Is Hotel Investment a Smart Move?

Looking to diversify your commercial real estate portfolio? Now could be the moment to explore opportunities in Canada’s hospitality industry, particularly the hotel sector.

After suffering huge losses due to travel restrictions and lockdowns during the COVID-19 pandemic, the hotel industry in Canada has notched a recovery that few thought was possible. When restrictions were finally removed in October 2022, pent-up demand for leisure travel resulted in the hotel industry recording its highest-ever occupancy rate, average daily room rate (ADR) and revenue per available room (RevPAR) in 2023, surpassing even heady pre-pandemic levels recorded in 2019.

With growth in all three KPIs slated to go nowhere but up and the federal government focused on increasing tourism’s contribution to Canada’s GDP from $38 billion in 2022 to $61 billion in 2030, now might be the time to enter or expand your footprint in the hotel investment market.

Types Of Hotels

The Canadian hospitality industry is segmented by business model (chain or independent) and hotel type (luxury, mid- and upper-mid-scale, serviced or extended stay, budget or economy and capsule hotels).

By understanding the target market, typical features and operation model of each type of hotel, investors can decide which best suits their investment goals and risk tolerance.

Luxury, Upscale Hotels

Target market: Affluent leisure and business travellers willing to pay a premium for high-end amenities and services.

Typical features: Elegant design, high-end furnishings, upscale services and amenities, including pool, gym, multiple on-site fine dining choices, spa services, concierge, valet parking, 24-hour room service, gift shop, business centre, conference facilities and meeting rooms.

Operation model: Large staff, high operating costs.

Average Room#: 200-300+

Examples: Luxury: Fairmont, Intercontinental, Four Seasons, JW Marriott, Ritz-Carlton, St. Regis, Sofitel, etc. Upscale: Delta, Sheraton, Westin, Hilton, Hyatt, etc. and various independently-owned/operated boutique hotels.

Midscale, Upper-Midscale (aka Limited Service, Select-Service) Hotels

Target market: Budget-conscious leisure travellers and short-stay business travellers.

Typical features: They do not contain as many amenities as luxury hotels but could have a pool, gym, business centre, and meeting rooms. No full-service restaurant on-site but may offer a complimentary continental breakfast.

Operation model: Can operate with fewer staff and a more conservative budget than a full-service hotel. As inflation drives up the price of airline tickets and resort packages, Canadians will be forced to stay closer to home, and even business travellers will face pressures to be more cost-conscious. Mid-scale hotels that can maximize their offerings while maintaining affordable room rates can win the day.

Average Room#: 100

Examples: Midscale: Quality Inn, Best Western, La Quinta, etc. Upper Midscale: Comfort Inn, Best Western Plus, Holiday Inn Express, Ramada, Hampton Inn, Fairfield Inn, etc.

Serviced or Extended Stay Hotels

Target market: Business professionals tired of living out of a suitcase and eating hotel food. Available for both short-term (weekly) and long-term (monthly) stays. Can compete with Airbnb in the vacation rental segment.

Typical features: Fully-furnished apartments with kitchen, living room, washer-dryer, weekly housekeeping, possibly pool or gym, but otherwise, a reduced range of services.

Operation model: Seven-days-a-week demand, but lower operating costs due to fewer check-ins and reduced room maintenance and services.

Average Room#: 10-200

Examples: Homewood and Home2Suitesby Hilton, Apartments, TownePlace and Residence Inn by Marriott, Embassy Suites, Hyatt Studios, etc.

Budget or Economy Hotels

Target market: Travellers looking for cost-effective, no-frill accommodations.

Typical features: Fewest amenities and services, lowest room rates.

Operation model: Low staff-to-room ratio designed to realize profits in the 10% range.

Average Room#: 70+

Examples: Days Inn, Travelodge, Super 8, Howard Johnson, Econolodge, Motel 6, etc.

Capsule Hotels: A New Entry on the Landscape

Target market: Downtown locations target international students looking for an affordable place to stay before settling into student housing. Airport locations target digital nomads and backpackers.

Typical features: Cubicle-like rooms (28-40 sq. ft), stacked one on top of the other, utilizing energy-efficient designs and sustainable materials. Shared bathrooms but may have on-site restaurant or outdoor/rooftop gathering areas.

Operation model: Originated in Japan, usage is growing in major cities due to rising hotel costs and the effects of inflation. Franchising opportunities.

Average Room#: 6-60+

Examples: Pangea Pod, Panda Pod, etc.

Advantages of Hotel Investment

The advantages of investing in hotel properties include:

Diversification of Your Investment Portfolio

Real estate investing can be an excellent way to build wealth and generate passive income. But like any investment, it comes with risks. Investing in different types of commercial real estate asset classes (warehouse, multifamily and hotel properties) can reduce dependence on any property type or investment.

Potential for High Returns Due to Consistent Demand

Unlike many other investments, hotels have the potential to generate daily revenue, and the income stream can be formidable.

Because there are only so many hotels in each geographic area and hotel development currently lags behind demand, hotels can charge premium rates during peak travel times that coincide with holidays, summer vacation periods and important local events or festivals. These periodic rate increases can add significant profit to a hotel’s balance sheet.

Tax Benefits

Investing in hotels can offer tax benefits that can help investors hold onto their profits and reduce tax liabilities.

Some of the tax benefits associated with investing in hotels include:

• Interest deductions
• Depreciation and cost segregation deductions
• Tax-deferred exchanges

Growth Potential

Depending on the services and amenities they offer; hotels can create a variety of revenue streams beyond room rentals. These include food and beverage sales, wellness services, themed weekend-stay packages, conference and event space rentals, and even daily pool or spa passes.

Investment Opportunities That Reflect Your Risk Tolerance and Financing

There are a variety of ways you can add hotel investments to your commercial real estate portfolio, including:

• Investing in Real Estate Investment Trusts (REITs)
• Purchasing shares in a publicly-traded hotel operating company
• Taking part in a crowd-funded hotel investment
• Purchasing a hotel property
• Building a new hotel property

Appreciation Potential

Well-located and well-managed hotels that optimize occupancy and room rates can generate consistent cash flows that increase the value of their hotel property. As owners or operators add profitable new services or make design improvements and upgrades, the hotel’s value escalates along with them. As demand increases for a particular type of hotel or location, hotel value can soar.

Disadvantages of Hotel Investment

The disadvantages of investing in hotel properties include:

Seasonality

Hotels that rely on leisure travellers for most bookings can experience extreme revenue swings based on seasonality. These swings can be mitigated by developing offerings that attract new customers, such as special promotions and packages, sponsoring local events – or even creating new ones – and marketing them efficiently.

Vulnerability to Changes in Disposable Income

The hotel industry is highly susceptible to economic downturns, leading to decreased travel and demand for hotel rooms or changes in the types of hotels travellers prefer. When a downturn happens, luxury hotels are often the first segment to experience reduced bookings, while those at midscale hotels increase.

High Operating Costs

Even in budget motels, operating costs for staff, utilities and maintenance can be substantial. Costs for property tax, insurance and travel commissions also cut into profits.

The Effect of Remote and Hybrid Work

The persistence of remote and hybrid work models has put a significant dent in hotel earnings from business travellers. Whether capitalizing on the new “bleisure” trend of adding vacation time before or after business trips can offset these losses remains to be seen.

How to Evaluate the Performance of Potential Hotel Investments

Once you’ve weighed the pros and cons and determined the type of hotel you’re interested in investing in, you’ll need a way of evaluating your investment’s performance.

The most commonly used hotel investment KPIs include:

Occupancy Rate

This metric tracks the percentage of available rooms occupied during a given time period. A high occupancy rate indicates strong hotel room demand and can be a good indicator of hotel profitability.

Average Daily Rate (ADR)

This metric shows the average price of each room sold during a given time period. A higher ADR generates more revenue per available room.

Revenue Per Available Room (RevPAR)

The gold standard for measuring top-line performance in a hotel investment, RevPAR is calculated by multiplying the ADR by the occupancy rate and provides a snapshot of how well hotels are filling and pricing rooms. When RevPAR goes up, either the occupancy or ADR rate is up, or both. By comparing RevPAR trends over time, you can see seasonal trends and compare the relative performance of one hotel versus another in a similar geographic area.

Gross Operating Profit (GOP)

The metric considers a hotel’s total revenue minus its operating expenses. GOP is a key factor for understanding the hotel investment profitability.

Return on Investment (ROI)

ROI is a key metric for evaluating the overall success of a hotel investment and can help stakeholders determine whether the investment is meeting financial goals.

Canadian Hospitality Market Strengths

Hotel investment in Canada offers the advantage of a truly diverse market – from traditional leisure and business travellers to students, digital nomads, outdoor adventurers and event attendees – reducing dependence on any single market segment, thereby lowering overall risk.

With plusses like high demand, the potential for steady growth and appreciation, tax incentives and solid governmental support, investing in the Canadian hotel sector has never been more attractive.