Hotels can be an excellent way to generate income and build long-term wealth, especially when the economy is strong. Unlike most types of commercial real estate, hotels can adjust their room rates on a daily basis. This gives them a unique ability to raise prices to match demand.
There are four main ways to invest in hotels:
- Buy an actual hotel/motel.
- Participate in a crowdfunded hotel real estate investment.
- Buy a REIT that owns hotels.
- Buy the stock of a hotel operator.
Here’s a brief rundown of each way to invest, some of the pros and cons of each, and how to determine which is the best way for you to get involved.
1. Buy a hotel
This is the most obvious way to invest in hotels, but it's also the least practical for most people. Depending on where you live and what you’re looking for, a hotel can require a ton of upfront capital. Plus, a hotel is a business and not a passive investment -- even if you hire people to manage the day-to-day operations.
Hotels come in all different styles, sizes, and costs, so they may be more within your affordability range than you might think. A quick search shows that there are hotels within 50 miles of my current location that start at $795,000 for a 70-room rural motel. This may be in the realm of possibility for many people reading this.
However, unless you have a real desire to be in the hotel business, I’d suggest choosing one of the other investment methods discussed here.
2. Participate in a crowdfunded hotel investment
Crowdfunded real estate is a relatively new way to invest. Check out our crowdfunded real estate home page to learn more about it. Here’s a simplified overview of how it works:
An experienced real estate investor or developer (known as the deal’s sponsor) identifies a real estate investment opportunity but doesn’t have the capital to execute on his or her vision. So the developer lists the deal on a crowdfunding platform to raise the required capital from individual investors in exchange for an equity interest in the project.
There are Crowdfunded investment opportunities for all types of commercial real estate, including hotels. They generally involve a single property and a value-adding strategy. For example, a developer might plan to acquire an older hotel, renovate the entire property to increase its income potential, and sell it a few years down the road for a profit.
There are a few main points you need to know about this type of investment. For starters, most crowdfunded real estate investment opportunities are only open to accredited investors. That means you must have at least $1 million in investable assets or annual income of $200,000 or more ($300,000 with a spouse) for the past two years.
Second, crowdfunded real estate is the most illiquid way to invest in real estate. These investments typically have a target holding period of several years. While the project is active, you won’t be able to cash out.
On the other hand, there's some serious money to be made in crowdfunding, so accepting the lack of liquidity and the project’s execution risk can be worth it. It’s not uncommon for crowdfunded real estate investments to generate annualized returns of 15% or more for investors. If you have a somewhat high-risk tolerance and won’t need the money for at least the next few years, crowdfunding can be a great way to invest in hotels.
3. Buy a hospitality REIT
Real estate investment trusts, or REITs, are similar to mutual funds, but for properties instead of stocks, bonds, or commodities. Specifically, a REIT is a special type of company that pools investor money and invests in a portfolio of real estate assets. REITs must pay at least 90% of their taxable income to shareholders, and many REITs trade on major stock exchanges, making them easy, as well as highly liquid, investments.
You can find REITs that specialize in almost any type of commercial property, including hotels. And there's significant variety within the hotel REIT market, as most specialize in a specific type of hotel, a specific type of area, or both.
Just to name a few of my favorite examples, Ryman Hospitality Properties (NYSE: RHP) and Xenia Hotels and Resorts (NYSE: XHR) both specialize in large-scale luxury resorts. Apple Hospitality Properties (NYSE: APLE) specializes in mid-level hotels, which it calls “select-service” properties. Hospitality Properties Trust (NYSE: HPT) also invests in mid-range hotels but diversifies its holdings by also owning a portfolio of travel centers and retail properties.
There are several good reasons to invest in REITs. Since they pay out most of their income, REITs they tend to be great for income-seeking investors. And because many REITs trade on major stock exchanges, they're easy to buy and sell whenever you want.
4. Invest in a hotel brand's stock
There’s a common misconception that hotel brands own their properties. In other words, many investors assume that companies like Hilton and Marriott own massive real estate portfolios.
However, this is generally not the case. Most hotels that bear these companies’ brand names are actually owned by REITs like those I discussed in the last section. A REIT or other owner will build or acquire a hotel, sign a management agreement, and maintain the property according to the brand’s standards.
Although hotel operators may own a few properties, their primary business is management and franchising. Take Marriott International as an example. The company has more than 7,000 hotels that carry one of its 30 brand names. Of these, only 63 are owned or leased directly by the company, 2,035 are only managed by Marriott, and the rest are either franchised or licensed to third parties.
Even though these aren't exactly real estate investments, these companies can be great ways to invest in hotels, as their income is typically dependent on how well their properties are performing.
Hotel investments can be very cyclical
As a final point, it’s important to mention that while hotels can be great investments during strong economies, the other side of the equation is that they tend to be the most economically sensitive type of real estate during recessions and other tough times.
Because they set their "rent" on a daily basis, vacancy tends to spike faster than with most other property types when demand falls. And pricing power usually erodes in down markets, so hotels end up making less money from their occupied space during these times. With other types of properties -- say apartments -- even if vacancies increase during a recession, the tenants who choose to remain still pay the same rent they had been paying.
Because of this, diversification becomes much more important when investing in hotels. It’s important to complement them with investments that aren’t especially recession-prone. As an example, office and healthcare real estate are some of the least sensitive property types, so these could be good ways to help offset the risk of hotel REITs.
The bottom line is that hotel REITs and other hotel investments can be great ways to put your money to work. Just be aware of the risks and invest accordingly.