Are Buy-to-let Hotel Rooms About to Replace Traditional Holiday Homes?

Property Investor - July 2008. Peter Hemple discovers if one of the fastest expanding property concepts is sustainable

Most people, especially property investors, will have at least heard about the hotel apartment concept, or buy-to-let hotel room, by now. Guest Invest was one of the first companies in the UK to promote the scheme in various locations around central London. It allowed people to invest both in the hotel industry and the London property market, to use the hotel room for a certain amount of days (52) a year, and get a 50% share of the income gained from renting the room on a daily basis to tourists or business travellers. Aside from the return-on-investment (ROI), the other main benefits for the investor include the fact that the management, maintenance and marketing aspects are all taken care of.

The investment can also be put into a self invested personal pension (SIPP) because it is a commercial lease and investors can currently obtain 75% LTV mortgages at rates of 1-2% over LIBOR, so a 6% net return should cover the mortgage costs.

So far so good, for the property investors who jumped into the unknown some four years ago according to Guest Invest, which uses the phrase 'earn money while others sleep' to promote its product - called the 'buy-to-let hotel room', The company is now selling rooms at its fifth hotel in London and claims that the original room owners are achieving net rental yields of 8%and that the price of an average room at Guesthouse West in Notting Hill increased from £235,000 in 2004 to £275,000 in 2007. Just over one-third of the original investors have now sold their hotel rooms, but one quarter have re-purchased another hotel room through the company, which would suggest that many are satisfied with the investment concept.

However, while it is a relatively new idea in the UK, it has been around for some time in the US where the hotel sector in general has now become an established commercial property investment category.

Funds 'fall in love' with hotels

In the US and other locations across the world it is quite common to invest in condominium apartments which are fully managed, maintained and marketed by a separate company. Many big cities in the US attract a large transient work force that arrive on a Monday and leave on Friday to return home to their families. Also, many employees have temporary work contracts that may be of an indeterminate length. This makes it difficult for them to commit to a six month rental contract as their situation can change with a few days notice. Both of these factors led to the emergence of the 'Condotel’ concept in the US.

“In the US and other locations across the world it is quite common to invest in condominium apartments which are fully managed, maintained and marketed by a separate company”

Dan Larkin at US legal firm Squire, Sanders & Dempsey, which is doing a lot of hotel acquisition work for developers and funds, says: "The apart-hotel concept has been around for over five years in the states and has now come to Europe. I don't think it will go away because it is a viable model, especially in big cities. We have seen considerable growth in the hotel sector and there are now five 'big food chains' in property, (residential, office, retail, industrial and hotel).
"Hotels have been the big new investment category for institutional investors and the funds have fallen in love with hotels. Historically, hotels were regarded as a cyclical asset where a slowdown, like the current credit crunch, usually forced operating margins to plummet but a lot has moved on lately and people have realised that in larger cities, hotel profits tend to hold up pretty well.
"The apart-hotel concept definitely works in resorts and that is where it really got going. It has already spread into the budget sector for resorts and it is also blurring with other investment types such as timeshare and resident clubs. It is a complicated deal for a company to put together, especially in cities where the cost of land is usually 50% of the transaction fee, while in a resort the land is a much lower percentage of the transaction fee. "I am not sure that apart-hotels will work at the Mediterranean resorts because the season is seven months long, so returns are lower than in the Red Sea or the Canary Islands for example and it is more likely to succeed in those locations, especially in the luxury end of the market because there is not much quality supply.
"The main threat to the hotel industry is if there is too much competition hotels will be forced to cut room rates, which will affect returns and room values. A major economic slowdown will obviously weaken demand as will a terrorist attack, which is not as significant for businessmen but in Egypt it killed tourism for a whole season. That is why there is a preference for city / business hotels."

London hotel market

One city that is growing in popularity for apart-hotels is London and the current big selling point is the 2012 Olympic Games. However, the rooms don't come cheap and prices generally start in the £250-300,000 range for standard studio hotel rooms. But, according to Guest Invest, average room rates are £145-175 per night depending on the time of year. Also, occupancy levels in London are high and appear to be increasing according to the latest report from STR Global which analyses over 500 hotel markets across the globe. STR reported that average occupancy rates in London were 82.4% in April 2008, compared to 78.8% in April 2007, and that the average year-to-date occupancy rate to April 2008 was 77.6% - 1% higher than the previous 12 month average. Also, from all of the cities listed in the report, only Hong Kong and Cairo had a higher occupancy rate (that was up on the previous year) than London. But occupancy rates for luxurious rooms can often be even higher in London and Guest Invest says its hotel occupancy rates are currently 87%.
Interestingly, Beijing which is about to host the Olympic Games has seen occupancy rates fall from 66% in the year to April 2007 to 62.5% in the year to April 2008, which is obviously a reflection of more hotels being completed during the latter period. But could the same thing happen in London? Residential property prices in the capital have fallen slightly of late, although not as significantly as in other parts of the UK. As a result, the amount of new construction has slowed from a trickle to a very slow drip. But the same cannot be said for the construction of apart-hotels. Guest Invest is currently selling rooms at three hotels in London, although rooms at Blakes, which start at £lm, are only being offered to 'the hotel's regular guests'.  Galliard Homes is building a 900-room buy-to-let hotel called Westminster Bridge Park Plaza opposite the House of Commons and 700 suites are already sold with a 6% net income guarantee until 2015.
More apart-hotels are either planned or under construction including a 218-room 4-star hotel in Chelsea Bridge Wharf, which is being built by Portuguese leisure group Pestana but only 66 of the rooms are initially being offered for sale at £295,000 excluding VAT. The group offers 30 nights stay but between years 3 and 5 the room owner may use 15 nights a year at any of its 82 luxury hotels worldwide. Pestana insists that by selling only a percentage of the rooms to private investors it shows commitment to the long term success of the hotel and any reader with concerns about the management company going bankrupt may prefer the idea of going into business with a well established multinational company rather than a new arrival to the hotel industry.

“We are offering a 6% rent guarantee for 2010 and 2011 and to pay for that we will need to achieve 80% occupancy”

Pestana's decision to enter the London hotel market coincides with a recent Deloitte Hotel Benchmark Survey which showed that occupancy and rooms rates in London are the highest in Europe. Furthermore, a recent report from Price Waterhouse Coopers (PWC) found that over the last five years room rates in London have increased by 18%, occupancy rates by 12% and RevPAR (revenue per available room) by 33%. PWC also expects both room rates and occupancy rates in London to increase in 2008 and 2009. Pestana says that its London hotel rooms are one-third larger than the average hotel room in the capital at 30sqm and there are also kitchen facilities and flat screen TV's in the bedroom and bathroom.
Two-thirds of the rooms have now sold at Chelsea Bridge Wharf and Pestana is considering releasing more rooms at the hotel to investors. The company's other hotels are located in Portugal, Madeira, Cape Verde, Mozambique, Brazil and Argentina. Peter Booth. Director at Pestana, says: "We have had a lot of interest from investors that have previously invested in traditional buy to let properties and some are disillusioned with the returns they are currently getting and want to diversify their portfolio. It's the first invest-hotel we have launched but we plan to roll the concept out across Europe. "Selling around one-third of the rooms allows us to reduce our borrowings on the project. For example, with the London hotel we may sell a maximum of 80 rooms but at £300,000 each that will give us £24m back. We can use this capital to start projects in other capital cities in Europe and we are currently looking at Berlin and Amsterdam. "We looked at the hotel market in London over the last ten years and found that the lowest occupancy rates were in 2001-2003, as a result of 9/11, but even then the average occupancy was 75% and room rates didn't fall they stabilised. The high point was 83% occupancy. We are offering a 6% rent guarantee for 2010 and 2011 and to pay for that we will need to achieve 80% occupancy at a room rate of £140 per night so we are very confident about London. When the rent guarantee expires it will be time for the Olympic Games."

But with so much construction taking place in London, is Booth concerned about an oversupply of hotel rooms? He says:

"There are a few hotel rooms being built but the ones that will feel the pinch are the hotels that have been around for a while and have not been refurbished. We offer good quality with big rooms and marble bathrooms and the hotel will have a four to five-star finish, but at a four-star price." Booth says that there is currently strong growth in both the luxury and budget hotel sectors and that the type of hotel usually depends on the location: It is not easy finding good locations in the centre of a city and budget hotels tend to be on the outskirts of a city. The important thing is to create a hotel that will have high occupancy rates and good room rates because it is all about delivering a return to the investors. I think it is harder to do that at a resort and I don't think the apart-hotel concept is suited to a resort."

He concludes: "The apart-hotel concept is very much in its infancy and Guest Invest has been at it for a while. We have years of experience and a vested interest in getting the maximum returns for our rooms because we own two-thirds of them! Also, our buyers get a privilege card that gives them discounted rates at our other hotels around the world."

Buy- to-Let hotel rooms spread to Europe and beyond

Owner Invest is selling hotel rooms at various locations across the globe including Dubai, Thailand, Spain, Greece and Germany, as well as Scotland and the Lake District with starting prices of £60,000. So what does the company look for when setting up buy-to-let apart -hotels?
Mark Bingham at Owner Invest says: "There are two key areas, first are city centres that have lots of business travellers demanding low cost quality rooms and the second are proven tourist destinations. We looked at Morocco for example but decided against it because it is not proven yet.

"This investment is not for someone that is looking for a holiday home. It is an investment. We allow personal usage though, depending on how many days the room owners are likely to want to use the room so in Costa del Sol we allow up to 56 days a year because people fly there quite often in winter for golfing weekends, while in Crete we allow 30 days because it is further away from the UK.

"Most of the hotels are fully built already and the first one officially opens this September. We don't offer rent guarantees because that is a cost that is just written into the price. We prefer to just tell buyers what the average room/occupancy rate has been in the area recently and give them an idea of what they should achieve. Having said that, we contract out the management of the hotel and there are clauses in the contract. For example, at our Frankfurt hotel, if there is not at least 60% occupancy in the first year the management company will be out, but these companies do their own research so they know what they can achieve before they start managing the hotel.

"We won't know for three or four years whether the city hotels perform better than the resort hotels and it is probably wise to spread the risk between cities and a resort you love to visit. The reason we won't do a London hotel is because those rooms are too expensive for many individual investors. The ROI will be the same at our hotels, so why not buy three cheaper hotel rooms elsewhere and spread out the risk? It is very early days to properly value hotel rooms and this is a long-term investment focused on annual incomes. However, if you get good returns the value of the room goes up."

Bingham says the biggest risk involved in hotel rooms is no different to the biggest risk when buying residential property.....oversupply. He says: "The big hotel chains may well follow the buy-to-let hotel room concept and that could lead to an oversupply like we have seen in Spain and Bulgaria and those hotels that are not in the best locations will lose out. The important thing to remember with hotel investment is that it shouldn't be built on future expectations, like a new Ryan Air route arriving for example. The destination should already be proven.

“I think the main thrust of expansion will be budget hotel rooms. In the UK, the feeling you get from owning a second home is wonderful until the first bills come in or you get a phone call telling you that a water pipe has just burst. The apart-hotel industry will get bigger in the UK but it will be much bigger in Europe because people still want to go somewhere hot. We are currently planning new hotels in Berlin, Almeria and Albufeira."

Conclusion

At a time when residential property prices in the UK are falling and many landlords have also been stuck with empty city centre apartments, while still paying mortgage/service charges, the thought of a 'hands-free' commercial investment that pays higher average net yields is certainly appealing.
So, before you decide to buy a second home in the UK or Europe, whether it be in the country or by the sea, first calculate how many nights a year you are realistically likely to use it and if it is 50 or less then ask yourself, 'would I rather stay in a fully managed hotel?'  If the answer is yes then the general public are likely to think the same way and you might be wiser investing in a hotel room instead.

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