By Dwight Kay and The Kay Properties & Investments Team
Investing into real estate always comes with risk. Vacancies, downward pressure on rents due to new developments coming online, the economy, loans maturing, and wider market forces often impacts how an asset performs over time. Integral to the investment’s potential success is the ability for the investor to weigh the risks and to decide if the risk is worth the potential return. Certain asset classes historically come with more inherent risks one of them being the hotel asset class. Let’s look at why:
- Hotels values tend to be cyclical and go thorough ups and downs. And while hotel values tend to recover from the bottom cycle, in 2009 alone hotels values fell by 41% from their peak in 2006.¹ Since 2009, they were up 44% in 2010 (based on date for the first 8 months of 2010). This extreme volatility was devastating to many hotels and many failed during that time, while others drove strong profits.
- Management Intensity: Hotels have the highest turnover of any asset class in the great real estate arena—leases expire every 18-24 hours as the guest comes and goes. The need to fill rooms never truly ends and a glitch in marketing, corporate outreach, reservation infrastructure and more can greatly affect the bottom line which in turn can cause asset values to suffer immensely.
- Shifting Trends: Understanding the local trends and demographics are vital to a hotel’s success. A weak location, poor public sentiment, new competition can all prove devastating.
- Declining Travel: Corporate and leisure/vacation travel accounts for a large amount of a hotels revenue. The fact that corporate/business travel as well as leisure/vacation travel both tend to decline in a recessionary environment does not bode well for hotel DST investors.² Along with recession risks, hotel investors also have technology risk as increased technology adaption continues to remove the need for corporate travel and proves an easy way for companies to cut cost.
- Potential devastation due to loss of the “Flag”: If a hotel owner has not set aside enough in reserves for the Property Improvement Plan (PIP) required by the national hotel chain then the chain can remove the Flag and the investment may have gone from a large national chain to a no name brand overnight which can drastically reduce revenue due to the loss of the reservation system provided by the national chain.
- Foreclosure: Due to hotels often having large balloon mortgages whereby the properties loan comes due in 5-10 years they run the risk of foreclosure if the property cannot be sold or refinanced prior to the loan coming due. Many hotel syndications that were both DSTs and TICs had to sell at large losses as well as many were foreclosed on during the last recession.¹
“In 2010 alone, U.S. hotels considered distressed by Real Capital Analytics approached 2,500 properties with total debt of $40 Billion.”¹
Given where we are in the market cycle, Kay Properties is uncomfortable offering hotel 1031 DST investments to our clients. We advise all of our clients and prospects to proceed with extreme caution as we have seen many DST and TIC sponsors who have brought out both hotel DST and TIC properties whereby the recession ate the investment alive and investors lost 100% of their principal invested in foreclosure and had to sell at extreme losses to their equity.
Investors would be wise to learn from the past mistakes of other 1031 DST and TIC investors who chose hospitality offerings, and who now if you spoke with them, would say that they wish they had stuck with more traditional asset classes such as multifamily apartments and industrial properties.
About Kay Properties and Investments, LLC: Kay Properties and Investments, LLC is a national Delaware Statutory Trust (DST) investment firm with offices in Los Angeles, San Diego, San Francisco, Seattle, New York City and Washington DC. Kay Properties team members collectively have over 114 years of real estate experience, are licensed in all 50 states, and have participated in over $9 Billion of DST real estate. Our clients have the ability to participate in private, exclusively available, DST properties as well as those presented to the wider DST marketplace; with the exception of those that fail our due-diligence process.
To learn more about Kay Properties please visit: www.kpi1031.com