Pre-pandemic, short-term rentals (STRs) seemed to answer burned-out landlords’ prayers. Guests paid their money upfront, eliminating the need to evict, and homeowners could use their personal residences to earn extra income should they wish to travel or rent out individual rooms.
The hotel industry quaked and pressured cities to introduce restrictions. However, STR fever was rampant. Soon, entire apartment buildings were dedicated to the vacation rental phenomenon. Everyone with a granny flat, RV, and spare room seemed to be competing for STR dollars. Would it last? Were hotels over?
Inevitably, some markets became saturated, and the narrative about short-term rentals changed amongst investors. Post-pandemic, the number of vacation homes in the U.S. increased by 23.3% from October 2021-2022. That spring, at the height of the STR booking season, 80,000-88,000 new short-term rentals were added to the market monthly.
Bookings dropped, and landlords fretted. Hoteliers breathed a sigh of relief.
After a shaky couple of years due in part to the economic downturn, the short-term rental business is expected to grow at a stable pace. Equally, the hotel business in the U.S. is predicted to exhibit an annual growth of 3.8% (CAGR 2024-2029), with a projected market volume of $133.3 billion by 2029.
So, which makes a better investment for investors looking to scale their hospitality business? Hotels or STRs?
Short-Term Rentals
As an active STR owner and landlord, I have found that the pros and cons of owning a short-term rental business are well-defined.
Pros
- Tenants pay upfront
- Potential to generate more revenue than long-term rentals
- Offer owners flexibility to rent properties when they want
- Allows owners to scale at their own pace
- Allows a diverse type of buildings to be used as rentals
- Popular destinations enjoy high-traffic
Cons
- Labor-intensive management
- At the whim of STR algorithms for market visibility
- Bad reviews can hurt your business
- Potential for guests to cause damage/use the property for parties
- Difficult to scale when using residential neighboring comps for appraisals
- Outlawed in some cities
While the short-term rental space has benefited from property owners using high-end homes as vacation rentals, scaling with smaller units is more difficult. Using apartment buildings is harder due to increased restrictions. Buying small multifamily or single-family homes one after another takes time, and competition is tough. Still, STRs and hotels do well nationally within their catchment areas.
“We’ve seen the strongest demand in small and midsize cities, coastal and mountain locations, and areas outside of major urban centers,” Jamie Lane, senior vice president of analytics and chief economist at AirDNA, a market research firm that specializes in short-term rentals, told the New York Times of the STR market. “Hotel supply is primarily in larger urban centers or along interstates.”
A Hotel Investing Case Study: Sathiyan Kadhiwala
Sathiyan Kadhiwala came to the U.S. from India in 1995 and started working at his uncle’s Super 8 hotel in Allentown, Pennsylvania. He swept the car park, cleaned rooms, and eventually graduated to the front desk.
“One of the first things my uncle told me was that apart from customer service, the three most important things for guests were a clean bathroom, a working TV, and a comfortable bed,” Kadhiwala told BiggerPockets.
Kadhiwala continued to work within his family’s business, investing with his brother, living frugally, and saving money. After being turned down by banks because of his lack of assets and cash, he saved $750,000 over 20 years, which he used as a down payment on a $5 million Hampton Inn Hotel in Clarion, Pennsylvania, in 2017, about 90 minutes outside Pittsburgh.
Kadhiwala said:
“The first thing I did was add lights to the exterior, particularly the parking lot. The next thing we did was a huge business outreach to attract customers, offering incentives.
As with any business, cash flow is the key. The advantage of a hotel is, firstly, you have a brand name that many people trust. Beyond that, the profitability of your business depends on payroll, property taxes, and insurance. If you can minimize these costs and increase visitors, you are in a good position. Unlike a short-term rental, which is mostly a small building, a hotel is appraised on its cash flow, not the neighboring buildings.”
Kadhiwala has scaled his business over the last seven years using SBA financing. Today, he owns 10 hotels comprising four Holiday Inns, two Hampton Inns, one Super 8, one Ramada, an Econo Lodge, and a Motel 6.
For ease of calculation, assume each hotel had 100 rooms (most of his hotels have 80 rooms). He gave me these numbers:
“With economy hotels such as Super 8 or Days Inn, if purchased at $6 million-$6.5 million, you can expect to generate $1.5 million in annual revenue and $500,000 in cash flow. For Hampton Inns and Holiday Inns, purchased at $10 million+, the cash flow on a 100-room hotel is around $900,000/year. Obviously, that is very dependent on the location.”
Kadhiwala prefers more rural locations in Pennsylvania for his hotels to mitigate the expenses.
The consensus on running a hotel is that it’s extremely labor intensive and far from the passive income model most investors prefer. Kadhiwala agrees, saying that he and his wife put in years of working 140-hour weeks to build their business. “My money was the time I put into the business,” he says. “Me and my wife lived in a one-room apartment and saved our cash.”
Now, they outsource much of the day-to-day running to trusted third-party management teams and are looking to flip some of their hotels and diversify to more passive-type businesses such as gas stations.
“The management teams have staff from their country—it’s often Egyptian or Indian, and they use the local community from that area,” Kadhiwala explained. “They charge an $8/10 per-room fee, so they have an incentive to make the hotel as profitable as possible.”
Hotels Are Changing to Replicate Short-Term Rentals
Many travelers have grown accustomed to the freedom and space that short-term rentals offer and have veered away from hotels entirely.
“Hotels have taken a page from the short-term rental playbook and said, ‘We want our restaurants open to the public, and we want rooms not to be beige boxes,’” Jan Freitag, national director for hospitality analytics at CoStar, told the New York Times. “On the amenities side, the room that used to be a place to crash now has to serve as an office.”
Extended-stay hotels are the middle ground between a short-term rental and a hotel, featuring kitchenettes and expanded living spaces. Larger hotel chains have taken notice, with new brands expected to debut this year, including MidX Studios from Marriott, LivSmart Studios by Hilton, and Hyatt Studios. Onefinestay.com rents high-end homes and apartments with concierge service and was acquired by Accor Hotels in 2016.
However, short-term rentals can be hit or miss. Despite online reviews, you can never be entirely sure what you’ll get, so many travelers prefer to eliminate the uncertainty, remaining loyal to trusted hotel brands.
Final Thoughts
There is no easy money in real estate. Passive income is largely a myth, especially while scaling a portfolio by leveraging. Take your eye off the ball, and things can quickly go south, especially in short-term rentals and hotel hospitality spaces, even with decent property managers.
However, the less debt you take on, the more cash flow you will have, making you less stressed when problems arise. Kadhiwala and his wife put in the hard yards building their hotel businesses to a point where they can look at a future where they can transition to more passive sources of income while still keeping an eye on their core hospitality business.
Invest to suit your risk tolerance, financial means, and appetite. Buying hotels requires deep pockets, either saved from years of working and living frugally like Kadhiwala or syndicated with other investors. Short-term rentals generally take less investment but generate less cash flow and equity.
If you’re looking to scale, examine the pros and cons of both, along with your borrowing ability and comfort level. Some investors prefer not to partner with others, in which case smaller short-term rentals could be a better investment. Hotels, however, generate more cash, equity, and the ability to exit quickly with greater profits due to increased cash flow—provided you know what you’re doing.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.