Pros and Cons of Investing in Hotels in 2024
The year 2024 is unfolding against a backdrop of global uncertainty and economic resilience, setting a complex stage for investors eyeing the hotel industry with optimism and caution.
Amidst the whirlwind of a U.S. presidential election and significant geopolitical tensions, the economy is exhibiting a defiant stance against recession. This is fueled by cooling inflation and a robust stock market that continues to invigorate consumer spending in the travel and tourism industry.
However, despite these tailwinds promising growth and recovery in the hotel industry, investors face a combination of challenges and opportunities that make 2024 a uniquely compelling year to invest.
As GlobeSt.com reports, the sharp deceleration in hotel investment transactional volumes due to skyrocketing interest rates in 2023 has left the market ripe with potential for those daring enough to navigate the widened Bid/Ask spreads and higher borrowing costs.
It's a year when the resilient economy's demand for travel might perfectly intersect with strategic investment opportunities in the hotel sector, provided investors are armed with the right insights and strategies.
But investing in hotels 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 hotels the right decision for you? Let's review the main pros and cons of investing in a hotel in 2024.
Outlook for Investing in the Hotel Industry in 2024
Drawing from the latest CBRE research, it's clear that the hotel industry is on a trajectory of recovery and growth, influenced by several key factors:
- The resurgence of international travel is fueling optimism across the sector. The anticipated 3% year-over-year increase in Revenue Per Available Room (RevPAR) marks a continuation of the positive trend observed in 2023. This growth is underpinned by a steady climb in both Average Daily Rate (ADR) and occupancy rates, signaling robust demand, particularly from inbound international travelers.
- Luxury and upper-upscale segments in particular are set to outshine, with projected RevPAR increases of 3.8% and 3.7%, respectively. This shift indicates a sustained appetite for high-end accommodation experiences, a trend gaining momentum and is expected to persist through 2024. Thanks to their appeal to international visitors and strong group segment performance, urban locations are poised for the most significant growth.
- Gross Operating Profit (GOP) margins have experienced pressure, declining throughout the majority of 2023, ending the year 256 basis points below 2019 levels. This contraction reflects the ongoing battles with cost increases outstripping RevPAR growth, a tight labor market, and escalating wage growth. Additionally, higher insurance and property tax expenses and rising construction costs threaten to burden operational expenditure further.
- Investment dynamics are also evolving. With short-term interest rates expected to decline by 100 basis points, the investment landscape appears ripe with opportunities, especially for trophy assets and boutique hotels in supply-constrained, differentiated locations. Group hotels with leisure appeal and premium select-service hotels, fresh off renovations and associated with globally recognized brands, are particularly attractive for investment.
While specific U.S. markets like New York City and San Diego have surpassed their pre-pandemic performance, others lag due to net migration outflows, rising crime, and political issues, among other factors. These disparities underscore the importance of strategic location selection and market analysis in maximizing hotel investment returns.
Potential Pros of Investing in Hotels
Superior returns
Hotels offer a fantastic potential return on investment—in fact, according to the National Council of Real Estate Investment Fiduciaries (NCREIF) hotel index, annual returns can be as high as 12%.
A key factor contributing to the appeal of hotel investments is the dynamic pricing strategy. This strategy enables hotels to reduce rates during periods of lower demand to ensure occupancy and to increase prices in response to heightened demand. This ability to adjust tenancy rates in real-time is a unique advantage not found in other real estate investment categories.
However, room charges represent just one of several income streams for hotels. Beyond fixed overheads like property taxes, utility bills, and insurance premiums, hotels incur variable expenses, which include the costs of food and beverages, room furnishing, and a variety of services offered to guests. The profit potential lies in the substantial markup that hotel owners can apply to these variable expenses, turning them into healthy revenue streams.
Brands offer recognition for guests and security for investors
In the U.S., the hotel industry is dominated by several renowned brands, including Marriott, Hyatt, Hilton, and Holiday Inn. These brands appeal to consumers because of their reliability and consistency. As such, investors are drawn to the significant brand recognition and the depth of knowledge available to franchisees, making these brands particularly appealing to those new to hotel investment.
Franchisees gain access to a wealth of resources through the brand, including expansive marketing efforts, expertise, and invaluable consumer insights gathered from loyalty programs. Furthermore, securing financing for a venture under a well-known brand is often easier for investors due to the perceived lower risk compared to backing an independent hotel.
But the partnership with these major brands comes with a catch—franchisees must adhere to a strict set of guidelines and operational protocols, leaving little room for flexibility. This rigidity can be a point of contention for independent operators, who may find themselves at a disadvantage, such as being unable to quickly adjust pricing in response to economic pressures.
Nearly infinite adaptability
Investing in a hotel offers various opportunities for adaptation and optimization, particularly for those managing independent operations. Even modest upgrades, such as aesthetic improvements, can significantly shift the market perception of your hotel, attracting a different demographic of consumers. Additionally, small-scale innovations, illustrated by the surge in customer loyalty programs, have the potential to markedly enhance profitability.
Running a hotel requires a substantial workforce, spanning from executive management to frontline operational staff, presenting another avenue for cost management. In times of economic downturn, reducing staff numbers (although tough) may become necessary. Hotels also depend on numerous external partnerships and supplier contracts, offering the possibility to renegotiate terms to achieve better financial efficiency.
As The American Hotel & Lodging Association notes in its 2024 State of the Industry Report, hoteliers will continue adopting sophisticated technology and strategies to make their operations more efficient and sustainable while enhancing guest experiences. Along with implementing new tools and strategies, the industry will continue to invest in bolstering the hospitality workforce, attracting new talent, and preparing teams for the future of the travel and tourism industry.
Potential Cons of Investing in Hotels
High barrier to entry
During times of economic distress, investing in hotels can produce prolonged ups and dramatic downs. 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 had not sufficiently funded the equity component of their transactions were suddenly faced with unsustainable mortgage obligations as revenue streams evaporated almost instantaneously. This situation underscored the unique challenges of financing hotel investments compared to other investment types.
Lenders frequently require assurance of proficient management being on board before approving financing, and the lending climate for hotel ventures is particularly volatile, reflecting the hospitality industry's acute vulnerability to economic shifts.
Hotels are active investments
Many specialists agree that hotel investments demand a greater level of active involvement than any other real estate category, whether commercial or residential.
Running a hotel encompasses a broad range of operational tasks, from front-of-house service excellence to meticulous housekeeping, culinary operations, and sophisticated marketing strategies. This requires a diverse team operating 24/7, all of whom need to be coordinated so that their activities are synergistic. It's a complex endeavor, especially as you rise through the ranks to more luxurious establishments, where expectations and operational complexity increase exponentially.
While investors can directly oversee their property or delegate to a professional management firm, navigating the complexities of hotel management goes beyond the more straightforward tasks of traditional real estate investments, such as leasing apartments.
Given the intricacies involved, some professionals advise hotel investors to stay geographically close to their properties to oversee operations effectively.
Digital marketing really matters
The digital era has profoundly impacted the hospitality industry, particularly in how hotels attract and retain guests, leading to a pivotal shift in a hotel investment's profitability.
In the same way that 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.
This transformation has eroded traditional pricing autonomy and brand loyalty, compelling hotels to adjust their rates competitively to maintain visibility and appeal on these platforms. Customers who might once have shown faithfulness to a specific brand or chain now prioritize convenience and pricing found on OTAs, forcing hotels to remain competitive in the digital marketplace.
Furthermore, review platforms like Yelp have the power to make or break a hotel's reputation with just a few keystrokes. Positive reviews can bolster a hotel's standing overnight while negative comments can trigger a reputational crisis, deterring potential customers.
In this environment, exceptional hospitality and customer service have become even more crucial, underscoring the importance of managing online feedback proactively to uphold a hotel's reputation.