Hotels vs. Offices and Other CRE Sectors

While Commercial Real Estate (CRE) is material, it is an illiquid investment that is not easily converted to cash, has high transaction costs, and ordinarily requires a significant financial entry. CRE is not altogether transparent, requiring substantial due diligence, and unlike stocks and bonds, it does not have a centralised market to determine the value. CRE typically has long-term durability, more often with no fixed maturity. Each real estate item is unique and depends on location, material structure, financing, environment, political changes and market demand for occupancy. This uniqueness provides an opportunity for investors with knowledge of the area and skills in each of the specific CRE sectors.

Hotels vs. Offices and Other CRE Sectors – Table of Contents

The Commercial Real Estate (CRE) Segment

CRE commonly divides into four or five primary subsectors: (i) office, (ii) retail, (iii) industrial (manufacturing & warehousing), (iv) residential and occasionally (v) hotels. Depending on the real estate activity within a market, hotels are sometimes excluded or lumped together with other real estate segments, such as hospitals, care housing, sport, leisure, and parking.

Office Property

Driven mainly by economic growth in medium and large commercially active cities, usually in the downtown CBD or a business park. New developments are constructed due to increasing demand for workspace for business administration employees in sectors such as finance, accounting, insurance, IT, real estate, services.

Office CRE is characterised by the following:

High project value and profile as are often large build volume in prime CBD
An appreciable amount of transactions
Typically, tenants provide their office fit-outs
Prolonged low vacancy creates elevated rental rates and high profitability
Variable returns sensitive to macroeconomic performance
It can be dependent on one or a few main office tenants
Co-working space trends may be disruptive but, conversely, could also create new opportunities for developers

Office vs Hotel

Due to the high volume of offices in commercial cities compared to hotels, developers tend to understand offices better and stay within their CRE speciality. In developing markets, such trends eventually lead to a surplus in office supply and undersupply in hotel room stock, creating prominent opportunities in hotel development. As no or minimal fit-out is required, office developments of similar build volume to the Hotel require significantly lower initial capital outlay and are straightforward by comparison.

The amount of office transactions on each market tends to be much higher, so values are more comfortable to predict, though conversely, the relatively low availability of hotel CRE can drive demand and price. In strong office markets, developers can often get long-term prelease agreements, securing future incomes and making financing more accessible. Long-term office agreements reduce flexibility to drive profitability on upward demand market cycles, especially if an office has a single or a few large-volume tenants. The loss of a large volume of office tenants on a down cycle can have a high impact and can be difficult to replace; most hotels manage occupancies daily and react to demand far quicker.

Retail Property

There is a broad variety of retail properties and tenant types, ranging from large enclosed shopping malls to retail parks and single-tenant buildings in pedestrian zones. Increases in household incomes and population growth drive retail occupancy, which depends on location, visibility, population density, and relative income levels.

Retail CRE is characterised by the following:

Traditionally, longer leases and relatively stable lease incomes
Highest per square metre CRE rental values
Strong growth demand when incomes are rising
Often dependent on the anchor tenant
Growth in destination and experiential retail mixing retail with leisure
Susceptible to changing consumer tastes such as out-of-town developments, delivery services and online retail

Retail vs Hotel

Like offices, retail units can be pre-leased during development and fitted out by the tenants, reducing investment volume and increasing access to finance. As with hotels, the common area volumes are typically much more extensive, and related development and maintenance costs are higher. However, these maintenance costs are usually passed on to retail tenants.

Retail leases, especially in prime locations, tend to create the highest CRE incomes and, like hotels, can have relatively small units. However, unlike hotels and offices, when vacant retail units with top visibility exist, this can diminish the ambience. If anchor tenants vacate premises, this can dramatically impact other tenants and the overall viability of the retail complex. While hotels are undergoing a consumer and technology-driven shift in concepts, trends in retail are changing fundamentally, creating both risk and opportunity in the sector.

Industrial Property

Industrial property includes warehousing, manufacturing, distribution with partial office components and research & development, often with a higher office component. Frequently zoned in industrial parks on the edge of cities along significant road or railway routes or close to air or seaports. Industrial CRE is driven mainly by economic growth with increasing demand for production and distribution facilities close to major transport routes or available skill and cost-efficient labour. Industrial property depends on building configuration, loading, specialised support, and labour skills in and around the property.

Industrial CRE is characterised by the following:

Generally, they require smaller investments
Less management intensive
Lower operating costs than office and retail
E-commerce growth drives warehousing, distribution and fulfilment demand
Functionality is often specific but usually flexible, as a unit is often an open internal structure
Low-profile secondary locations requiring large land plots

Industrial vs Hotel

Frequently pre-leased or even commissioned for a specific tenant, industrial CRE generally has lower land costs outside CBD, and relatively straightforward open low-rise construction provides lower investment costs. Unlike business hotels, offices, and retail, industrial CRE is rarely in competition for prime CBD locations.

Residential Property

Residential property includes apartment buildings, town and vacation houses with five or more units, occupied by private individuals giving regular rent payments to the owner, driven mainly by population growth.

Residential CRE is characterised by the following:

Physiological human needs and, therefore, always an underlying demand
Individuals, especially families, tend to stay in the same residence for the long term
Relatively small units and the loss of a single tenant have minimal impact compared to other CRE
Availability of government-supported financing
Individual tenant rights under the law make recovery of property difficult even if the tenant breaks the lease terms.
Recovery of bad debt or costs for damage challenging from private individuals

Residential vs Hotel

Residential CRE can be similar to hotels and typically requires a high level of fit-out but not usually furnishing. Unit sizes are relatively small compared to other CREs, but developments are generally more expansive than hotels and do not need extensive public facilities. Rental rates are somewhat lower than hotels, but annual occupancy is higher. Relative to other CRE, it requires reasonably intensive management, less so than hotels, but has fewer third-party management options. Due to the similar occupant profile, it is more straightforward than hotels to combine residential property sales of individual assets and, therefore, modify the financing model to reconcile short-term investment returns and long-term income.