Hotels interest me. Fresh towels arriving when demanded (though nowadays with a fair share of guilt), rooms allocated and emptying like a massive game of Djenga, the logistics are simply fascinating. Heck, anyone would be proud to own one, especially if their hotel, their brainchild, is not only NOT in a deep mire of debt (as is usually with the hospitality industry) but part of a global, profitable mammoth. Or would they?

Hilton, Hyatt and Mariott seem to disagree, and rather vehemently given the data. These are three of the largest hotel conglomerates in the world, with Hilton and Mariott operating over 9000 each and Hyatt operating almost 1500 hotels and properties. However, less than 10% of these hotels are actually owned by these conglomerates. Hilton only operates and owns 5% if its properties, Marriott an even lower 0.5% while Hyatt owns and operates a shocking total of merely 20 US properties. The very vast majority of the properties are franchise driven, with independent owner-operators, the most prominent of which includes MCR and Apple.

From what I thus understand, there is essentially a shift in the revenue model of these conglomerates. Revenue is now also derived from these owner-operators who are mostly real estate investment trusts. They pay a certain percentage fee on profits to “fly the flags” of the conglomerate brands and in exchange get credibility, name and hence, business. This also goes easy on the balance sheet of the conglomerate brands. As these tangible properties are sold off, wiping assets also implies a wiping off of massive debt incurred from those properties. That liquid cash is then used to buy up other hotel brands. In fact, Hyatt bought Standard International after it sold real estate for Playa resorts for USD 2 Billion, reportedly to pay off loans worth USD 1.7 Billion, hence reducing debt from the balance sheet from USD 6 Billion to USD 4.3 Billion. There are further such sales, as Hyatt sold more than USD 5.7 Billion in real estate since 2017 at 15x EBITDA and invested USD 4.4 Billion at 9.5x EBITDA in acquiring SI and Apple leisure group. Brand acquisition is what conglomerates spend now, not real estate. 

This goes on in a cycle; as more and more rights are bought, Return on Equity increases since in since independent owner-operators which used to pay a fee to Standard international to fly their flag will pay it to brands like Hyatt. What essentially thus results is something rather lucrative: a one-time investment to generate consistent income, a golden egg of sorts. There is low responsibility of handing real estate which essentially serves as a means of hedging against real estate prices.

But it goes both ways; brands must also prove themselves worthy for independent hoteliers to demand such a hefty fee on profits. Apart from the name attraction, brands provide data driven logistic support. Dynamic pricing data is also made available, which helps hotel managers make decisions on how to time their price changes so that the number of rooms booked remains consistent across days even with a highly versatile demand. They also provide discounts on bookings through third party aggregators, all contributing to greater business for these independent hoteliers as well as healthy cash flow. Really makes you think: what’s the point, what’s the future of these megalithic brands?

These real estate investment trusts are the ones owning the hotel properties, employing crew and operating services. The brands thus lose their touch, since at their base identity they are hoteliers. 

Furthermore, REITs require standardization for maximizing profits; predictability is thus vastly preferred over having diverse outliers. Following this doctrine, standardizing the standard operating procedures of services along with a universe system of logistics management to reduce operating costs gives off a monotonous “feel” as they are often not just making the quality consistent but rather the aesthetics too. This reduces brand loyalty through lack of variety. Close substitutes being available thus imply high elasticity of demand where low price takes precedence as a parameter when deciding one’s stay.  There is thus no point left of loyalty programs to maintain brand loyalty even when brands don’t own hotel properties themselves. In essence, brands are reduced to utility companies and service providers, which basically turn into commodities with close substitutes. Demand is thus not hedged against price hikes as the differentiating factor, or some unique selling point disappears. Some other utility or service provider (which may be far away from the hospitality industry too!) like Amazon or some SaaS company or some other facility provider which have achieved economies of scale could give the same service as these brands for a lower price. REITs can thus be willing to  sacrifice brand recognition for cost efficiency, making these brands highly dispensable.

The risk of the formation of a bubble is also something to be considered. Real estate at the evry least has some kind of intrinsic value even though prices get inflated in that sector as well. An imperfect estimation of brand value is what generates revenue and profit. When there’s no tangible product for hotel brands to tether themselves to, there is a much more serious risk of overvaluation of brand value. If the previously explored risk of other companies providing the same service for lower price to elastic demand owner operators is actually realized, this bubble will burst,and  investors of these brands would take a big hit.

Bottom line: I feel that this asset light model is indeed a short run win. Maybe the goose will keep on laying eggs. But it is important to be careful and let’s not overestimate how indispensable these brand name flags are for owner operators.