Extended-stay hotels can elevate returns for property investors

Against the backdrop of a global economic slowdown and market volatility due to on-going trade tensions and, more recently, the spreading coronavirus, investors are changing tack in their quest for stable, risk-adjusted returns.

 In this environment, property has reemerged as a preferred asset class, particularly among US investors. For instance, a 2019 Gallup poll revealed that 35% of American investors believe that real estate is a superior long-term investment to stocks (27%) or other investment options.

https://news.gallup.com/poll/251696/real-estate-leads-stocks-best-investment.aspx

 But before you adjust your portfolio allocations in response, consider that property investments aren't homogenous and trends within this sector are shifting.

 While the prevailing low interest rate environment favours buyers, investors must carefully consider where they invest and what they buy amid prolonged low nominal property price growth. The illiquid and capital-intensive nature of this asset class also warrants a considered investment strategy.

 The legacy approach of buying commercial or residential properties to derive basic rental income and benefit from capital growth, albeit modest in recent years, has run its course. 

 The dynamic global market and tectonic sector-specific trends, such as technology's impact on production and manufacturing, or rapid changes in consumer demand, could leave investors without an anchor tenant. These influencing factors also make it difficult to predict long-term trends.

 For example, a warehousing facility currently occupied by a global motor manufacturer, which in the past offered a secure and reliable tenant, could abruptly vacate the property due to a realignment in global production, or close in response to an abrupt drop in demand as electric vehicle adoption accelerates exponentially.

 In light of these factors, Stonewood believes that the best opportunities currently available to property investors exist in real estate that looks beyond the asset value and leasable space, and instead considers assets that are underpinned by operational competencies.

 Real-estate that offers an operational element, like extended-stay accommodation and healthcare facilities such as assisted living and nursing homes, allow investors to leverage the management team's experience, proficiency, the property's unique operational offering, and niche market demographics to drive growth and sustain income streams, instead of relying solely on capitalisation rates.

 In essence, investors invest in the fixed asset value and in the operator, who can apply operational intensity and proven operational and asset management methodologies to extract greater value from the property.

 A property's unique functional use can also insulate it from conventional market risks, such as supply and demand dynamics, or dips in nominal property prices as the asset's value is based on more than just the bricks and mortar.

 Operational competencies and excellence can also distinguish properties from market competitors, which ideally positions these properties to deliver above-average market returns.

 It is, however, important to understand that these property investments can introduce additional risks, specifically in the form of operational risk. These include the complexity inherent in managing and maintaining the property itself, and the operational complexity of the functions performed there.

 A five-star hotel, for instance, has onerous operational requirements to ensure standards and service quality are maintained, while high-care or healthcare centres have inherent operational complexity due to the nature of the business, the specialised skills required and the myriad compliance requirements.

 However, properties located further down the complexity curve, like extended-stay accommodation, can deliver superior returns with minimal operational complexity.

 Due to the homogeneity in extended-stay properties, small, proficient teams that don't require specialised expertise and work according to a good operational plan can run them efficiently and achieve operational excellence.

 The resultant benefits include low overheads, economies of scale and the ability to deliver management excellence due to the simplicity of the operation, the combination of which creates an asset that consistently delivers market-beating, risk-adjusted returns.

 These properties also meet the growing demand for clean, safe and affordable long-term accommodation from an increasingly mobile global workforce, which is fuelling demand for hotel investments in the mid-priced, extended-stay segment, particularly in the US market.

 As such, the extended-stay value proposition, specifically when considered in the context of prevailing global economic trends, is ideally positioned to weather the market volatility and offer investors cash flow longevity as they ride out the global economic storm that is potentially brewing.

By Eldon Beinart, director of Stonewood Alchemy Real Estate

February 2020