A basic room at Ibis Gangnam in southern Seoul. Mid-range hotels in Korea are attractive options for travellers as well as for global real estate investors. / Courtesy of Ibis Korea

Business hotels with selected amenities offer better investment than 5-star hotels

By Jennifer Choi

When someone mentions the word hotel, most people will think of luxury or upscale full-service hotels. This is particularly the case for Korea, since the country’s main hotel market started with upscale full-service properties by major brands including Hilton, Hyatt, Inter-Continental Hotel Group, and Starwood Hotels. However, such a stereotyped view of hotels has been changing among more knowledgeable travelers.

While hotels are typically classified as limited-service and full-service, a new segment, more specifically select-service properties, has been increasing globally in recent years. Major hotel chains have been expanding their brands by diversifying and creating multiple brands. Different brands target specific clientele and provide alternative levels of service in addition to featuring varying average room rates.

Limited-service hotels usually refer to hotels without any restaurants or banquet facilities. However, the amenities have expanded to include a business center, fitness center, and small meeting rooms. This segment typically has lower operating costs because they do not offer catering services or multiple restaurants.

Select-service properties feature some amenities from full-service hotels, including restaurants and banquet services, but on a more moderate scale. Properties with limited-service hotel brands but with on-site restaurants can also be classified into select-service segments.

Full-service hotels offer a variety of services for their guests including a full-service spa, valet service, retail shops and almost always include more than one food and beverage option along with expansive banquet services and larger meeting spaces.

Due to its distinctive characteristics, the hotel industry experienced shifts between segments during the global financial crisis. With tightened budgets, travelers grew more price-conscious and began to look for more value in each dollar they spent. This trend made an impact on each type of hotel in different ways. Many travelers who formerly stayed in luxury and upscale full-service hotels began to stay in mid- to lower-tier full-service hotels or even select-service hotels. Travelers who were already somewhat price-sensitive became even more price-conscious during the recession and stayed at limited-service hotels where they could get breakfast and internet access included in their room rates.

As Korea’s hotel market matures, a number of the lower tier hotel brands have been entering the market with some success. There are now three Ibis hotels in Seoul and Suwon; nine Best Western hotels throughout South Korea including Seoul, Incheon, and Gumi; and nine Ramada hotels are also located throughout South Korea including Seoul, Incheon, Gwangju, Suwon, Chungju, Sooanbo, Pohang and Cheju.

According to Cushman & Wakefield, multiple global limited-service and select-service brands are expressing interest and considering entering or expanding in Korea’s hotel market. Additionally, local full-service hotel brands including Shilla have also recently announced plans to expand by constructing lower-rated hotels throughout Seoul.

Low cost, higher profit rate

Though select-service and limited-service hotels generate less revenue per room, there are reasons many hotel investors are looking into these segments. Limited-service and select-service hotels are not as costly to construct or to operate, leading to a higher chance of return on investment in a shorter time period. According to Cushman & Wakefield’s in-house database, construction costs for limited-service hotels in Seoul average around 75 million won per room and select-service hotels average around 100 million won per room while full-service hotels in Seoul range from between 150 million won and 250 million won per room, depending on the size and quality of the property.

Additionally, the net operating income ratio to total revenue for many select-service or limited-service hotels is relatively higher than that of some full-service hotels. On the other hand, although full-service hotels require higher construction costs and operating costs due to higher level of services and amenities, they have the advantage to capture more selective demand and command a higher average rate in addition to featuring multiple revenue generating departments, like banqueting and meeting facilities.

From my years of hotel valuation experience in the United States, I have seen U.S. hotel values decline roughly 20 to 30 percent in 2010 in comparison to a valuation 12 to 18 months earlier. The primary reason for the value declines was due to the decrease in the net operating income levels as a result of suffering occupancy levels and average room rates. Similar to other revenue generating real estate valuations, hotel valuations are heavily derived by Income Capitalization Approach and therefore correlated with the hotel’s cash flow projections. Specifically, its net operating income level plays a key role in a hotel’s valuation. This is why the lower-rated hotel segments are considered attractive to some hotel investors as many of these properties feature higher net operating income ratios to total revenue — thus higher return to investment — than some full-service hotels, as previously mentioned.

As all property types have their pros and cons, it is important for hotel owners, operators, and lenders to hire professionals who can provide high quality services to analyze the hotel’s location, types of customers and demand generators in the areas that can make a property successful. It is also important to keep track of the potential supply in the market to prevent being hurt by oversupply. It doesn’t always have to be a luxury brand hotel to be successful, so keep your options open.

Jennifer Choi is a manager at Cushman & Wakefield Korea. Soo Jin helped this article.