As you look at the current landscape and wonder about the long-term effects of Covid on the economy, you may be tempted to look up recession-resistant real estate investments and start bolstering your finances for the next big dip.
Commercial real estate in general is a great hedge against a potential recession, but in this article, we’ll explore why investing in hotels is an excellent move toward diversification that will also give you a high chance of passive income success during the next economic downturn.
First, we’ll start with five things you should know about the US hotel industry – what they’ve implemented over the past two years to improve consumer confidence and retain business, even during the lockdown.
Then, we’ll walk together through ten reasons why investing in hotel properties should be at the top of your list, even during times of recession suspicion!
You’ve had a poor experience in a hotel, haven’t you?
And I bet you’ve also experienced an excellent hotel visit too! Some of the not-so-obvious reasons for the stark contrast between those two experiences might be brought to light here and make you think twice about expanding your investing horizons toward hotels.
5 Things Real Estate Investors Should Know About How The Hotel Industry Rose To The Challenge In 2020
Hotels are different from more traditional commercial real estate categories like multifamily, mobile home parks, and office space because the way they make money is completely different than that of any other category. So, during any economic dip, whether it be limited to the local economy from a negative news story or across the nation due to the recent pandemic, hotel management gets creative about revenue streams, services available to guests, and cost structure.
It’s no secret that Covid_19 drastically changed human behavior across the US, and that the decline in travel drastically affected hotels and the travel industry nationwide. But what’s interesting is how the hotel industry adapted to win customers back, provide people peace of mind, and instill travel confidence in consumers.
Clean Stay Initiatives Were Implemented
The American Hotel and Lodging Association (AH&LA) was the first to take charge of developing industry-wide hotel cleaning and safety standards, recognizing that the hotel business is largely a human contact business with numerous guest and employee touchpoints. The “Safe Stay” program was created based on CDC standards and has since been implemented across the country.
Attractive Packages And Partnerships Were Created
The operators and asset managers of the travel industries recognized they needed to replace the jobs that were formerly filled by large gatherings and conventions. As a result, they marketed “staycations” with food and beverage offerings to locals and established partnerships with hospitals to accommodate healthcare workers. Many hotels also embraced the concept of working from home, encouraging business travelers to work from their top line rooms while taking advantage of packages including room service and a health or fitness plan.
Revenue Strategy Got A Makeover
Revenue managers were forced to evaluate which strategies and marketing techniques really drive income. Discounts, for example, did not result in greater occupancy, but rather a stronger focus on client communication resulted in unrivaled rapport with clients, resulting in return business.
In 2020, hotel management learned that relying on historical data is no longer enough. When predicting future trends, it’s vital to rely on market intelligence sources rather than historic data. It’s become more essential than ever to understand different market segments, their travel motives, behavior, value perception, and more.
Existing Spaces Were Reimagined
Next, hotel owners were required to reimagine what a socially distanced, safe stay would really look like for customers. This led to an unprecedented degree of versatility, reduced contact, and increased technology and convenience being implemented in every nook and cranny possible.
Furniture was rearranged, bathrooms were remodeled, and outdoor spaces were revived so that new functions could be carried out in the same physical space. Contactless payments for food orders, laundry services, and check-in/out were all made possible using cutting-edge technology.
Operating Expenses Were Thinned
Finally, as I’m sure you can assume, hotels reacted quickly to the decrease in expected travelers by slashing internal expenses wherever possible. Sometimes those choices were easy because cutting costs on fitness center updates, FF&E room upgrades, and designer-inspired furniture observably took the back seat to expenditures on sanitation equipment, air filtration systems, and reconfiguring food and beverage delivery. But sometimes trimming operating expenses was tough, like when deciding whether to furlough or lay off employees, deciding what benefits and severances to provide, and dealing with union issues.
By analyzing their contracts with marketers, operators, lenders, and service providers, asset managers were able to reduce expenses. It was critical that they defer payments, avoid fees, waive minimum order or contribution standards, and accommodate to payment strategies in coordination with their industry partners in order for everyone to survive through the downturn.
Now that hotels across the US have risen to the challenge of facing the Covid_19 Pandemic by implementing these five sweeping adaptations, they are a fresh and relevant lean running machine, ready to weather whatever is on the horizon.
The performance of a hotel is not linked to the stock market or other real estate trends, making them an appealing investment right now.
10 Reasons Hotels Should Be Your Next Real Estate Investment Move
A hotel is more than a potentially profitable piece of real estate in that it’s an actively functioning (24 hours a day, 7 days a week) operating business with a real estate component. Hotels derive most of their value from the proven ability to generate cash and the potential to increase income. In fact, the hotel’s robust operational nature is one of the primary reasons you want a hotel as a part of your real estate portfolio.
In a few ways, hotel investment differs from the Big Four commercial real estate asset classes – multifamily, office, industrial, and retail. The operational element adds risk and uncertainty, but it also offers a slew of additional perks that make hotel investing more appealing.
The following factors are only a starting point for why you should invest in hotels. Any seasoned hotel investor could easily add another ten or more reasons to this list.
Reason #1 – Nightly Stays
The majority of a hotel’s income is generated by individuals who rent one or more rooms on a nightly basis. They might require just one night’s lodging or two weeks’ accommodation. Every night is another chance to boost income. The issue comes in optimizing each additional night’s net earnings per room sold.
The technical success of a hotel is determined by marketing and sales. It’s simple to attract the proper audience by utilizing advertisements and collaborating with nearby activities and convention centers to increase the number of visitors staying at your hotel. The intangible assets, such as loyalty, guest experience, and property culture, are what keep guests talking about their experiences with you and bringing friends back to stay – the most crucial ingredient of any revenue stream.
Real estate is the first to bounce back from a recession, but it’s also the first to suffer if the economy goes in the opposite direction. To ensure that the hotel can withstand a decrease in demand (like during recent months) and yet remain profitable, an excellent investment opportunity in real estate must be based on strong economic fundamentals.
Reason #2 – Expense Structure
The Departmental, Undistributed, and Fixed categories in the USALI standard hotel financial statement distinguish costs into three groups. The profit lines that follow each of these represent varying degrees of control over them.
The cost of goods sold is a departmental expense. This category covers the costs associated with servicing rooms, offering food and drink services to visitors, and other departmental sales. The majority of these costs are associated with labor, while the remainder is composed of supplies and services.
Undistributed costs include management, maintenance, sales-related expenses, and other generally required administrative-type costs. Outside goods and service expenses exceed labor costs in this category.
Fixed expenses are incurred whether or not the hotel is full or profitable. Property taxes, site fees, and energy bills are examples of this category.
As you can see, these costs increase in “stickiness” as you go down the financial statement. Wages and utilities are examples of expenses that are rather fixed and governed by external market forces, although the majority are subject to negotiation.
One of the most compelling reasons to invest in hotel real estate is hotel administration can negotiate with providers, reducing operational costs while revenue grows on another track. As revenue rises, the cost to maintain the hotel doesn’t go up drastically, allowing for a healthy profit margin.
Reason #3 – High Risk-Adjusted Return
High yield is one of the most frequently cited reasons for real estate investors to invest in hotels. Across the board, hotel cap rates are greater than those of other business real estate assets. They do, however, carry a higher level of risk to manage.
Any seasoned investment manager understands the risks and is always on the lookout for ways to minimize the downside while increasing the upside.
The most competent hotel investment managers have considerable knowledge of both hotel operations and hotel asset management, as well as a thorough understanding of how to assist the real estate and operations aspects of the company.
Reason #4 – Tax Benefits
If you’re already a real estate investor or have been hanging around for a while, you know that direct real estate ownership is one of the most tax-efficient methods of investing available. The top three advantages of direct property ownership in business real estate are depreciation, equity growth, and tax-deferred exchange. Hotels take these three advantages to another level, as they combine all three of them.
Through use and deterioration, real estate depreciates in value. So, United States tax law allows investors/owners to apply a depreciation expense schedule over a specified period to offset taxable income. Hotel investments are unique since they incorporate real, personal, and intangible property. As a result, investors do not only get the tax benefits and depreciation limitations for real estate, but also those for personal and intangible property.
The most significant tax benefit to investors is realized during a cash-out refinance, which is why equity growth is so essential. When cash equity is taken out during debt refinancing and capital paid out to investors, the funds are not taxed at the federal level. So, as part of the business plan, management may make minor changes to a hotel’s operations in order to improve cash flow and provide huge value, allowing investors to benefit from equity without paying tax on it.
Finally, a 1031 exchange is the hallmark of any successful real estate empire. When you defer capital gains taxes by immediately rolling your funds into another “like-kind” piece of investment real estate, you’re increasing your income potential and centralizing operations into a single, large-scale property.
Flip four green houses to build a red hotel on your lot, just like in the game of Monopoly, right?
Reason #5 – Cost Segregation
Hotel investments are divided into three categories for tax purposes: building, furnishings, and equipment (FF&E) and goodwill. The first two – buildings and furnishings – are real items. Customer loyalty, employee relations, and other intangible factors that contribute to the hotel’s success are known as goodwill.
The depreciation periods for the various asset classes are different. Depending on whether current government initiatives are intended to boost specific investments, some subcategories have their own depreciation schedules. Investors in hotels can benefit from bonus depreciation policies that are unavailable in the multifamily, office, industrial, or retail asset classes.
Cost segregation is a tax deferral strategy that frontloads depreciation deductions into the early years of ownership, which is an important aspect of increasing after-tax income. However, it can also have an important impact on transfer and property taxes.
In many jurisdictions, real estate investors are required to pay a documentary stamp tax based on the value of the property sold. In many situations, you may separate the intangible assets from the real and personal assets.
Note 1: Make sure the purchase price allocation and cost segregation values are consistent with your overall tax approach. A single, clear balance sheet will prevent problems between taxing authorities.
Note 2: Don’t attempt to wing it. For purchase price allocation and cost segregation, get professional tax advice. This is a sophisticated asset management process that requires specialized training.
Reason #6 – Many Levers for Adding Value
Hotels’ primary source of value is their core business. Those activities may be enhanced or curtailed to meet demand, trends, the economy, and other factors. This adaptability is one of the finest aspects about investing in hotels. However, there are a plethora of additional elements that influence the final property/investment value.
The four areas of value enhancement in a hotel are:
- Capitalization – You make money when you buy, but you also need to ensure the capital stack supports your investment objectives whether that’s through disbursements or profits at the sale (or both!).
- Renovation – Expectations for hotel interiors, style, and amenities are always changing. In many instances, these are purely aesthetic modifications, but having a management team in place that is committed to keeping up with current trends and design will ensure a steady source of income over the long term.
- Operations – Hotel management is a people operation. Customer loyalty and employee engagement have a major influence on the ability of an organization to increase revenue and minimize costs. Many of these enhancements are free or inexpensive, but their discovery and implementation are crucial.
- Contract Positioning – Hotels need a wide range of sales and service contracts with quality operating partners to ensure quality operations. The brand licensing agreement and certain important maintenance agreements might have a significant influence on revenue and profitability.
An excellent investment manager balances the influence of each of these factors while also determining where each hotel requires the most attention. Even the tiniest value-add feature may improve a hotel’s income, allowing investors to profit from value while multiplying cash flow.
Reason #7 – Community Impact
Labor makes up half of hotel running costs. To run a hotel effectively, you’ll need a lot of hands, all of which belong to residents of the local neighborhood.
Hotels have a significant job-creating impact on the local economy. They not only provide a place for individuals to work, but as a temporary housing solution, they also give shelter to families, business partners, and others in need.
Full-service hotels provide social and business gatherings space, strongly representing the opportunity to relax and reconnect with those you care about.
The most successful brands extend the hotel’s ability to create community beyond the confines of their real estate. They are actively involved in developing a community that is consistent with their company beliefs and those of their guests.
Reason #8 – You Can Experience It
Although the financial advantages of owning a hotel are obvious, experiencing it is beyond comparison to any other real estate investment.
Even the simplest limited-service hotel offerings provide a space for guests to move around with very few impediments. They can get in and out of their room, stop by public spaces, and visit amenities with ease. Add a restaurant, meeting space, or a gym to that, and guests’ experiences are instantly amplified.
Investments in tangible assets, such as equities, bonds, and commodities, have little real worth. Even many real estate investments are meaningless without the ability to provide cash flow and tax benefits. A hotel is a unique sort of real estate because, by nature, it is a public place that was developed especially for visitors’ convenience and pleasure.
Reason #9 – It’s Challenging
As you’re already well aware, investing in commercial real estate isn’t just about cash flow and equity profits. There are many other ways to make money that are considered much less risky than investing in real estate. Most investors do it for the love of the game.
Hotels represent one of the most challenging asset classes for a real estate investor because every level of investment in hotels – from passive to active – requires tremendous due diligence and a deep understanding of the industry.
Investors must scrutinize and scrub all factors that impact the operation, especially external, market-related factors. As big as the hotel investment industry is, it still represents less than three percent of the total commercial real estate square footage in the United States. The major players all know and respect each other because they understand how difficult it is to consistently perform at the top of their game.
Reason #10 – It’s Cool
The best reason to do anything is because you love it. But if you can look good while doing it, that’s just a big bonus.
Plainly stated, investing in hotels is cool.
When you invest in a hotel, you’re making a high-profile investment into a beautiful property that sees lots of visitors, but you’re also gaining invisible accolades. Investors who primarily keep their cash in the Big Four CRE categories have respect for hotel investors that continually pump out great investment returns because they know how much energy it takes to break into the hotel asset class and execute at a high level.
Also, how fun would it be to go visit and experience a stay in a hotel of which you’re part owner?!
The ability to welcome your family and friends into a hospitality environment is very rewarding. You spent time building your investment portfolio, carefully selecting real estate investments that support your financial goals, and you want to share an experience in one of your investments with the people you love. That is difficult in many investments, but a hotel is a public space built for just that – sharing.
Why Invest In Hotels NOW?
I believe the hotel industry has adapted and grown more resilient and innovative during the recent crisis, and that the changes implemented within the industry are paving the way for exceptional returns during the recovery of the travel industry as a whole.
Some of the best advice I ever heard was to try to anticipate the next best move before the masses jump on board. Investing in hotel real estate syndications is this right now – people are nervous to travel, but a few brave souls are already venturing out to explore.
Meanwhile, since hotel revenues have hit a historic low over the past 18 months and commercial property value is based on how much income they make, hotel real estate is essentially “on-sale” right now.
By the time the travel industry is roaring again, I want ownership in a piece of it. Of course, nothing is guaranteed, and real estate IS a risky investment, but I’m looking forward to riding the travel trend wave as it grows back to pre-pandemic levels.
How Do I Start Investing In Hotel Real Estate?
My favorite, most hands-off way to invest in real estate is through real estate syndications, which are basically group investments where we all throw money in a pot together to buy large commercial assets (like hotels). Lucky for you, inside the Goodegg Investor Club, we present pre-vetted opportunities that already have our stamp of approval to investors.
This means we’ve already explored the business plan, checked out the financials, looked at the property, and vetted the sponsor team so that we can confidently present real estate investment opportunities to investors just like you!
Once you’ve identified your investing goals and are confident you have capital that can remain invested for about five years, you’re ready to start reviewing deals and finding one that supports your cash flow or equity appreciation needs. Jump inside the Goodegg Investor Club and keep your eyes peeled for the next real estate syndication investment opportunity!