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

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.

Update 6/27/25:

The market says that I was wrong about the potential returns in this high-cost concept, especially in places like New York, London and Miami.

By itself, ownership of an average hotel is not particularly attractive, which does not bode well for investors in individual hotel rooms. In a 2021 study, one company estimated that, in 2021 dollars, owners of a hotel can expect to earn, on average, around $49,000 – $74,000 per year. To put that into perspective, the American middle class in 2021 consisted of those people earning between $48,500 and $145,500 per year.  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, increasing Effectiveness and Economies of Scale. 

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.

-Reduce Inputs not Producing Output,
-Reduce Unique Activities in Processes and
-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.

 

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.