Turning Around Distressed Hotels Can Make You Rich

Distressed Hotels are Inn!

Did you know that hotels are an undiscovered niche investment area that is largely undervalued in today’s market with a lot of upside potential?

Growing Market Niche

The hospitality hotel market represents $120 billion in the US. Yet few industries are so fragmented. In fact, there are 40,000 firms with 50,000 single location establishments. This means that virtually all hotels are owned and operated by an owner with one location. Of this number, 2,500 of these hotels are considered “extended stay” hotels which advertise extended rates to longer term customers. These might be tech workers attending a training with Apple Computer, or construction workers on a big utility company project. These hotels can also accommodate those traveling who want to stay only one night for a daily rate

This hotel type is relatively new to the industry and has experienced sudden growth because of increased demand in a day when workers travel nationwide for their companies. In fact, each quarter since 2009 has seen near double digit growth, for a total of a 76% increase since July of 2009.

Many of these properties were built in the early to middle 2000’s when financing for commercial projects was readily available. Market projections by lenders welcomed new financing for these large projects. As a result, 1000’s of new hotels were built during that time. A spate of new hotel construction loans were originated that bore onerous balloon payments based on overly optimistic projections of a continuing upward trend in the value of real estate and occupancy rates.

Desperate Need for Refinancing Creates Opportunity

But the flurry of building met the stultifying reality of the downturn in the general economy. This coupled with the entrance of many new and inexperienced hotel owners and managers spelled trouble for the industry. Rather than being able to refinance their hotels, these owners found less than ideal occupancy rates and lower overall property values an insurmountable obstacle. Therefore, thousands of hotels across the country are in desperate need of refinancing while the value of the property is not high enough to pay off the old loan, trapping the owner in a downward spiral that will ultimately lead to foreclosure. Many of these owners further hastened their own demise by using their hotel as an ATM, refinancing when the market was still going up.

Tired Brands Ripe for Reinvigoration

Weakness also exists in the hotel industry in many of the brands that were established in the 50’s and 60’s like Super 8, Best Western, and Motel Six. Although these franchisor-companies had hotels that enjoyed their heyday, in the decades since they have become tired, market insensitive, and burdensome to the owners that support their bloated fees and self-interest. For example, hotel owners of many franchises must shell out hundreds of thousands of dollars for surprise Property Improvement Plans (PIPs) and are forced to only use “franchisor-approved” vendors for the supplies and services needed to improve the property, at prices that would make even a gangster blush. All this skims money and profit from the hotel owners that could be used to truly improve the property, instead keeping the property enslaved to a greedy corporate office. It is not hard to notice these properties all across the country with bulbs burned out in signs worn from use. Add to this the fact that many hotel owners do not have the vision to invest in sufficient marketing and property improvement and you can see why the hotel industry is ripe for new, enterprising entrepreneurs to reinvigorate the industry--while profiting as well.

Need for Clean, Safe, Modern Hotels

While all these inefficiencies exist in the hotel industry, the need for clean, safe, and modern hotels for traveling and extended stay workers has never been greater. Most companies cannot find sufficient mid-level hotels to house their employees. Hotels are usually divided in a community between expensive and less than desirable. There is not much available in the middle price range to put a travel representative at ease when she is scheduling hotel stays for her company.

What is the Opportunity?

So, what is the opportunity for the smart money investor in today’s market?
1) Find a hotel in need of being turned-around because of ineffective management, deferred maintenance, in pre-foreclosure, or foreclosure.
2) Find a team who knows how to engage in a thorough improvement plan.
3) Buy the hotel from the bank, hedge fund, or private seller with seller financing if possible. That is, offer to master lease-option the property while you make improvements. Offer to buy the property at less than 3 times annual revenue.
4) After the property has improved occupancy and market value, obtain bank financing to cash out the previous owner.
5) Choose hotels that are not as susceptible to swings in the economy because they cater by location to a steady stream of extended stay workers instead of only tourists.

It Gets Better

Although we can’t completely explore the financial potential of hotel investing, consider that if an apartment can cash flow with renting one door for X dollars a month, imagine the profit potential of renting that same space short term multiple times each month. In my city, an apartment can rent for an average of $1400 per month which is $45 a night. Compare that to the average mid-level hotel room that rents for $140 per night for a total of $4200 and you begin to see the potential. Add to this the benefit that if you have an unruly guest, there is no need to evict. You simply change the code on the door and they cannot reenter. No drama like a rental would present.

In Short

Although investing in distressed hotels is not for many investors, those that both see the opportunity and find a team to help them can benefit greatly from this unique niche.
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Brian Netzel is a real estate investor who lives in San Jose, California. He invests in distressed real estate and notes nationwide.