Capital seeking reasonable returns is in love again with the recovering hotel business. However, the issue for anxious buyers is a lack of appealing assets on the market. Some of the best deals seem to be getting done off-market, leaving some of the less-connected players wondering how the rest of the year will stack up for deal making, and what asset classes offer the biggest upside?
With lenders helping so many owners hold on through the pandemic, those same owners now appear to be in no big rush to sell at any sort of discount as they see more upside potential in their assets. That leaves too many buyers either overpaying or on the sidelines.
HOTELS asked leading brokers for their take on the hotel M&A market. We broke it out by three asset classes – limited-service, big urban assets, and resort hotels – and asked the brokers to make a case for investing in each of these spaces. Today, we start with the outlook for limited-service hotel sales contributed by Burton Brooks, Mumford Company.
The no-fuss efficiencies of limited-service
Higher net operating income equals a better ROI as both an ongoing business and as a limited-service property ready for disposition at the end of an economic cycle.
From the land it stands upon to the guest that crosses its doors, limited-service hotels provide the most efficient return on investment in the lodging space. This has remained true, and this segment continues to provide impressive returns during upcycles and muted diminished returns during challenging economic times. Limited-service hotels provide a return on investment by generating cash flow through operations and executing an exit strategy upon the disposition of the asset.
Limited-service hotels enable any size business operator to operate successfully in this space of the lodging industry. There are many different types of owners in this space, including single asset owners that operate all the way up to publicly traded REITs and institutional investors. These groups have all capitalized on the opportunity to focus on this segment with limited rooms to fill, limited complexity, limited square feet to manage, limited staff, and, of course, limited volatility. There is a lot of consumer demand for limited-service products. It is easier to renovate and convert, has consistent operations, is adaptable to change, and appeals to both lenders and prospective investors.
Limited-service hotels generally have a small footprint for new construction. In many cases, the site size ranges can be as small as one acre and go as large as is required to deliver revenue-producing guest rooms and amenities. Modular construction and prefabricated building components are being tested with positive early results in certain markets.
Most limited-service brands work with the conversion of existing franchised or independent hotels, allowing owners to quickly improve their upside with the addition of a recognized brand’s reservation system. Some brands require a more substantial food and beverage offering, but most are limited to a complimentary breakfast. The “grab and go” concept will continue at properties post-pandemic and complement a limited buffet for guests that desire to have a seat.
With fewer rooms, limited-service properties require fewer employees than their full-service counterparts, which is a cost-savings and an advantage in this current labor market. Properties have been able to institute servicing the room at check out.
Limited-service properties only offer amenities required by most guests. In most cases, these are limited to a business center, fitness center, swimming pool and meeting room. Revenue is generated primarily from room sales and can be supplemented by the marketplace, parking, and early check-in fees.
Expenses at a limited-service hotel are much lower, as well. Reduced staffing means lower labor costs, which we have seen creep above 50% of gross operating expenses for less of a headcount of employees. Food and beverage costs are lower but typically vary more, depending on menu items offered and whether a breakfast attendant services the area. These cost savings translate into an improved net operating income with a higher percentage of revenues than at a full-service hotel. Higher net operating income equals a better return on investment as both an ongoing business and in the disposition of the property at the end of its economic cycle in your portfolio.
Finally, the best business case upside for a limited-service hotel is that its customer base is much larger than its full-service counterparts. Travelers across all income levels, essential workers, logistics providers, commercial and industrial employees all spend the night on the road at limited-service properties across the country. With many different price points, and every brand having an offering, limited-service hotels attract rate-conscious vacationers and seniors. At the end of the day, limited-service properties allow the operator to focus on selling room nights and not have the operational risk that can be part of focusing on other amenities.
We strongly believe the limited-service segment will continue to be a strong invest and hold strategy for owners in both the short and long term. With an expected ADR increase over the next few years, this segment allows owners to invest in an operation that will hedge against inflation and continue to deliver positive results.
With limited amounts of limited-service properties on the market currently, owners in this segment will be able to list and sell their hotel reasonably quickly and at a premium due to the segment being a preferred investment class. Many investors are looking for limited-service product in the market, and there is an inordinate amount of capital on the sidelines. All these factors make limited-service properties the best investment in the hospitality industry.