When you think about investing in real estate, what comes to mind?
- Single family homes?
- Office space?
- Self storage?
But what about a hotel investment? That’s right, the hotel industry.
In 2020, the pandemic caused a major disruption within the travel industry. Hotels saw their occupancy rates drop to single digits.
Up until that point, I’d only invested in multifamily property and had never considered a hotel investment.
If you perform an online search, you’ll notice that there’s not much general information about how to buy and sell hotel properties.
Unfortunately during the pandemic, many hotel owners had to sell their property which opened up opportunities within this asset class.
“In the midst of every crisis, lies great opportunity” – Albert Einstein.
After performing research, I found that hotels offer investors the opportunity to further diversify their real estate portfolios while generating potentially attractive returns.
In 2021, I decided to attempt to capitalize on the opportunity with this property type and made not one but two hotel investments.
If you’re wanting to learn how to become a hotel investor, consider taking the time to understand how they actually function as investments.
Here are 5 things you should know before investing in the hotel sector.
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5 Things You Should Know About a Hotel Investment
#1. Variable pricing
One of the main differences between hotels and other commercial real estate is based on the pricing structure. Regarding hotel operations, the owners typically rent out a hotel room on a daily or nightly basis.
On the other hand, office, retail and multifamily tenants generally sign leases that range from one year for an apartment to up to 10 years for an office.
With hotel property, you may see an increase in the cost to book a room during a holiday weekend or if a large local event is happening (concert, sports, etc.), whereas the same room would cost less off-season or even mid-week.
The hotel’s ability to instantly respond to changes in the local market is a big plus. Hotels are able to adjust daily rates to quickly capture benefits of a tight market or lower the risks of a day or month with lower occupancy.
This flexibility allows hotel investments the opportunity to benefit from capital improvements and operational enhancements much faster than other sectors.
But as quickly as hotel operators can increase rates, they may find the need to lower rates while experiencing market disruptions such as:
- increased competition
- weakening in the local economy
- during a pandemic
#2. The 5 different hotel categories
Typically hotels fall into 5 main categories which are defined by the services and amenities they offer. But also keep in mind that the hotel brand may also play a defining role.
Here’s an overview of each:
a. Full service
Luxury hotels and resorts such as Ritz Carlton, Four Seasons, St. Regis and Montage fall into the full service category.
They’re typically known for providing their guests with a variety of services and amenities such as:
- spa/fitness center
- meeting rooms
- banquet space
- on-site restaurants/retail
These hotels heavily depend on their competitive positioning of their amenities and service and also rely on a large staff.
b. Limited service
When you think of limited service hotels, these are the Hampton Inn, Comfort Inn, and Holiday Inn Express hotels.
Most of these do not have a restaurant but still provide certain services and amenities such as:
- fitness center
- limited meeting space
You can expect to encounter a smaller number of staff at these types of hotels.
c. Select service
Hotels within this category were created to bridge the widening gap between full and limited service hotel offerings.
They adhere to the same core principles of Limited service category, though they have a subset of the services and amenities characteristic of a Full-service property such as:
- a scaled-back restaurant offering
- banquet facilities
Examples in this category are Hilton Garden Inn and Courtyard by Marriott Hotel.
d. Extended stay
These hotels were designed with longer-term guests in mind such as those needing temporary housing or business travelers on long assignments.
Most offer larger rooms with access to a kitchen and laundry with discounted rates on longer stays.
Brands within this category include:
- Extended Stay America
- Homewood Suites
- Embassy Suites
Budget hotels are just what they sound like, lower cost lodging for people on a tight budget.
These hotels offer few services and amenities with the more popular brands are:
- Super 8
- Days Inn
#3. Key metrics to understand
Before considering to invest in the hospitality space, it’s important to be aware of the key performance indicators (KPI) involved.
The 3 main ones are:
- ADR (average daily rate)
- RevPAR (revenue per available room)
The number of rooms that are sold divided by the total number of available rooms is the occupancy rate.
This measures the utilization of a property’s available capacity.
b. Average daily rate (ADR)
Average daily rate (average rate) or ADR is calculated by dividing the total room revenue for all rooms by the number of room actually sold.
- ADR= Room Revenue/Rooms Sold
This is especially helpful when assessing pricing levels.
RevPAR or revenue per available room is a metric that provides information regarding rooms being sold and how much revenue is being generated from those bookings.
This helps operators measure their revenue generating performance to accurately price rooms.
If the RevPAR is increasing, it could mean the average room rate or occupancy rate is increasing – or both.
To calculate RevPAR, multiply the average daily rate (ADR) by the occupancy rate.
- RevPAR=ADR x Occupancy Rate
For example if a hotel is occupied at 80% with an ADR of $100, the RevPAR will be $80.
RevPAR complements ADR because while ADR only considers the average rate of rooms sold. RevPar takes into consideration the number of rooms that were actually occupied at that rate over a given period.
Even though operators use daily, weekly, monthly and annual RevPAR trends to see what’s impacting their hotel’s performance, an even better way is to compare the RevPAR over the last year to the RevPAR of competitor hotels.
This can provide a powerful metric for analyzing the performance and competitiveness of any hotel over a given period.
In the hotel world, the owners and operators focus a lot on the performance of their “competitive set”.
This is due to the fact that hotel guests tend to make lodging decisions in real-time and weigh factors such as:
Usually their decisions are relative to certain moving demand drivers (events, offices, restaurants, etc.).Join the Passive Investors Circle
#4. Drivers to hotel real estate success
Before I invested in the hotel space, I thought the majority of hotel demand was based on the tourism sector. That’s one part of it.
The other part relies heavily on the business traveler.
While tourists typically increase weekend and holiday season demand, it’s the business travel that boosts demand Sunday through Thursday.
Something else to consider is the local market the hotel is located in. Local attractions such as popular venues, universities (LSU!) and waterparks can offer unique demand drivers to their respective markets.
We love to snow ski and notice that our favorite Colorado resort in Beavercreek experiences peak occupancies during the winter, while hotels near convention centers can expect high demand during key events.
Another way to help drive top-line revenues is to ensure a quality operating team is in place as the hotel management team plays a major role in operations.
#5. How to get started
One of the first steps to take before investing (in any type of real estate) is to figure out whether you want to become an active or passive investor.
Related article: Active vs Passive Real Estate Investing – 5 Factors To Consider
By doing this, you’ll be able to choose from the main 3 ways to invest below:
a. Hotel REITs (real estate investment trust)
REITs are real estate investments that are an easy method a busy, high-income professional can passively invest in real estate.
When investing in a REIT, you’re purchasing stock in a company that invests in commercial real estate. This can be either public or private.
Typically REITs specialize in one particular property sector such as:
- lodging REITs
- resort REITs
One of the advantages that attracts investors to this type of investment is you’re able to buy or sell shares at anytime making your money liquid.
b. Direct purchase
As you can imagine, purchasing a hotel yourself would require hundreds of thousands or millions of dollars of capital and a source that would be willing to finance the debt.
Most professionals would have a hard time with a direct purchase as being an active investor as your main responsibility would be managing the daily operations.
This option would appeal to the busy professional that wants to focus their time doing what they do best yet still invest in a hotel business.
Hotel syndications are set up similar to apartment syndications as there’s the sponsor (GP – general partner) and passive investors (LP – limited partner).
The sponsor (hotel ownership group) are the ones that would identify, purchase and eventually manage all of the hotel operations.
As with most syndications, these deals are for accredited investors with an initial investment of $50,000 – $75,000.
The limited partners simply kick back and receive quarterly distribution checks during the hold period (5-7 years).
If you want to learn more, check out this video where I go into more detail about hotel investing:Join the Passive Investors Circle
Performing due diligence with the sponsor of any hotel syndication is the #1 consideration.
Related article: 7 Ways To Evaluate a Real Estate Sponsor
A great way hotel investors can accomplish this is to seek those with a solid track record. Consider asking for a list of current and previous investors to interview regarding their experience with the sponsor in question.
Important question to ask:
- “How many deals have they had go full cycle?”
- “What were the realized returns versus the projected returns?”
Any additional information they can provide regarding previous deals will allow you to better vet them.
Remember, these people will be your investment partners for the next 5-7 years so finding likable and trustworthy individuals will go a long way.