In today’s age, the idea of investments is more prevalent than ever. The deep desire to create a better life has made investing more accessible for everyone. We see online advertisements and content on how to buy securities through brokerage accounts, start your own small business, and invest in real estate.
I have been seeing a lot of information about real estate investing on social media, and I wanted to share my thoughts and insights.
First and foremost, I want to stress that real estate is a vast industry. There are many different kinds of real estate investments, from residential real estate, like single-family homes and apartments, to commercial real estate, like offices or industrial parks, and even crazier niche investments, like billboards and telecom towers.
Today, I want to focus on one of the lesser-known pieces of real estate that I have experience with: Hotels.
How hotels are similar to traditional real estate
Hello, everyone. My name is Aarya, and I, along with my partner Ronak, manage five hotels worth approximately 40 million dollars. Before investing in a hotel, here are some things to know.
Hotels are found in every community in the United States, from small towns with less than 2,000 people to bustling metropolitan cities. Just like most other real estate, hotels can produce a return for investors in four main ways:
Cash Flow - profit made by renting out hotel rooms and servicing other auxiliary amenities like selling snacks, running a restaurant, and renting out banquet halls. Some hotels, especially on the luxury side, have many different types of auxiliary amenities (coffee shops, bars, spas, water parks, etc.).
Appreciation - increasing property value by maximizing profit, either by adding value to the property or by allowing inflation to grow revenues faster than expenses over time.
Mortgage Paydown - If the property is cash flow positive and bought using debt, investors pay down their real estate using income generated from the deal rather than money out of pocket.
Depreciation - a non-cash loss that the Internal Revenue Service allows on real estate in order to bring down an investor's tax bill. Be aware this is just deferring taxes; you will have to pay taxes on potential gains. However, there are strategies to postpone the process to a lower basis. For more information on depreciation, click here on our other blog: (insert link).
How hotels are different from traditional real estate
Hotels also have some significant differences compared to most real estate. An investor must consider these distinctions before choosing to invest in hotels. Here are the three biggest differences I have experienced:
The Business Component:
Hotels are a different business than traditional real estate. Typically, real estate cash flow is generated by leasing the property for more than 30 days and providing minimal services to tenants. The value in most real estate industries is giving renters their own space for their needs, such as housing or business.
In the hospitality industry, however, we are selling an experience to our guests, and therefore we need to be more hands-on. Think about when you go to a hotel. You want to be taken care of by the staff. You want to be served a clean room and a hot breakfast and have people who can help you with any issues you may have. Because of this more hands-on model, hotels have more operational complexity than traditional real estate. Depending on the size of our hotels, we have anywhere between 25 and 50 team members to serve our esteemed guests. In comparison, a similar-sized multifamily project has a staff of 5-6 people.
When considering whether to invest in hotels or even Airbnb, consider the complicated nature of running them. You will have to manage your staff and deal with the constant inflow and outflow of guests.
Higher Cash Flows
Because hotels require a more complicated, or rather demanding, business model, there is a higher reward. Here is a chart showing hospitality versus other traditional real estate median sold cap rates.
This graph, created according to Crexi Intelligence Insights, shows that the median sold cap rate for hospitality assets is approximately 9.7%. Comparatively, the multifamily median sold cap rate is 5.6%, the office median sold cap rate is 7.3%, the industrial median sold cap rate is 7.2%, retail is at 6.4%, and self-storage is at 6.9%.
The return on investment varies significantly depending on the market you are looking at. Feel free to reach out to us here if you have a question about a specific market. We can provide you with an in-depth analysis for free.
Hotel real estate investments offer attractive cash flow, but potential investors must weigh the property's management demands and market risks against its promising returns. There are ways for investors to take precautionary measures against both risk and complexity; read (COMING SOON) for how to do that.
Revenue Opportunities… or Risk?
In traditional real estate, income is tied to market rates and lease terms. For example, if you own a residential rental property, you can only collect rents that the market allows, and you must adhere to the lease duration, even if market rents rise. Though this provides revenue predictability, it also limits income and, thus, returns.
In hospitality, it is a little different. Not only can we change the price at a moment’s notice, but we can also try to capture more income from both our primary and adjacent markets. Year over year, hotel revenues are more dynamic because of the waves that travel causes.
The fluid and nuanced nature of revenues allows us to buy in strong markets and get outsized returns by advertising and promoting a superior product. However, it can also swing the other way. If you buy in a market where there is a one-time business that will never come back or is declining, then you are condemning your investment. Yes, we learned this the hard way (we have bounced back since then).
Hotels as a Real Estate Investment Conclusion
Ultimately, many investments are successful for different reasons and different people. You must outline the goals for your money and then consider which investment vehicle will most effectively help you get there. We have found that hotels are an excellent investment for those looking for higher cash-flow returns with proportional lower risk.