6-There is a new (rich) sucker born every minute…

In March 2008, individual investors were paying premium prices for hotel rooms in buy-to-let condo-hotel deals in London and New York — prices set to exploit demand, not to reflect what it actually cost to build the rooms. I called it a bad trade. The market didn’t wait long to prove the point: prices collapsed within a few years, and the same mechanism is still at work today, just showing up as rising costs instead of falling prices. Here’s the full arc — an 18-year case study in what happens when buyers show up at the top of a capital-intensive cycle.

Posted 3/21/08

For those fortunate few out there who travel to London regularly, I envy you. What I don’t envy are the hotel rates you pay, which are averaging over $600 a night in the city. We have seen hotel rates go up a great deal in the U.S., as well, over the last few years. New York is a particular example of that phenomenon.

The hotel companies have finally run out of the excess capacity they had from 2000 until 2005. Occupancy rates are high and room rates are even higher. Just the time to invest in new hotel rooms. That is, it’s the right time if you are a hotel company and want to keep your regular customers satisfied and coming back because you always have a room for them.

It is an awful time to invest if you happen to be an individual who thinks he can make a killing in London real estate. In London, as in parts of the U.S., there is a fad for what’s called buy-to-let hotels. This phenomenon sells individual hotel rooms to investors who hope to make a good return on investment by letting out these hotel rooms. Bad idea, at least today. Room prices are above replacement costs. Room rates are extraordinarily high because prices have to be high enough to discourage demand, not because the cost of replacing those hotel rooms is anywhere near the $600 they are commanding today. These poor investors are buying at the top of the market when they have no business requirement to keep customers satisfied. If this investment were such a great deal, do you think it is likely that the current hotel owners would be willing to part with their precious ownership? Not likely.

This is a capital-intensive industry where there has been, and will be again, overbuilding. It is a regular cycle in hotels, even luxury hotels. These are likely to be very poor investments for these individuals who are buying at the peak of a market. They should have been buying in 2001, when prices were depressed. Then they had a chance to make a decent return.

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Update 6/27/25

I originally scored this call as a miss, based on a hotel-profit figure that turned out to describe the wrong thing — a franchisee running an entire branded hotel, not the individual room investors this piece is about. Looked at correctly, the market says I was right about the potential returns in this high-cost concept, especially in places like New York, London and Miami: the 2008-2010 crash hit the buy-to-let structure this post warned about directly, well before any 2021 data comes into it.

One widely cited estimate puts the average profit for an owner running a single franchised hotel property at around $49,000 to $74,000 per year in 2021 dollars — an inflation-adjusted extrapolation of a 2009 BusinessWeek figure, not a fresh 2021 study. That figure is the take-home for someone operating an entire branded hotel, not for the individual room investors this piece is actually about, and the two shouldn’t be confused. For perspective, Pew Research’s middle-income band for a three-person U.S. household was $48,500 to $145,500 in 2018 dollars, the base year that range is usually quoted in.

On the other hand, the program is good for the capital structure of the hotel industry. It reduces the net capital employed for the hotels, improving RONCE (Pattern: Return On Net Capital Employed: EBIT divided by total debt plus equity.) and building Economies of Scale (Pattern: unit costs decline as unit sales volume increases because part of the cost structure grows slower than unit sales volume.) — the freed-up capital lets the hotel company build a larger property and spread its fixed costs over more rooms.

Our research into several thousand examples of cost reduction efforts reveals four major patterns of cost reduction.

– Reduce the Rate of Cost for an Input Such as, People, Purchases or Capital (Pattern: the three basic cost categories every business uses to create customer benefits: people, purchases, and capital.)

– Reduce Inputs not Producing Output

– Reduce Unique Activities in Processes

– Spread Activities Over New Output

The hotel condominium concept is an example of the fourth pattern, spreading activities over new output. By selling some of the hotel rooms the hotel company can build a larger property with better Economies of Scale.

In particularly attractive urban and resort areas, hotel companies can cover much of their investment by using the condominium concept to reduce total investment. The hotel company may offer a significant minority percentage of rooms for sale to private investors. The company might charge these investors a room price that is usually two to four times its cost to build a hotel room.

The private buyer’s returns can be attractive in markets with high demand. The private buyer receives about half of the revenues from their room sales and incurs other ancillary fees for the use of the room. Still, investors in the New York market might see average returns of 10% after fees. In London, where the concept of condominium hotels is somewhat behind New York, private investors might see returns of 6 to 7%, after fees. By far the best returns and the most successful investments come at the very high-end of the market with the finest premium hotel brands — another example of the unique value of Reliability (Pattern: the consistency with which a company delivers on its promises: reliability of delivery, of function, and of market presence.).

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Update 9/26

The 2008-2010 crash is the sharper proof of the original call than anything in the 2021 data above. Buy-to-let condo-hotel prices collapsed across the board within a few years of the peak this post warned about. In Whistler, B.C., units at the Four Seasons condo resort that sold for about $1.1 million in 1999 were down to $520,000 by 2012, and one-bedroom units elsewhere in the same complex went for as little as $61,000. Near Kamloops, two-bedroom condo-hotel units that once sold for about $199,000 were changing hands for as little as $19,000. One B.C. real estate consultant put it bluntly: every single one of the province’s condo-hotels had lost money for investors, with the 2008 credit crunch doing much of the damage. Analysts had flagged the same overpricing before the crash even hit — a hospitality analyst who studied condo-hotel financials for developers called buyer expectations “very exuberant,” and a National Association of Condo Hotel Owners report found most South Florida condo-hotel projects wouldn’t even cover maintenance fees and taxes, let alone a mortgage.

Where does the concept stand today? The math has gotten harder, not easier — mostly on the cost side now, rather than the price side. In Miami, a Brickell unit priced around $450,000 generates an 8% gross yield on paper, but after HOA fees, insurance, taxes and management, the net return falls under 3%. Citywide, insurance and HOA carrying costs are up 40-50% since 2022. London tells a more mixed story: one current hotel-room listing near the ExCel center shows a historic net yield of about 8.6%, ahead of ordinary London buy-to-let residential yields of 5-6% — a sign the room-investment structure can still outperform conventional rental property in the right building, even if that remains the exception rather than the rule. The condominium structure remains the more common way individual investors try to get exposure to this business.

The lesson holds. Room prices set above replacement cost — priced to exploit demand rather than to reflect what it costs to build — are still a bad bet near the top of a cycle. In 2008-2010 that showed up as a price collapse. Today it’s showing up more as a slow erosion from rising operating costs. Same mechanism, different symptom.

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Quick Hits

Three patterns from the StrategyStreet system this story confirms.

1. Return math always shows up in the numbers, whether the market corrects on price or on cost. Buy-to-let condo-hotel investors took the hit through a price collapse in 2008-2010 and are taking it today through a slower operating-cost squeeze — a Miami unit’s 8% gross yield falls under 3% net once HOA fees, insurance, taxes and management are subtracted. The seller side of the same trade benefits from Economies of Scale by spreading fixed costs over more rooms once capital is freed up. Same transaction, opposite outcomes for buyer and seller.
2. Overcapacity doesn’t announce itself before the correction — it shows up only in hindsight, once prices have already fallen. Overcapacity (Pattern: when industry competitors can supply more than the market demands at the current price.) The original 2008 post flagged hotel companies building and buyers paying up near the top of a cycle; the reckoning came two to four years later, when Whistler and Kamloops condo-hotel units lost 70-90% of their value and one B.C. consultant said every condo-hotel in the province had lost money for investors. So what: buying at the peak of a capital-intensive, cyclical industry is a bet against a clock, not a business plan.
3. The best returns still cluster where Reliability is strongest, not where the deal looks cheapest. Across every version of this story, 2008 through 2026, the finest premium hotel brands consistently produced the best investor returns, because a brand’s consistency of delivery is worth more to final consumer demand than a lower purchase price. So what: buying into a weaker brand to save on entry cost is buying the wrong variable.

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You can use our many cost reduction concepts and examples to brainstorm improvements for your own company.  You may find them HERE.

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THE SOURCES OF STRATEGYSTREET.COM: For over 30 years we observed the evolution of more than 100 industries, many hostile.  We put their facts into frameworks applicable to all industries and found patterns.  Strategystreet.com describes the inductive results of these thousands of observations and their patterns.