a downturn. On the other hand, it is also typically the first to suffer when the economy moves in the opposite direction. A deal based on sound economic fundamentals may ensure that a hotel can weather a decline in business and come out the other side a successful investment.
Another good reason to invest in the hotel industry is its flexible expenses. You can negotiate with suppliers to keep expenses at a certain price point while revenue increases. As revenue improves, the cost to service the hotel doesn’t necessarily increase. This provides a healthy increasing profit stream.
The Uniform System of Accounts for the Lodging Industry (USALI) separates expenses into three categories: departmental, undistributed, and fixed. The profit lines that follow each category represent varying levels of control over these expenses.
Departmental expenses are the cost of goods sold. This is what it costs to service the rooms, food and beverage, and other departmental sales. Most of these expenses are related to labor and goods and services.
Undistributed expenses are related to the cost of operating the hotel. Management, maintenance and sales-related expenses fall under this category. They relate more to outside goods and services, compared to labor.
Fixed expenses are expenses that the hotel incurs regardless of occupancy or revenue, such as property taxes and the cost of tv and internet services. As you move further down the financial statement for a hotel property, the expenses become more and more fixed. Some expenses are “sticky,” meaning they are set by outside market forces, such as wages and utilities. Still, most are more flexible.
High potential yield is one of the biggest reasons investors choose hotels, especially experienced commercial real estate investors. Statistics show that hotels tend to trade at a higher cap rate than other assets in the same real estate category. One disadvantage is the potential for higher risks.
These risks include the fact that the hospitality business tends to be seasonal, which can make room rates and thus the rate of returns, volatile. This is particularly true for places that rely on seasonal tourism, such as ski resorts or beaches. Add to this the highly variable room rates, taxes, and the nearby hotel market, which can make accurately predicting the ROI a bit more difficult than it would be for other commercial properties.
An experienced investor would benefit from understanding the risks and constantly work to optimize the advantages of hotels, such as adjusting room rates based on the market, while trying to mitigate disadvantages. Successful hotel investment managers, for example, tend to have experience in hotel operations or hotel asset management. This allows them to understand the needs of the property and its operations.
Depreciation and equity growth through refinancing are some of the biggest benefits that come from commercial real estate investment. This applies to hotels as well, though they may not seem like a traditional commercial real estate asset.
One of the most useful benefits for hotels is depreciation. Hotel investments have a variety of real, personal, and intangible property, meaning they may benefit from more tax laws, which may accelerate depreciation.
Equity growth is also important, but one of the most significant tax benefits comes in recapitalizing the investment. Cash equity pulled from a debt refinance is not subject to federal income taxes, which allows the investor to increase their capital gains. Minor tweaks to a hotel’s operations may boost this cash flow and add value, benefiting from this tax incentive.
Another facet of these tax benefits is the ability to segregate costs. Hotel investments are comprised of three major tax categories: building, FF&E (furnishings and equipment), and goodwill. The first two, building and FF&E, are physical assets. Goodwill refers to the intangible value given to customer loyalty, employee relations, and other intangible factors that make a hotel successful.
Each of the physical assets have different depreciation schedules. Some even have subcategories with their own depreciation schedules depending on government policies. A hotel’s operational and capital-intensive nature allows them to take advantage of many bonus depreciation policies not available to other commercial real estate assets.
Cost segregation is a tax deferral strategy that allows an investor to accelerate depreciation deductions in the early years of ownership, which is an important aspect of potentially increasing after-tax income.
Hotels’ primary source of value is their operations. These activities may be enhanced or reduced to meet demand, trends, the current economy and other factors. This adaptability makes hotel properties an attractive asset, as investors can adjust different operations to suit their investment needs and add value to the property. Whether it means cutting back on expenses in some categories, taking advantage of the price of construction to make enhancements to the property, or finding ways to improve guests’ experiences while being cost effective, investors can choose the strategy that best fits.
There are four areas of value enhancement in a hotel.
Capitalization: An investor makes money when they buy but would benefit from ensuring the capital stack supports their investment objectives, whether it’s through disbursements or profits at sale or both. This means they need to make sure the capital stack is structured appropriately in order to make everything more cost-efficient, which may increase the ROI of the property.
Renovation: Standards for hotel interiors, styles, and amenities are constantly changing. In many cases, these are simple aesthetic modifications, but having an experienced hotel management team committed to keeping up with current trends and designs may help in ensuring a steady flow of income over the long term. Hotel chains, such as Hilton or Marriott, can also request certain renovations to maintain their brand. These are called property improvement plans.
Operations: Hotel management is a people operation. Customer loyalty has a major influence over the ability of the hotel to increase revenue while minimizing its costs. This includes employee levels of engagement, or how the employees engage with customers, as well as the relationship these workers have with management. By fostering a good working environment, both the customers and worker benefit and the business profits. Many enhancements designed to improve customer experience and employees’ service also tend to be free or inexpensive.
Contract Positioning: Hotels need a wide variety of sales and service contracts with quality operating partners to ensure high quality operations. Brand licensing agreements and certain maintenance agreements may have an impact on revenue and profitability. This enhancement overlaps with flexible expenses. Savvy investors may negotiate contracts and the expenses associated with them to benefit the property and its revenue. This, in turn, adds value to the investment as it potentially offers a higher ROI.
An experienced investment manager or investor benefits from trying to balance the influence of each of these factors and use them to an advantage, while also determining where each hotel requires the most attention. Even the smallest feature can potentially increase a hotel’s income, allowing the investor to profit from an increase in property value while multiplying in-place cash flow.
Labor can make up a lot of a hotel’s running costs. To run the business effectively, it requires a lot of people, most of whom tend to be residents of the local neighborhood and surrounding areas.
Hotels have the potential to make a large impact on the job market and local economy. They provide a workplace, temporary housing for visitors, families, and businesses.Full-service hotels also provide social and business gathering spaces, presenting an opportunity for individuals to relax and reconnect with those they care about. The most successful brands benefit from extending the hotel’s ability to create community beyond the walls of their property. Often, they do this by actively involving themselves in community development, building a community that is consistent with their company beliefs and those of their guests
While there are obvious financial benefits to investing a hotel, an overlooked benefit is the ability to experience a hotel’s service in person. Even the simplest hotels provide a private space to stay and enough amenities to make your stay comfortable. Guests have a place to relax, or they can choose to visit different restaurants, gyms, and other facilities.
The pandemic has also led to new and innovative ways to improve the comfort of hotel stays. This included encouraging business travelers to work from “home” at the best rooms their establishment had to offer, all while taking advantage of packages that included room service and a health or fitness plan. Some properties chose to focus strongly on client communication, which could help build rapport and a loyal client base. Another important change also included accommodating pandemic requirements so that guests could easily order food, laundry services, and check in or out with contactless payments and technology.
Strictly financial investments tend to be intangible. Even some commercial real estate investments can seem intangible if you do not oversee them yourself. Hotels, however, offer the ability to visit and stay as a guest, and experience the worth of the investment.
Investing in CRE isn’t always about cash flow and equity profits. There are other, less risky ways to make money if an investor chooses to pursue those paths. Many investors, however, like investing in hotels for the challenge.
Hotels can be one of the more challenging real estate asset classes for an investor because every level of investment, passive or active, requires some due diligence. Investors tend to thoroughly investigate all factors that can impact the hotel’s operation, especially external, market-related factors.
For some investors, the final reason is simply because they love investing in more niche categories. They value investing in less popular, but still potentially profitable, assets. It allows them to diversify their portfolio across industries within commercial real estate. They also become knowledgeable about investing in hotels, which may establish them as experts in this investment class.
To further add to the appeal of the hotel industry, properties nationwide have weathered the recent pandemic and are expected to grow as recovery continues. Though this drop in revenue over the past couple of years may seem detrimental, it presented a unique opportunity for investors to add hotel properties to their portfolio while these assets were less expensive. The hotel industry is recovering as the demand for leisure and business travel increases, which may improve the overall performance of any hotel assets an investor has in their portfolio.
Avistone is a fast-growing commercial real estate investment firm that focuses on the acquisition and asset management of hotel properties and the acquisition and operation of multi-tenant flex properties nationwide. Accredited investors have the opportunity to purchase equity shares with the potential to receive distributions from in-place cash flow and capital appreciation upon sale.
Additionally, as one of the keys to our successful investment strategy, we focus on asset and property management that provides superior service to tenants and guests. Since our founding in 2013, we have acquired 26 commercial and hotel properties in California, Georgia, Texas, Florida, and Ohio, totaling more than 4 million square feet.