Investors polled at a real estate event earlier this year ranked hospitality at the top when asked what sector they believed would outperform in the next twelve months. However, despite the bullish sentiment, many traditional investors remain hesitant about diving in, preferring to stick with non-operational assets.
But experts say this is ill-advised because while traditional real estate investors may feel daunted by the operational complexities of hospitality, they stress it’s currently the best sector for investment.
Weighing the options
David Hart, CEO of RBH Hospitality Management notes “If you look at the options out there, retail is a very messy space at the moment and it has been for a while. Every man and his dog is going into student accommodation.”
“Office is a disaster with people not coming back to work and working remotely now,” Keith Oltchick, senior vice president of business development at Remington Hospitality adds that: “Multifamily has become overbuilt in some areas. Industrial is very hard to get into if you're not one of the major players.”
This leaves hospitality, a sector that they stress has proven to be resilient, bouncing back astonishingly quickly post-Covid, a result which should give potential investors confidence in the event of any major downturns.
“Coming out of Covid, hotels recovered far more quickly than anyone expected. People just wanted to get back out. To me that’s a positive. if you said to an investor ‘you have to underwrite a business and there might be a global event at some point in time’, we at least now have real data and a real experience of how hotels came back after that situation,” Hart says.
The challenges and solutions
However, experts acknowledge it’s not all sunshine and roses, as the hospitality sector, just like others, has to deal with increased costs on the back of inflation, with higher labour and utility costs as well as higher interest rates also posing a problem. They note that the uncertainty around inflation and interest rates and the effect these factors may have on returns, make up a large part of why core investors are reluctant to dip their feet into the market.
“The number one problem is inflation. It impacts labour and all the products needed in order to run hotels. High interest rates have also put a damper on transaction volumes because it's very difficult to buy something staring at a 9 per cent to 10 per cent interest rate,” Oltchick says.
However, he also notes that the hospitality sector – more than others – is a good hedge against inflation, highlighting the phenomenal ADR growth hotels have been able to achieve post-pandemic.
Hart agrees, stating that while rocketing utility bills, the potential future costs of complying with ESG and fire safety standards and the colossal increase in payroll costs, add a degree of uncertainty to investors worried about the cost base, the concerns are offset by revenues which “have seen fantastic strides over the last 12 to 18 months.”
“Generally speaking, from our point of view, we’ve seen that the increased revenue has more than covered off the increasing cost base. So from a profitability point of view, we see hotels essentially back to better than they were pre-Covid. That’s a good place to be.”
For those investors concerned about costs and operational challenges, they say choosing the right partner is of critical importance, adding that management companies are able to deal with many of the complexities that accompany the day-to-day operation of a hotel/hospitality business.
Large all-encompassing management companies can leverage their scale and capabilities to deal with any operational issues which may arise including utilities and finding staff amidst the current labour shortage.
Hart says, “It’s about making sure an investor picks an appropriate partner to manage their hotels and maximise performance and returns. You need to have a really strong commercial team that has a strong track record of revenue management, that has a national sales capability to talk to the agencies that an on-property sales team or an individual hotel just won't be able to get access to.
“You need to have a marketing team that can support what the brands do, a procurement team that can really buy well, and a finance team that can really drill down into your performance and returns. If you’re nervous, you need to pick the right partner that can do everything and has the right experience and the internal capability.”
Oltchick agrees, stating that core funds can collaborate with operators/management companies that have the resources and the experience to source deals, who will look at things creatively and figure out ways to monetize the entire property.
“We're looking at spaces differently than we may have in the past; how can we re-conceptualise stuff, do we need all this meeting space or can we use it for something else? We're exploring how to implement technology to be more efficient. We’ve looked at how to use less products, change ingredients or rework menus so there's a lot less waste and F&B is more profitable.
It’s about finding value-add opportunities to improve the investment return profile for our partners whether that's through brand changes, restaurant re-conceptualising or reutilization of different spaces in the hotel. Investors need a partner who's creative and who can adapt to the changing demographics of the traveller in order to be successful” he says.
Communication
He adds that communication between investors and management companies/operators is essential in order to assuage any concerns and nip any nervousness any bud.
“We try to be very transparent and conduct bi-monthly calls with ownership groups just to keep them abreast of some of the volatility in the market, whether that's on the operating side, on the labour side or on the demand side. It’s just talking and communicating more often and more proactively with the ownership group to make them more comfortable.”
Despite any concerns which potential investors may have, Hart stresses that metrics have shown that over a longer period of time, the total return on hotels is better than almost very asset class, adding that it’s an industry that has long-term sustainability because people are always going to want to travel and are always going to want to meet up socially.
“My view is that you won’t get a better industry to invest in than hotels. It’s clear it can be resilient in the face of the biggest issues that we can face globally and revenues have recovered beyond what people expected, to deal with the cost base issues. The fundamentals of why the hotel industry will succeed are still there and will remain there and therefore, it’s a solid place to invest,” he says.
In conclusion, traditional investors can indeed bridge the gap to the hospitality sector. By partnering with management companies, they can navigate the operational complexity, mitigate risks and unlock returns. The sector's resilience coupled with its potential for high returns, makes it an attractive investment prospect, well worth consideration by core funds.