Hotels: Quite Different from their Peers


By Tim L. Edgar

Founder & President of Hotel Innvestor

Hotels as a distinctive product type of commercial real estate are quite different than their peers.  Hotels are an operating business that has real estate as one of its assets.  Because they are open 24/7, 365 days a year, they effectively have a one-day lease that needs to be re-leased every day.  As opposed to multi-year leased investments, i.e., retail, office, industrial, or even apartments that have monthly or yearly leases, a hotel’s nightly room inventory are perishable goods.

The practical implications of these characteristics have a tremendous effect on the return on investment (ROI) of a given property.  In a down market, the safety of a guaranteed lease payment is ensured as the base payment does not fluctuate with the economy, although percentage rents will decline.  In this situation, hotels can be forced to literally lower their rents nightly as they operate in real time to sell their room inventory.  In contrast, while the guaranteed lease payments come in every month, as the market improves the ability to increase the lease payment is limited to inflation-adjusted or other pre-negotiated “bumps”, but usually not more often than once a year and quite frequently every five years.  But just as a hotel may have to lower its rates nightly to reflect the real-time market conditions, there is no other product type that can raise its rates nightly as hotels can when market rents move higher.

Because of the greater volatility of Average Daily Rates versus market rents, leased investments and apartments traditionally trade at a premium to hotels on a Capitalization Rate basis – anywhere from 200 to 300 basis points depending on the property and market.  While warranted in the macro sense, the perception of greater risk in hotels overall is overstated because of the inclusion of both budget and luxury properties, which tend to fluctuate more.   Additionally, the age-old real estate adage regarding location applies to hotels as well and for the same reason; great locations will continue to do well regardless of where we are in the real estate cycle.  The savvy investor will see the opportunity this presents in investing in a well located hotel that has been properly underwritten at a discount to comparably located apartments or other leased-investments.

As an accredited investor, it is of the utmost importance to understand the qualifications and track record of both the issuer and the platform offering a given private security, regardless of property type.  But given that two offerings have excellent sponsors and an experienced and knowledgeable team underwriting the projects in a comparable location, the risk-adjusted return for the hotel offering is compelling.

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