Hotels and Resorts: Investing Essentials

Find out what you need to know about investing in the hotel industry.

Aug 6, 2014 at 2:15PM

Hyatt
Source: Hyatt Hotels.

For most people, the topic of hotels and resorts conjures up visions of exotic vacations in faraway places. But hotels and resorts make up a huge industry, and investors have found many different methods of making money from companies that provide places for travelers to spend a short time away from home. From owning hotel and resort real estate itself to managing their operations, various companies use well-tailored business models to maximize their profit opportunities and give investors a comfortable risk profile. Let's take a closer look at the industry with an aim toward understanding how its biggest players have been successful.

What is the hotels and resorts industry?

The core concept of the industry is pretty simple: Provide a place for travelers to stay, as well as entertainment to help them enjoy their destinations. But behind this simple concept you'll find a lot of painstaking work that goes into building, maintaining, and operating hotels and resorts. The initial phase involves finding a suitable property and obtaining the permits and financing to move forward with construction. Once the physical real estate is in place, hotels and resorts require extensive staffing and management in order to maintain and operate the facilities efficiently. Moreover, with substantial competition within the industry, these companies must have a marketing presence to promote their features in order to draw visitors.

Www
Source: Robert Agthe.

As a result, you'll find a number of different players in the hotels and resorts industry. Hotel owners include both individuals and investor groups, including real estate investment trusts that specialize in the hospitality industry. Hotel management companies often don't own the hotels they manage, instead focusing on operations and sometimes serving hotel-brand franchisees in individual locations that are part of larger hotel networks. These companies work together, enjoying the benefits of high-travel periods and struggling through the inevitable downturns in travel activity.

How big is the hotels and resorts industry?

According to the American Hotel & Lodging Association, the hotel and lodging industry employs 1.8 million people in the U.S. alone, and that only measures direct employment by companies in the industry. Domestically, estimates put the number of hotel rooms at 4.9 million, with annual sales of more than $155 billion. Globally, total revenue comes in between $400 billion and $500 billion.

The sizes of businesses within the industry can vary widely. Independent owners tend to operate their properties, often owning only a single hotel and relying on it for their entire livelihood. At the other end of the spectrum, massive hotel chains often have hundreds of locations scattered across the globe, all under a single management umbrella even if different properties have different owners. Real estate investment trusts often have extensive portfolios of properties around the world in order to offer diversification to their investors. For instance, Hospitality Properties Trust has $7.7 billion invested in almost 300 hotels and 185 travel centers in the U.S. and Canada. Host Hotels & Resorts owns a wide variety of properties with different brands, including Ritz-Carlton, Four Seasons, and Le Meridien. Host has more than 100 U.S. hotels and resorts, as well as a few dozen more internationally.

How does the hotels and resorts industry work?

Historically, many hotel operators both owned the real estate and managed their properties. More recently, though, there has been a shift toward asset-light hotel management companies that leave ownership of the properties to separate entities. That has the benefit of allowing hotel and resort real estate to be held within tax-advantaged real estate investment trusts, where real estate investors get the pure-play exposure they want. At the same time, hotel management companies require relatively little capital investment, greatly enhancing returns on invested capital and making them more attractive as investments.

Hyatt Lounge
Source: Hyatt Hotels.

Because business cycles in real estate and travel aren't perfectly aligned, these two factors interact in different ways. During periods in which real estate is suffering but travel activity is still high, interest in management companies rises. At other times, real estate comes into favor even when management companies struggle from short-term weakness in demand.

What drives the hotels and resorts industry?

A number of factors drive the success of hotels and resorts. Obviously, the industry needs healthy travel trends in order to sustain demand. The declines in travel activity following the Sept. 11 terrorist attacks in 2001 and during the 2008 recession created challenges for the industry, and hotel operators had to respond by catering to changing trends favoring local travel over blowout vacation spending. Moreover, business travel is a key driver of profits, as those traveling for work tend to pay higher rates and support weekday occupancy rates in key business destinations.

Marriott Dubai

Source: Marriott.

More generally, economic conditions spur expansion and contraction in the hotels and resorts industry. Often, boom times will lead to massive development of new capacity, as occurred in Las Vegas in the 1990s and early 2000s. Money floods into the industry for investment, leading to high levels of building activity. Overdevelopment, in turn, leads to overcapacity, causing revenue per available room to plunge, turning once-profitable properties into money-losing propositions and bringing new construction to a halt. Eventually, demand catches up with supply and the cycle begins again.

One new threat to the hotel industry comes from the emerging social-sharing niche, in which homeowners offer couches or rooms to visitors for short periods of time. The hotel industry has responded by noting the safety considerations of relying on strangers for accommodations, as well as calling for fair taxation to match what hotels have to pay. Still, websites such as HomeAway and Airbnb have become popular among certain travelers.

The hotels and resorts industry nevertheless continues to play a vital role in travel for business and pleasure. As long as people are willing to visit new places in person, investors will have an opportunity to profit from the hotels and resorts where they stay.

Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends HomeAway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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