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Extended-stay hotels a modern-day gold rush

When it comes to extended-stay in the hospitality industry, it is normally applied when guests stay for more than seven nights. Although there are various reasons behind extended-stay’s growing popularity, the rates, accommodations, locations, and guests are all similar, but slightly different than your regular hotel industry averages. Over the last five years, this segment of the hotel industry has outperformed any other segment across the United States. As a result, the economy and midscale extended-stay class hotels have captured a great deal of interest from developers who are looking to build such assets that are designed to be high margin, while also being more recession and pandemic resilient.

Kip Sowden, CEO and Chairman of RREAF Holdings, Dallas, Texas

An interesting, and counter intuitive fact is that extended-stay popularity has been increasing globally even since the introduction of services such as Airbnb. The main reason is the increased awareness of such possibilities combined with the need for business travel, that often comes with a pre-paid company budget, and the desire to focus on basic services and not a vacation-oriented location. There’s also more certainty of the level of product you get when you book with a known brand, as opposed to the randomness that comes with a gig-economy style stay in someone else’s home.

During the COVID-19 pandemic, data shows that economy extended-stay hotels were very popular with the essential workers who never stopped traveling as business travel for these workers is a job requirement, not an option. The primary demand sources being medical, business travel, construction, road/infrastructure work crews, and basically anyone with a per diem is a prospect. These guests want a comfortable, clean, safe living space, and the full kitchen in every guest room is an attractive alternative to dining out every meal for both health and financial reasons.

At the core of this business model is the thesis that by designing hotels to control operating expenses, extended-stay hotels can be quite profitable. In most markets the primary competition for economy extended-stay demand is typically 20-plus-year-old economy hotels. These old hotels are “settle for” alternatives, where the low cost is the sole determining factor. New extended-stay hotels act more like workforce housing apartments, with the benefits of being furnished and the flexibility of no long-term leases. Investors have begun to look at these assets as hybrid multi-family housing, and there is room for cap rates to fall and values to rise.

However, developers are being squeezed by rapidly rising land and construction costs. In many markets the land costs have risen 50% over the last two years, worrying developers as to whether they can build and open new properties on time. Finding well-located sites is also a challenge. What if the property that developers purchased ends up having red flags before construction even begins? In the last 18 months, labor and material shortages have pushed construction costs up 40%. Plus, rising costs are making many markets infeasible – the biggest problem facing the future of the extended-stay industry.

The secret to delivering high cash-on-cost returns is to design the hotel to eliminate, or minimize, any non-revenue producing space. In these hotels, guest rooms account for more than 70% of the building square footage. This is accomplished through smaller lobbies and workout rooms. They do not have swimming pools, offer breakfast or have conference rooms. They are easy to design and less expensive to build. By using standard prototypical design, the design and approval process can be measured in weeks and months as opposed to months and years for custom hotel designs. Lower construction cost results in higher multiples.

Much like low-cost airlines, these economy and midscale extended-stay hotels are filling a need for reasonably priced “no frill” hotel options for essential workers. The benefit of having essential workers as your customer base is that their jobs are still essential during economic downturns, making essential worker demand very quick to bounce back.

While this segment of the industry is very promising, it is clearly not easy to succeed. Some of the more challenging tasks include identifying and acquiring the land parcel, zoning, and entitlement, structuring a competitive capital stack, securing a viable general contractor, and managing the complex building process. Even after a successful design-build phase, the operations, marketing and financing of these assets differ from more traditional hotels and require an expertise to be successful.

As companies continue to allow, and even encourage, remote work, and as the pandemic withdraws and demand for hospitality continues to increase, it will be very interesting to see what the future holds for this very unique class of investments and the impact it will have on jobs, local markets, tourism and the global economy.

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