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
This material does not constitute an offer to sell nor a solicitation of an offer to buy any security. Such offers can be made only by the confidential Private Placement Memorandum (the “Memorandum”). Please read the entire Memorandum paying special attention to the risk section prior investing. This email contains information that has been obtained from sources believed to be reliable. However, Kay Properties and Investments,LLC, WealthForge Securities, LLC and their representatives do not guarantee the accuracy and validity of the information herein. Investors should perform their own investigations before considering any investment. IRC Section 1031, IRC Section 1033 and IRC Section 721 are complex tax codes therefore you should consult your tax or legal professional for details regarding your situation. This material is not intended as tax or legal advice. There are material risks associated with investing in real estate, Delaware Statutory Trust (DST) properties and real estate securities including illiquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multifamily properties, financing risks, potential adverse tax consequences, general economic risks, development risks and long hold periods. There is a risk of loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, potential returns and potential appreciation are not guaranteed. For an investor to qualify for any type of investment, there are both financial requirements and suitability requirements that must match specific objectives, goals and risk tolerances.
Securities offered through WealthForge Securities, LLC, Member FINRA/SIPC. Kay Properties and Investments, LLC and WealthForge Securities, LLC are separate entities. There are material risks associated with investing in DST properties and real estate securities including illiquidity, tenant vacancies, general market conditions and competition, lack of operating history, interest rate risks, the risk of new supply coming to market and softening rental rates, general risks of owning/operating commercial and multifamily properties, short term leases associated with multi-family properties, financing risks, potential adverse tax consequences, general economic risks, development risks, long hold periods, and potential loss of the entire investment principal. Past performance is not a guarantee of future results. Potential cash flow, returns and appreciation are not guaranteed. IRC Section 1031 is a complex tax concept; consult your legal or tax professional regarding the specifics of your particular situation. This is not a solicitation or an offer to see any securities. Please read the Private Placement Memorandum (PPM) in its entirety, paying careful attention to the risk section prior to investing.