More and more investors are seeing hotel room investment as a way of expanding their portfolio, generating high stable returns, and not needing to expel huge amounts of energy for those returns.
With UK tourism at record levels, and growing, now is the time for investors to capitalize on this strong performing market offering high, sustainable, yields and capital growth.
PwCs Emerging Trends in Real Estate Report (ETRE) Europe 2018 (produced jointly with UTI) found that alternatives continued to dominate the list of sectors being considered for investment, with Hotels ranking second among such niche sectors and Serviced Apartments fourth with 28% and 17% of respondents indicating interest respectively.
Among all Real Estate Sectors, Hotels and Serviced Apartments were ranked 12th & 9th of the 23 sectors for overall prospects in 2018, both equating to a ‘generally good’ investment score In terms of development prospects Hotels ranked 14th and Serviced Apartments 10th again equating to ‘generally good’ development scores.
Source : PwC 2019 Forecast
Although it appears a relatively new concept, Hotel Room investment has been around a number of years, and has been used by many of the major hotel chains as a way to finance and purchase new hotels. Essentially how it works is that an investor purchases a room within a hotel on a leasehold basis, in the same way that you would purchase an apartment within a block of apartments.
Then the investor has a rental agreement (sometimes known as a sub-lease) with the hotel operating company. It is standard practice that the owner of the freehold (sometimes known as the developer) is a different entity to the operating company. The reason for this is that for each hotel within the hotel group there is usually a Special Purpose Vehicle (SPV) company set up to ring fence the activities of that hotel from any others within the hotel group.As part of the rental agreement, the operator agrees to pay a fixed rent to the owner of the room in return for the privilege of being able to use the room to house hotel guests. The rent is paid regardless of occupancy. So if the room is empty, the investor still gets paid, equally if the room is fully occupied all year round, the investor also still gets paid. Usually this rental agreement is for a fixed period of time, after which is can be renewed on new terms, or the investor can exit out of the investment through the way of a buy-back.
The buy-back is usually structured as an option agreement – both for the investor and the developer, giving both parties to exit and trigger the buy back with a period of notice (usually 1-2 years) at a pre-agreed uplift on the initial purchase price. Some developers offer buy backs at Year 5 or 10, with an uplift anywhere from 1.5-2.5% per year on the initial price. The way the developer is able to buy back the rooms is either through a direct purchase from funds they have generated from the rooms they have retained themselves within the hotel, or if they were to trigger all the buy-backs, they could look to refinance the hotel with a bank now that they have completed their renovation works, and added sufficient value to the hotel, or thirdly they could sell the hotel to another group, triggering all of the buy-backs.
It’s hard to say any one asset class is better than another as it depends on what the individual investors strategy is. Hotel room investment, similar to student accommodation is a cash only investment, with no financing options available, so it is suited to cash rich investors looking for high returns.It is very similar to student accommodation, however hotel investment has the contractual buy-back agreement in place, giving investors a cleaner, clearer exit rather than having to resell to another investor, which you can still of course do with hotel room investment should you wish. It’s also worth noting that there are no ongoing charges such as maintenance, or service charges with hotel investment. Some hotel rooms attract a very small ground rent which is deducted from the returns automatically before they are paid to the investors. For investors looking to leverage, buy-to-let would be a better investment.
One of the added bonuses of student accommodation is that you often get the option to use your room for one or two weeks per year free of charge, or you can gift it to friends or family. Unfortunately anything more than this would be charged (at a preferential rate). The reason operators cap their free usage allowance is because they need to generate revenue from the rooms in order to pay the returns.
Hotel investment can vary in price from £50,000 – £250,000 depending on which are of the country you are looking. London hotel rooms are generally up to £300,000 and offer yields around 5%. If you looked outside of London you can achieve higher returns and lower investment requirements, and as the property is being purchased for an investment, 99.9% of investors opt for the lower cost, higher returning asset. The only other costs to factor in are legal fees (usually about £1,000) and if the property is over £150,000 you would be required to pay a small amount of stamp duty.
The answer is quite a straight forward one. With bank finance, a borrower is usually required to start paying the interest within one month of borrowing the money. When a hotel is being purchased and/or renovated, it takes a while for the hotel to reach maturity in terms of occupancy rates and income, therefore it makes more sense for a developer to pay a higher annual interest payment to investors and having maybe 12-24 months before having to start paying out returns, rather than paying a lower interest payment, but being under pressure from day one to meet those payments. It also gives the operating company an element of freedom to get on with what they do best – running a hotel, rather than spending their time doing reports for the banks, and being restricted by various red tape.In addition, it creates a nice story and buzz around the hotel. When you have 50-100 investors connected to that hotel, it inevitably creates a small buzz, which is essentially free marketing!
The reason for any company going bust is due to a large number of creditors forcing the company into liquidation. With this hotel investment model, by using investor funds for the purchase and renovation of the hotel, the majority of the time the only creditors are the investors themselves, so no third party is able to come in and force the company into liquidation. Same goes for the operating company – they shouldn’t have any debt, and as long as they are able to reach their target occupancy rates, which is usually based on a business model of 50% to break even and cover investor returns, they should be fine. If for some reason investors weren’t receiving their returns, they could force the operator out, and have a new operator brought in to run the hotel until the point of buy back. Alternatively, if the developer has other hotels that are performing well, providing they have retained rooms there, they could look to reassign your investment to another hotel, keeping your returns and buy back price the same, but what it does is bring the break even down from the under performing hotel.The reality of this is slim as occupancy rates of 50% should be easily achievable by an established operator, as average UK rates are over 75%.
Not all hotels will be SIPP approved but the majority should be able to get SIPP approved. Investing through a SIPP has some excellent benefits in terms of tax savings, so if you are thinking about investing some of your pension funds, we’d suggest speaking to a SIPP advisor to discuss how you might be able to purchase a hotel room through your SIPP. Feel free to contact us and we can make an introduction for you.
For more information on our hotel room investments take a look at one of our hotel room investment opportunities with prices starting from just £82,000 and returns of 10% per annum for up to 10 years.
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