Over the last decade, hotel investment has become a valid alternative for investors in Singapore and beyond, as opposed to stocks investing.
Traditionally, hotels are seen as operational businesses.
Success depends on the hotel’s brand, marketing strategies, and operational excellence, all of which are not priorities for other types of commercial real estate.
Marriott as an Example
In 1993, the then owner-cum-operator Marriott split itself into Host Marriott and Marriott International.
Host Marriott became an asset-owning entity, owning Marriott’s hotel assets in North America; whilst Marriott International became the operator, owning the Marriott brand family.
Under the split, the Marriott hotels are owned by the hotel owner but managed — via a management contract — by the hotel operator.
The hotel operator invests in the brand image and marketing strategies and maintains service levels at the individual hotels.
This frees the hotel owners from the operational details.
Hotel Owners are also Buy-and-Hold Investors Now
Like the owners of any other commercial real estate, hotel owners now focus on investment strategies such as buy-and-hold, renovation and development, shifting expertise to focus on investment returns and capital management.
Hotel REITs including several listed in Singapore, Hong Kong, and Japan, became pure hotel owners that provide individual investors access to hotel ownership throughout Asia Pacific.
In addition, over the last twenty years, limited service hotels have expanded its footprint to Asia and all other major regions in the world.
Rising demand from growing tourist markets is the primary reason, but changes to the hotel ownership and operational models have also accelerated capital investment into the sector.
Various private equity options, ranging from an allocation within general real estate private equity to hotel-themes vehicles, provide investment access to more substantial investors.
Starting from a notion that the room experience is key to travelers, limited service hotels have stripped out many traditional amenities that characterised full-service hotels.
This modification lowers investment outlay and operational cost, which leads to an investment product that generates stable income returns and an on-par to slightly higher risk-adjusted total return versus other commercial real estate assets.
Factors that Lowered Risks for Hotel Investments
Hotels were once seen by institutional investors as being higher risk than office or retail assets, but several factors have lowered risks that used to be inherent to hotel investments.
First, the segregation of hotel ownership and operations started in 1993 has shifted hotel operations to hotel brands. Freed from the operational burden, owners can now focus on investment strategies such as buy-and-hold, renovation, and development.
Second, revenue management systems, driven by artificial intelligence, allow hotel chains to manage occupancy, average daily rates, and RevPAR in real time.
This allows a better revenue optimization than the previous model driven by fragmented, local managements.
Third, the lower operational cost of the limited service hotel model has lowered the seasonality nature of hotel markets. Most hotel markets, saved for the largest metropolises have strong and weak seasons.
Operational cost, especially that for full-service hotels, can potentially create a material risk if the strong season is not strong enough to compensate for the operational cost for the full year.
Because limited service hotels offer only a selected few amenities, more floor area is typically used for rooms.
Together with the fact that limited service hotels typically carry smaller rooms, the per room floor area is usually between one-third and a half lower for limited services hotel.
Hotels Need Lesser Staff Now; Higher GOP Margins
The economy on amenities also reduces the staff requirement.
According to our analysis, the number of staff at a similar-sized limited service hotel can be less than one-third of the staff number at a full-service hotel.
On the income statement, this typically translates to a 20 percentage point increase in Gross Operating Profit Margin (GOP Margin).
A higher GOP Margin lowers the breakeven RevPAR and breakeven occupancy of a limited service hotel.
A limited service hotel also manages better the seasonality issue identified above, as the overall cost during the off-season period is lower than that of a full-service hotel.
In fact, a similar-sized limited service hotel typically has a breakeven occupancy that is about 30 to 40 percent, versus over 60 percent for a full-service hotel.
Conclusion: Hotels are Less Risky Investments than Commercial Real Estate Now
Hotels, in most markets that Admiral covers, yield between 100 to 300 bps higher than office or retail assets.
For example, in Hong Kong, retail assets typically yield at around three percent, while hotels yield at about five percent.
We have also observed similar capital value increases between general office, retail, and hotel assets.
On a risk-adjusted basis, hotels are considered to be either on par or even slightly better than other forms of commercial real estate.
We believe that hotels can be best compared to logistics assets two or three decades ago.
Logistics assets saw a similar cycle when investors were initially concerned with its long-term investment value.
However, once the ownership and operational models matured, logistics assets saw a one-time, secular value appreciation in multiple markets.
This tightened the yield gap between logistics and office assets, and now in many markets, especially those with an active REIT market, logistics cap rates are on par with office or retail cap rates.
We see hotels, more specifically limited service hotels, as having similar potential.