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Investing in Hotels / Lodging
October 14 | 2013

The Hospitality Sector

Commercial real estate is made up of a number of market segments, and a significant one is the hospitality sector – hotels, motels, resorts, and other tourist or business accommodations.  Ownership of these properties is closely tied to the underlying business, so it’s important to understand the dynamics of the sector. 

The ownership and management of lodging facilities has undergone many changes.  A sector that began with entrepreneurs who owned and managed individual properties has come to be dominated by national and international chains.  The most recent trend is for many major hotel chains to develop and manage properties for outside investors, rather than owning the properties themselves.

The hotel sector can be divided into a number of segments:

  • Deluxe:  Four Seasons, Ritz Carlton, Wyndam Luxury Resorts
  • Luxury:  Sheraton, Hilton, Westin
  • Upscale: Crowne Plaza, Doubletree, Embassy Suites
  • Midscale:  Holiday Inn, Best Western, Comfort Suites
  • Economy:  Rodeway Inn, Econo Lodge, Motel 6
  • Extended Stay: Summerfield, Homewood Suites, Extended Stay America

Luxury and upscale hotels tended to be more resilient in the aftermath of the recent recession, perhaps because they cater primarily to business travelers.  Mid-scale hotels with food and beverage services constitute a very large segment of the overall market, while economy hotels are more favored by seniors and others traveling on a limited budget.  Extended-stay hotels have larger, apartment-style guestrooms and typically service relocated employees and engineers assigned to a building project.

The lodging industry is closely tied to national – or even worldwide – economic conditions.  Prosperous times mean increased room and occupancy rates, but a faltering economy causes both leisure and business travelers to stay home or at least spend less.  New construction is also a factor – in the late 1980s, oversupply caused a period of stagnation for the industry as a whole, even though the economy was doing well.

The degree of this correlation with general economic strength is stronger than with other real estate asset classes.  Demand for tourism services is particularly sensitive to both price competition and non-predictable shocks like terrorism, political unrest and natural disasters.  At the same time, the supply side of the industry can be quite “sticky” – new hotel construction requires large-scale capital investment and a long-term investment horizon, leaving the industry sometimes slow to respond to demand increases requiring a short-term response.

Hotel economics depend on both occupancy rates and room revenues, so an important industry yardstick is RevPAR (Revenue Per Available Room).  This metric is calculated by multiplying a hotel’s average daily room rate by its occupancy rate, or by dividing a hotel’s total guestroom revenue by the room count and number of days. 

   Example:  $80 average room rate  X  70% occupancy rate  =  RevPAR  =  $56

Following the 2008-10 recession, hoteliers at first sacrificed room prices in order to increase their occupancy rates; more recently, though, room rates have also increased significantly.  An industry survey recently forecast RevPAR as growing between 5-6% over the next few years, which would be at the high end of average figures over the last 30 years or so.

Another recent trend is the lack of supply scheduled to come on-line over the next few years.  Concerns about Europe, among other things, held back new construction financing during the last few years, and the supply pipeline now appears to be below the long-term average – leading many industry observers to conclude that fundamentals will remain strong through at least 2017.

The hotel industry thus appears to have stabilized and entered into what looks to be an improving environment over the next five years or so.  Hotel values are now regaining the values last reached in 2006, so that owners who were previously “underwater” have now returned to the market, and the number of hotel transaction is up significantly – more than 50% over comparable periods in 2012, according to Jones Lang LaSalle, a major industry player.   Other observers project an average 40% increase in hotel values through 2016, largely because of an expected continued improvement in the fundamentals of the segment.

Hotels are more cyclical than other real estate asset classes, but the recent dynamics of the sector have made it attractive to many investors.  Much-improved demand, along with a projected shortfall in supply, make it an interesting play on future economic recovery.  The industry has recovered to normal levels and that solid recent performance, along with upward-trending occupancy rates and room revenues, make it an exciting segment of commercial real estate.

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