10 reasons why investors are flocking to hospitality
by KEN PATEL
As the economy remains turbulent due to many macro challenges such as the pandemic, Russia’s war in Ukraine, and challenges with inflation, investors have had a difficult time figuring out where to put their money. When compared to other investment assets like stocks and bonds, hotels seem to rebounding quickly and providing a place for investors to find the returns they’re demanding.
In the first quarter of 2022, more than $12.5 billion worth of hotels were sold, which was the highest first-quarter sales amount since 2016. Since investors feel that hotels are less overpriced vs. many other assets, the hospitality industry is making a comeback in terms of finances and visitors. Aside from the price tag, there are many reasons that investors see hospitality as a good investment. Here’s why.
1. BRAND RECOGNITION
Investments that occur in the commercial real estate realm are rarely attached to a national brand in charge of design, operations, marketing and reservations. Since there are many unique brands all over the country, being associated with a specific brand is just as important as making an investment in the right location. Brand recognition can provide protection to investors through higher valuations, better yields, more visitors, exclusive owner incentives, and networking events with the best names in the industry.
2. INFLATION HEDGE
Since inflation in the U.S. has hit a 40-year high, investors are scouring the markets for assets that combat rising prices and overinflated investments. Since real estate is a fixed, tangible asset, the returns associated with rising prices are often baked into the valuation of the asset. For instance, if a hotel undergoes renovations but the cost of construction and materials goes up the replacement cost of the asset will rise in a commensurate manner.
3. MARKET-RATE PRICING
When investing in other commercial real estate assets, such as office spaces or retail locations, investors are locked into long-term rental agreements with their tenants. While these rental agreements can bring some upsides if the market dips, they react less quickly to times of rising prices, leaving money on the table through a “loss to lease” when compared with the true market rates. Hotel rates can change day by day or even hour-by-hour, reflecting current market rates in real-time. If inflation continues to rise, the yields on your investment will instantaneously continue to rise as well.
4. HIGH YIELD
When compared to many other asset classes, hotels and other hospitality investments have incredibly high yields. The rate of return for hospitality-related investments often sits around 15%-20% – but sometimes even higher. Many ETFs and major-market indexes such as the S&P 500 only offer an average rate of return of 10% every year. The potential yield from hotel investments makes them stand out in the market.
5. SUPERIOR ACQUISITION CAP RATES
When you invest in real estate, the actual profit comes from the price you end up paying for the asset. For some real estate investments, such as multi-family, the capitalization “cap” rates currently sit around 4%, but the cap rates for hospitality-related assets are usually closer to 8%. The cap rate refers to the purchase price of an asset versus the annual amount of net operating income generated by the investment. For instance, if you have the chance to invest in two projects that will both bring in $1 million in annual NOI, you need to assess their cap rates. The multi-family home, with a cap rate of 4%, would require a $25 million investment but the hotel would only require a $12.5 million investment to provide the same $1 million NOI return.
6. CAPITAL PROTECTION
Because real estate investments are a fixed asset, this investment class offers capital protection. Since other assets such as equities or bonds can have their prices changed by something that has nothing to do with the asset itself – war, investor sentiment, or high inflation for example – those assets have low capital protection and can swing solely based on investor emotions. The value of your real estate investment is dependent on the physical asset first, followed by other economic conditions such as market behavior.
7. CASH FLOW
Investing money in stocks will generally not provide regular cash flow. Yes, you might have access to dividends, but while you hold those assets, you can’t access much monthly cash flow. In fact, out of nearly 20,000 U.S.-listed stocks and funds, only a few hundred pay their dividends monthly. Real estate, on the other hand, can provide regular payments from tenants, lining your pockets with cash and giving you more money to invest immediately.
8. TAX ADVANTAGES
When you buy and sell assets such as stocks, you have to declare your capital gains or losses, which are then taxed accordingly. Investing in hospitality allows you to find multiple ways to reduce your tax liability each year. Investors can offset much of their hospitality-related income by non-cash depreciation expenses and cost-segregation studies. This deferral of tax obligations allows you to reinvest pre-tax dollars to maximize your returns.
9. DIVERSIFIED MARKET SEGMENTS
For those investing in multi-family assets, their asset can be ranked between class A, B, C, or even worse. The market rental rates available for each asset type will vary based on the asset’s demographics and the economics of potential renters. However, with hospitality-related investments, properties are split into different classes based on the brand and can be separated depending on the location and submarket. Some hotels thrive from business travel and conferences, while others target vacationing families. The ability to further diversify your investment in this manner isn’t offered by many other real estate investments.
10. BUILDING EQUITY
When you own a tangible asset, such as a hotel, your equity in that asset will grow as you continue to pay off any loans you secured to acquire the asset. With increased equity as a result of debt reduction from in-place cash flow, you can access more funds through refinance in a way that’s not available to traditional investors in stocks and bonds. Additionally, your overall equity position will increase in value exponentially as the asset grows in value over time, and the debt is reduced on a month-by-month basis.
After a couple of years of major challenges, hospitality is back and headed on a path to be better than ever.
HOSPITALITY IS HERE TO STAY
Investors of all levels are treating hospitality as a safe haven for investments. Yes, we’ve had our share of difficulties due to economic, market, and pandemic issues, yet people will generally always go on vacation and conferences, and business travel will continue to rebound in the post-COVID world, and the value of the hospitality industry will continue to recover. After a couple of years of major challenges, hospitality is back and headed on a path to be better than ever. Even if we have some downward economic pressures due to short term recessionary impacts, there is no time like the present to jump into the hospitality asset class. In short, don’t miss this buying opportunity!
Ken Patel is the owner and CEO of A&R Group. After immigrating to the U.S. in 1996, he began his career in the hospitality industry by managing a family-owned hotel. He soon became more familiar with the industry and decided to invest in his first hotel in 1998. With his tireless energy and passion for hospitality aided by a great deal of business knowledge and a drive and determination to succeed, Patel founded A&R Development Group, LLC. In addition, Patel has accumulated a portfolio of globally recognized brands such as Hilton, Intercontinental Hotel Group, and Wyndham.