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Buy-to-Let vs. Hotel Room investing… part II
July 31, 2018Article by Paul Avery
Investing in hotel rooms has been a feature of the UK property investment space since 2007, long enough for the model to become a trusted, mainstream asset class, but comparatively young by the standards of buy-to-let. It offers individuals the chance to access attractive commercial property returns, which are rarely available outside of institutions and funds, with very little input.
As such, the chief advantages of investing in hotels are low entry points, high yields, and a completely hands-off experience. On each of these metrics, hotel rooms are superior to buy-to-let investments:
They are cheaper because hotel rooms are effectively studio apartments, usually without kitchens and other expensive features. As commercial property, they are also highly tax-efficient. They do not incur stamp duty below the threshold of £150,000 – around twice the average price – nor is there any withholding tax for international investors. Hotel rooms are also sometimes eligible to be purchased through Self-Invested Personal Pension schemes, conferring additional tax advantages.
They are substantially higher-yielding because nightly rates at hotels are far higher than monthly residential rents, while administrative and cleaning costs are spread over a large number of rooms. In fact, income to investors is always net of running costs and there are rarely any additional charges, so the yield is almost always a final net amount. Net yields in excess of 8% or even 10% are among the best available in any kind of property investing.
Hotel rooms are hands-off because the management is an integral part of the product. In fact, these days the running of the hotel is so predictable in its inputs and outputs that most hotel room investment products offer fixed rates of return over fixed timeframes, so income to investors is entirely stable and predictable.
In many instances, the sole extent of investor involvement is a free annual stay at the hotel, as part of the free personal usage deals that are packaged with many investment products, taking the idea of a stress-free investment experience to a whole new level.
When an investor buys a hotel room, he or she leases back the space to the hotel operator, who then functions like a tenant. The only thing the investor needs to care about is that their tenant can pay the rent, and that is a function of the overall profitability of the hotel business: how well-run it is and the popularity of its location. So the most important role of the investor is choosing well at the beginning.
Choosing well means looking at the market where the hotel is located, using common sense to determine whether it will attract consistent and lasting demand from guests. City centres where business is conducted, beautiful natural locations where holidays are popular, proximity to particular event venues or tourist attractions, and so on, are sensible choices. Seasonality of demand is not a problem, as long as it is accounted for in the hotel’s business model, or if the high-seasons are sufficiently profitable to compensate for low-seasons.
Choosing well also means assessing the track record of the developer and operator. Do they operate other successful hotels, or work under a well-known national brand, for example? Even better if the developer is refurbishing an existing hotel with performance indicators that can be confidently improved upon. (In that case, the existence of a useable physical asset also supplies greater security of title for investors.)
Measuring success for hotels means looking at occupancy rates (the percentage of rooms occupied over a specific period) in relation to the average room rate charged to guests. Combining these two metrics gives the hotel’s Revenue per Available Room, or RevPAR – a measure of its overall profitability. Happily, most hotels require surprisingly low occupancy rates in order to turn a profit and supply investors with their income.
In many locations or regions of the country, investors can access statistics about the average performance of comparable hotels, which gives a good indication of the demand for the new hotel. (The only additional thing to look out for is supply: if there are five other hotels being built or refurbished in the immediate vicinity, they may well need to compete on price.)
While for some people a fixed rate of return over a specified time period is an advantage for financial planning, for others it limits their flexibility to do other things with that money.
Hotel rooms are not yet eligible for mortgage financing from most providers, so the input is entirely in cash. Although prices are significantly lower than for residential apartments, the actual cash amount required can be higher than the equivalent deposit a buy-to-let investor would put down on a unit.
The other main disadvantage of this asset class is a lack of flexibility for exiting the investment: while a house can be listed and sold at any time, there is no well-developed public marketplace for the buying and selling of hotel room investments. As a result, investors must arrange a secure exit strategy.
The best option is a contractually agreed buyback from the hotel developer, meaning that the developer is obliged to buy back the investor’s hotel room at a pre-agreed moment in time and at a pre-agreed price. Fairly typical would be a 5-10-year term in which an investor can request a buyback with a modest level of uplift, such as 2.5% appreciation per year.
The relatively low level of uplift is a further limitation to this form of investing: since appreciation is usually agreed in advance, investors will not benefit from roaring growth in the residential market. That the yield is significantly higher should compensate for this, but it is also a further measure of security because there is no risk that the value of the asset will decrease.
Hotel rooms: the verdict
Hotel room investing is the essence of certainty: predetermined yields, uplift, and timeframe. Just the opposite of the unlimited variation and flexibility offered by buy-to-let. It therefore suits an entirely different kind of investor or investment strategy.
Hotel rooms are ideal for people who want fixed income over a specific term but are not able or do not wish to get a mortgage, such as near-retirees. They are great for those who value regular income with minimal effort above equity growth. And they are an excellent choice for those already heavily involved in the buy-to-let sector in search of diversification.
The point about diversification is particularly clear at this moment in time – Brexit has provided a perfect example of how hotels can be counter-cyclical to the residential market. As house price growth in many areas has slowed as a result of political certainty, the lower value of the pound is bringing more foreign tourists and staycationers to the UK’s hotels. Domestic holiday trips and expenditures increased by 6% last year, while international visits rose by 7% and expenditure by a whopping 11% (Visit Britain). As a result, UK RevPAR growth is projected to continue at an annual rate of 2.3% this year (PwC).
Investors who choose to take advantage of the different benefits offered by both asset classes together are not only achieving a more equal balance between income and growth, they are also bolstering their financial security in the face of most externalities.