Although the pandemic walloped the hospitality industry, hotels have been steadily and quietly recovering. In late 2022, hotel demand was only 6% below pre-pandemic levels.This impressive rebound confirmed why many experienced investors love investing money in hotels. Not only can investing in hotels offer impressive returns, but the asset class has proven highly resilient.
But investing in a hotel is by no means a sure thing. A hotel is an incredibly complex operation, incorporating diverse disciplines, subject to a fickle customer base, and vulnerable to the slightest economic fluctuations. So is investing in a hotel the right decision for you? Let’s review six main pros and cons of investing in a hotel in 2023.
Potential Pros
Superior returns
Hotels offer a fantastic potential return on investment — in fact, it isn’t unusual for annual returns to be as high as 20%. That easily beats even the hottest residential real estate markets, such as Austin, Texas, or Washington, D.C.
One of the main reasons for this is a hotel’s flexible pricing model. A hotel can lower its prices to keep the rooms full when demand is low. When demand increases, a hotel can adjust its prices to take advantage. There aren’t many real estate investments where the tenancy price is this responsive.
Room fees are only one revenue stream among many. Hotels generally have fixed added costs, such as property taxes, utilities, and insurance, and variable costs, such as food and drink, room accessories, and various guest amenities. The margins on variable costs — the markup between what the owner pays and the overall price they charge the guest — make them highly profitable.
Brands offer recognition for guests and security for investors
Most hotels in the U.S. are owned by a few well-known brands, such as Marriott, Hyatt, Hilton, and Holiday Inn. Consumers like them because they’re getting a consistent, trusted product, and investors like them because they have built-in brand recognition and a considerable amount of institutional knowledge for franchisees to draw on. They are especially attractive to novice investors.
Franchisees benefit from the brand’s marketing machine, expertise, and valuable customer data via the brand’s loyalty programs. In addition, lenders are much more likely to sign off on a loan for a branded hotel investment since the risk is so much lower than it is with an independent hotel.
The main downside is that franchisees receive a stringent set of standards and operating procedures from which they’re not allowed to deviate. Independent operators may chafe under this type of agreement, especially if that inflexibility comes back to bite them, for example, by preventing quick price cuts during an economic downturn.
Nearly infinite adaptability
With a hotel investment, you have many different ways to adjust and adapt, especially if you’re an independent operation. Even a relatively simple aesthetic renovation can move your hotel into a completely different consumer arena, and minor innovations (see the explosion of customer loyalty programs) can quickly impact your bottom line.
It takes an army of staff to run a hotel, which can also be an effective area to optimize. From upper management to day-to-day operations staff, job cuts can be an unpleasant reality in economic strife. Over 50% of jobs in the hospitality sector, all the way up to the highest levels of management, were cut during the pandemic.
Hotels also rely on contracts and agreements with many outside vendors, which can be renegotiated as needed.
Potential Cons
The high price of admission
As we saw during the pandemic, the hotel business can have prolonged booms and steep drop-offs. Because of that high-risk profile, it’s recommended that investors put a lot of cash into their hotel investment upfront — as much as 40% equity.
During the pandemic, investors who underfunded the equity part of their deal found themselves burdened with unworkable mortgage payments as revenues all but dried up overnight.
Financing a hotel investment can also be trickier than funding other types of investments. Lenders may want proof that you have expert management in place before they sign off on a loan, and the lending environment for hotel projects can fluctuate wildly since the hospitality sector is so sensitive to changes in the economy.
Hotels are extremely labor intensive
Many experts argue that hotels require more hands-on work than any other type of real estate investment, commercial or otherwise.
The operation of a hotel requires everything from specialized front-of-house staff to cleaning and sanitation personnel, to food prep staff, to marketing and branding experts. This staff works around the clock, and all these people need to be managed so their efforts complement each other. It’s a massive job with many moving parts, and it only gets more difficult as you move toward the higher end of the industry.
As with any real estate investment, the investor can manage it themselves or hire a professional management company. But managing a hotel is much more complicated than collecting rent from apartment tenants, and some experts suggest that hotel investors reside close to their hotel investment so that they can monitor the management.
The internet can make (or break) you
There are two main ways the internet has a significant influence on a hotel investment’s success or failure.
As real estate apps have captured the lion’s share of home buyer attention, online travel advisors (OTAs) have effectively inserted themselves between hotels and their potential guests. Their sheer prominence has depressed hotels’ pricing power and consumer brand loyalty. Hotel customers who — in the past — might have been loyal to a particular hotel brand or chain now just hop on an OTA website, and book a room in their price range. This behavior, in turn, has pressured hotels to keep prices in line with their competitors, or they’ll look uncompetitive on the OTAs.
Additionally, review sites like Yelp have an outsized impact on a hotel’s reputation. While a stellar review can instantly establish your bona fides, a few negative reviews can quickly set off a crisis, especially if they gain a little visibility and start driving off customers. Hospitality and customer service — a cornerstone of the hotel business — is more important than ever, especially as more customers seek to leverage their online influence.
The Bottom Line
Hotels require high liquidity and an appetite for risk, but overall, the hospitality sector could bring outsized ROI to the savvy investor. Consider the above factors and stay abreast of market shifts to determine if investing in hospitality property is best for you.
Check out available hotel properties for sale on Crexi.
Ben Mizes is the Co-Founder and CEO atClever Real Estate, the nation’s leading real estate education platform for home buyers, sellers, and investors.
