What are the Biggest Risks of Investing in Hotels?

What are the biggest risks of investing in hotels?

Hotel investing can be lucrative, but it does carry risk.

What are the biggest risks of investing in hotels? Investing in hotels can take many forms. You can own hotel stock, you can buy into REITs, you can be a partial owner via crowdfunding, or you can own the real estate outright and operate the property as a business. All can be lucrative, but there are also risks to be aware of.

Operating Risk

This risk is the ability of the asset to produce sufficient cash flow to sustain and justify the business. The hotel industry can be volatile which can cause wild swings in cash flow over periods of time. A recession, and consequently a high vacancy rate, could be enough to cause the property to default on a loan.

Operating risk is often more volatile early in the lifecycle of a hotel. It is also dependent on the type of hotel in question. A full-service hotel has much higher expenses than a no-frills establishment for instance.

Operating risk is also a factor of external economic forces. A crowded market, barriers to entry, and zoning laws all can play a part.

Obsolescence

Obsolescence can take many forms. Normally, we are referring to internal and external obsolescence factors.

Internal factors include things such as the physical deterioration of the property. Most of this can be fixed, but there are cases where it may not make economic sense to do so. If heavy damage occurs from a natural disaster or if a floor plan becomes obsolete due to changing laws or codes, then an investor may choose to sell the investment and move on.

External factors could be something like physical location. If a hotel is in an area where a new highway is built, then it could see a decrease in traffic, since motorists will no longer need to pass through the area where the hotel sits. If a hotel is near an airport, and a new terminal is constructed 20 miles away, then there is going to be a significant decrease in demand at that location.

Changing tastes and competition are also external factors. A hotel showing its age with limited amenities may not be able to compete with a brand-new luxury hotel that is constructed next door to it. Airbnb and other short-term rental sites can also impact hotel demand as they steal market share. Many travelers would rather have a private house with a kitchen and other amenities as opposed to staying in a hotel room.

Economies of Scale

If you own hotel stock, then you are more than likely invested in a multi-national company with thousands of properties spread across the world. This is one way to mitigate risk. The more markets a hotel is in, and the more types of hotels that are in the company’s portfolio, the less risk they have in operating. Risk can occur if you are invested in a single property in one location for many of the reasons outlined above.

Conclusion

What are the biggest risks of investing in hotels? The main risks that occur in hotel investing stem from factors that prevent the business from generating sufficient cash flow. Some of these factors can be internal but many are external and can’t be controlled.

It may be best to invest in stocks or REITs to spread the risk as opposed to trying to buy a hotel outright. At least, early on in your investing journey.

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