What is Hotel Investing?
Despite what you may have heard, hotel investment continues to be profitable — if you do your research. The hospitality industry can have its ups and downs, but generally, hotel investments are one of the asset classes where you’ll see both cash flow and equity growth over time.
If you put the time into understanding how hotel operations become profitable and look for operators who build a good relationship with the management team, hotels can be a profitable portion of your real estate portfolio.
At Goodegg, our experience in hotel asset management provides us with an intimate understanding of the needs of the hotel real estate asset and operations teams to become profitable. We also know direct real estate ownership is among the most tax-efficient investments in your portfolio.
Hotel investments are slightly different from other more well-known asset classes, such as multifamily, but one of the great things about hotels is they are so adaptable. As a result, quality operating partners can increase hotel investors’ cash flow simply by making small tweaks to offerings, service levels, and accessibility.
Selecting the Type of Hotel Investment
There are various types of hotels providing varying levels of amenities and services. In addition, each hotel chain and boutique hotel operates differently.
Full-service hotels, high-end luxury hotels, and business hotels command the higher end of the price range. Meanwhile, budget-friendly and extended-stay hotels accommodate the demand for reduced rates. So, when you think about making a hotel investment, you need to be clear about where in the hotel business you’re planning to invest.
As you narrow the hotel investment you desire, you can choose from independently-owned properties and hotel assets that are already part of a successful brand.
For example, when we’re looking to invest in the hotel market here at Goodegg, we focus on serving the business traveler. We want to get involved in hotel operations that are less focused on tourism (a volatile industry) and more on attracting people who need a hotel to facilitate a business-related stay.
We want to invest in hotel real estate that caters to people like travel nurses on short-term contracts and professionals traveling for meetings and conferences; therefore, the hotel investment needs to be close to hospitals, conference centers, colleges, sports venues, manufacturing, and similar businesses.
Why Distressed Hotels Are Popping Up On the Market
After COVID restrictions were lifted, hotel occupancy started rising as people began to travel again. Confidence in visiting new destinations has gone back up, and if you’ve tried to book a hotel recently, then you KNOW that rates are through the roof!
If you’re looking for a hotel room in a popular location like New York City or L.A., you’ll pay north of $1,000 per night to stay in a comfortable hotel. So, you may wonder how it could be possible for hotel owners not to make money right now and why distressed hotels are available on the market.
The problem is historical – hotel operators took a hard knock during COVID. The lack of occupancy skyrocketed and cash flow became nonexistent. So, many owners/operators decided to move on to other real estate investment opportunities. This means that in 2022, there is a real opportunity for motivated operators to jump in and scoop up those “left behind” pieces of commercial real estate.
An Important Consideration: Hotel Occupancy Rates
Some of the largest owners in the hospitality business have recently shared that occupancy is high again, even with average daily rates higher than they were before COVID. However, we’re also hearing in the same breath that they’re struggling to make money. The reality is that even though occupancy and rates are great right now for all the tourist-space hotels, they’re still making up for the past 18 to 24 months of losses.
Even big hotels have minimal cash reserves left because they were all used up to pay their lenders during the height of the Covid shutdowns. There’s also a labor issue; high-end hotels that have 400-500 rooms are labor intensive. They need tons of employees – serving in the restaurants, cleaning rooms, at the front desk, concierge, room service, and more.
Finding enough people to do those jobs is tricky in the current market. Even if they find qualified employees, labor is much more expensive than it was two years ago.
2020 marked the beginning of an avalanche of financial events for some hotel owners who, frankly, haven’t been able to climb out from underneath the weight of the financial obligations.
This puts us in an advantageous position for an acquisition. We’re able to buy the property at a reduced value, allowing the owner to harvest their profit. Then, we can implement value add strategies, service contract adjustments, and marketing updates to drive occupancy upward and generate profit for our investors.
Our Favorite Hotel Type for Real Estate Investment
There are always risks wherever you choose to invest, be it in the stock market or in real estate. However, right now, as business and consumers’ habits are evolving, so must we.
As seasoned real estate investors, we understand investing in commercial real estate, whether you lean toward apartment complexes or hotel properties, can be lucrative as long as you are discerning. Various hotel property asset classes provide excellent opportunities for cash flow and appreciation, especially select service hotels that serve business travelers. This particular class of customers is loyal to hotels that provide a dependable experience and excellent service.
Select service hotels tend to be smaller, usually located on the outskirts of major metros, and there’s usually a strategic reason for their extremely practical location. With this type of hotel, we’re typically looking at 90 to 100 hotel rooms – comparable to a fully functioning high-end, full amenity hotel, just smaller.
When doing your research, look for places with an excellent hotel management company and low staff turnover. These are operational signs of an efficient hotel with happy staff, which is more likely to make better cash flow and ROI.
The Tax Benefits of Hotel Real Estate Investments
Under United States tax law, hotel investments are unique since they incorporate real, personal, and intangible property. As a result, each real estate investor not only gets tax benefits from the physical hotel asset’s depreciation but also receives deductions for the personal and intangible property associated with the hotel investment.
Depreciation in hotels can reduce taxable income because of investment recapitalization resulting from income derived from various physical properties inside the hotel.
Stack those unique, bidirectional property depreciation benefits on top of the most significant tax benefit to investing in commercial real estate – depreciation, equity growth, and tax-deferred exchange factors.
How Cost Segregation Works in Hotel Investments
In addition to the general tax benefits available via hotel investing, management can have a cost segregation study performed to separate the various value components of an asset. The cost segregation results identify 3 separate categories of value for tax purposes: building, furnishings & equipment (FF&E), and goodwill.
Buildings and furnishings are real tangible items, but goodwill comprises aspects such as customer loyalty, employee relations, and other intangible factors that contribute to the hotel’s success.
This categorization of value provides real estate investors with a depreciation expense schedule in which they can write off a percentage of costs of each of these components each year, significantly reducing their federal income tax throughout their ownership.
Key Reasons to Invest in Hotel Real Estate
Before you invest in hotels, it’s important to take a step back and consider your investment goals.
Take stock of your portfolio’s existing real estate component and examine whether hotel real estate assets align. Evaluate the current financial landscape and consider whether you need to add traditionally recession-resistant property investments.
Hotel investment opportunities offer great potential for passive income, even during an economic downturn, but getting into the hotel industry also has a range of tax benefits. The hotel investment industry is growing but currently accounts for less than three percent of the total commercial real estate square footage in the United States.
Another major advantage of investing in the hotel business is the flexibility to offer value-adds, increasing after-tax income. This may be done in a few ways: investing in an older hotel and renovating it, or targeting poorly operated hotels and upgrading their hotel operations to increase customer loyalty and boost recommendations, or identifying and improving sales and service contracts.
Advantages of Investing in the Hotel Industry
For us, it’s all about two key things; the partnership and the metrics. For example, we’ve got a partner-in-hand group out of Indianapolis that has been involved in this business for 60+ years, so they know how to operate hotels better than virtually anybody.
We’re also in a position to assume debt, we can put things in place where we’ve got below market rates, and we’re able to position ourselves for the next three to seven years without really any fear of what’s going to happen in the interest markets.
For us, these are easy investments because we’re able to buy below market with cost per unit.
We’re not spending $1000s per unit because our investments are in those secondary markets just outside of major metropolitan areas. Hotels are a tempting investment if you combine real operations knowledge and the static numbers we know with a reasonable average daily rate and dual occupancy numbers.
Real estate investing is all about relationships. The Goodegg team has spent a lot of time and effort forming reliable, strong partnerships to position ourselves and our investors well in this market. Head over to our YouTube channel to hear Jason and Max discuss the ins and outs of hotel investing in further detail.