Have you ever played Monopoly and thought to yourself – “owning a hotel would be a great investment.” Unfortunately, hotels are expensive and typically far beyond the realm of possibility for the everyday investor. However, there are ways you can invest in hotels without physically owning the properties.
Hotel real estate investment trusts (REITs) allow you to add hotels to your portfolio in the same way you would add stocks and bonds. These REITs focus on acquiring, developing, managing, and/or financing hotels and other hospitality projects. And they’re not limited to a particular type of hotel. These REITs can range from roadside budget inns to five-diamond prestige resorts.
Thanks to several unique attributes, hotels may help you combat today’s interest rate environment.
Economic trends are “key
If you haven’t heard, the hotel industry is in the midst of one of the longest up cycles in recent history, and marked its ninth consecutive year of growth.1
Thanks to our strong, growing economy, there’s been an uptick in business travel as companies continue to perform well. Personal and family vacations have also increased thanks to significant consumer confidence, increased spending, and an unemployment rate that currently sits at 3.8 percent.2,3
Travel and tourism trends have been strong in recent years. International tourist arrivals are predicted to reach 1.8 billion worldwide by 2030 – an average growth of 3.3 percent per year from 2010 to 2030.4
Overall, fundamentals for the hotel and hospitality industry are on solid footing, and that’s a plus if you’re looking to invest in lodging. In July, revenue per available room, or “RevPAR” for short, rose to $98.17, up 1.8 percent from 2017. And, barring any “black swan” type of event, experts expect positive RevPAR to continue through 2019. Additionally, average occupancy sits at 65.9 percent, up 70 basis points from last year. Average daily rates are also expected to increase 2.4 percent above inflation in the coming year.2
Industry experts have also noticed the forming of a unique supply and demand imbalance. In July 2018, travelers spent a combined 120 million nights in U.S. hotels – the strongest month of demand ever. But, recently there’s been moderation in supply. Starting in April 2018, due to increased construction costs, the number of rooms under construction declined in six of seven months, and overall construction activity was down 2.2 percent compared to 2017. This type of imbalance may signal a unique investment opportunity.2
Checking-in when interest rates rise
Interest rates rose off historic lows as the Federal Reserve responded to an improving economy. Interest rates have been rising steadily for several years before hitting today’s current bout of uncertainty.
Rising rate environments can have a dramatic impact on investment portfolios. For example, rising rates can erode a currently-held bond’s principal, and stocks may also see lower share price growth due to diluted cash flow. And while it’s true that real estate can suffer short-term, interest rate shocks, not all sectors react the same. Real estate with short-term leases, like hotels, can capture the income generated by a property to keep pace with the growing economic footprint. Triple-net lease, on the other hand, have an average lease length of 10 to 20 years, giving them less flexibility as rates rise.5,6
Understanding the potential risks
While hotels may be positioned well for a rising rate environment, lodging REITs are notoriously volatile because occupancy correlates with general economic conditions, making them highly sensitive to economic expansion and contraction. When a recession hits, businesses slash their travel budgets and families and organizations postpone vacations, choosing to stay closer to home.7
So, as we approach the latter part of the current business cycle, it’s important for hotels and resorts to prepare appropriately and control expenses. If a hotel can raise its net operating income by a point or two and the economy stays on its current course, then it will be generating extra cash. By improving operations now, hotels may have the ability to weather any economic storms that arise.1
Do hotels have a place in your portfolio?
The economy continues to grow, but with a growing economy comes a tighter labor and monetary picture. Hotels are today’s hot investment mainly because they have the potential to strengthen as the economy does. Compared to other sectors, real estate with short-term leases historically performs best during rising rate, inflationary environments – as long as the economy continues to grow.