There’s room at the inn for nimble investors

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I have backed a few companies in the hotel and resort business over a number of years, but recently I have committed more capital to the sector after buying a stake in a Caribbean hotel company. So now I am getting serious.

Hotels have always made up a big part of the overall hospitality industry, which is where I have made my living over the past quarter of a century. While restaurants, pubs and so forth have total annual revenue of about £75bn in the UK, the turnover of the hotel business is about £25bn, derived from roughly 45,000 establishments offering about 730,000 bedrooms.

Hotels, like eating and drinking out, employ a lot of staff — about 500,000 in Britain as a whole. Because both sectors are labour intensive and have been in growth since the financial crisis, they have probably created at least a quarter of all new jobs in the past eight years.

Moreover, thanks to the fact that foreign visitors are big users of hotels — both tourists and commercial travellers — the sector adds more than£10bn a year of foreign exchange export earnings. A weaker pound will certainly boost inbound tourist arrivals next year. I fully expect Britain to welcome record numbers of tourists in 2017 — and more Britons will choose to holiday here, too.

However, like almost every business, the trade becomes steadily more competitive. I own a hotel and training centre in the Midlands. Although it is a picturesque converted country house, we often net only £75 a night per room after paying a cut to the giant online travel agencies such as booking.com. And cost inflation is becoming more of a challenge: the national living wage, the business rates revaluation and rising food and drink prices will all hit margins.

It is a high fixed-cost business even if you own the property, which a substantial majority of independent hoteliers still do. And property is always at the heart of any successful hotel business. In many ways it is as much a real-estate undertaking as providing lodging and refreshment.

This means that half the secret to achieving economic returns is the financial engineering employed in building or buying the premises. Plenty of hoteliers do not make a great deal of net profit from their core activities of letting rooms and providing food and drink, but the appreciation in their property means they can generate attractive returns once capital gains are taken into account.

Fundamentally, innkeeping should be a high-margin business: letting a room has a minimal cost of sale, and 30% operating margins should be achievable for a well-run operation. But most leisure destinations experience seasonal demand, and the industry is increasingly dominated by giant brands, from Hilton at the premium end, to Premier Inn at the budget end. Many hotel companies are now asset-light; they manage facilities for external investors and do not own the property.

As ever, measuring earnings before interest, tax, depreciation and amortisation (ebitda) can be misleading: depreciation is a real cost and cannot be avoided if you want to stay in business. Bedrooms, bathrooms and common parts must be refurbished regularly, or ratings collapse and bookings evaporate. And guests expect ever-higher specifications; in our Mediterranean beach resorts at Neilson Active Holidays, we have to offer more comprehensive wi-fi to keep guests happy.

Traditional hotel operators are being disrupted by the digital revolution on various levels. The online travel agencies dominate the flow of room bookings; websites such as TripAdvisor allow guests to tell the world the good and bad things about your hotel; and Airbnb is a fairly new competitive offering that some experts believe poses a long-term, existential threat to the entire industry.

Having seen how ecommerce is impacting retailing, I suspect the hotel trade is waking up to the risks

A couple of years ago I spoke at a conference of hoteliers.

It was clear to me then that some were in denial about the challenges the trade faces from digital interlopers.

But, having seen how the growth of ecommerce is impacting mainstream, store-based retailing, I suspect the hotel trade is waking up to the risks. Supposedly, Airbnb steals more leisure customers, rather than higher-end business travellers, but that distinction may not persist.

One way hotels can succeed is through outstanding service — especially higher-end institutions. The entrepreneur who champions this more than any other is Isadore Sharp of the Four Seasons chain. Together with Mandarin Oriental hotels, I think they are the best managers of luxury hotel properties. The latter brand is part of the Jardine Matheson empire, controlled by the Keswick family, who hail from Scotland.

A world of low interest rates, full of investors looking for safe homes for their cash, means hotels remain a favoured asset class for many, especially trophy buildings in prime locations. It is also an easy sector to understand — at least at a superficial level. Yet I find many hotels do not exploit their food and beverage facilities sufficiently — frequently they assume all meals except for breakfast and functions will lose money. This is a missed opportunity, given the space they occupy.

On balance, the rise of staycationing and more foreign tourists should boost the British hotel sector in the next few years.

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