Buy-to-let hotels: A slow burner ready to catch fire?

Recently weary commuters passing through London's Paddington station were given the opportunity to rest their bones at the nearby Nest hotel - and not just for one or two nights. Through a loud leafleting and advertising campaign on the concourse, the public were given a chance to buy into one of the country's newest and, for some, most contentious hotel financing models: buy-to-let.

The campaign by buy-to-let hotel room pioneer GuestInvest was to advertise its second property, the 163-bedroom Nest, which is set to open later this year. It follows on from the company's prototype 170-bedroom Guesthouse West in Notting Hill, launched in 2004. And last autumn, a third property, the 400-bedroom Chiswell Street hotel in the City, which is due to open in 2008, was added to the portfolio.

Guaranteed return

The concept behind buy-to-let is straightforward. Investors buy a room (those in the Paddington hotel are marketed from £175,000) on a 999-year lease. The hotel is managed and marketed by GuestInvest, with the investor receiving 50% of the room's income, a guaranteed 6% return for the first year, plus any capital appreciation when the investment is sold on. Investors also get to use the room at no charge for 52 nights a year.

Yet, as GuestInvest founder and chief executive Johnny Sandelson concedes, there's still some way to go before the public and industry fully understand what he's trying to do. "A lot of the worries about this type of model are based on a lack of knowledge," he explains. "It's different because it's a new asset class. But people who've bought rooms in Notting Hill have already resold them, and people have made a return on them. It's been a very successful pilot. Some of our investors have gone on and bought in Paddington and now in the City."

Philip Camble, hotel adviser at KPMG's travel, leisure and tourism practice, says buy-to-let hotel rooms can and do work. In the USA, for instance, including a buy-to-let component within a new hotel development is commonplace, with the concept known as "condo hotels", and in France, operators such as Pierre et Vacances have made use of various tax incentives to make buy-to-let an attractive option for retirees in particular, who can live in their property after 20 years. It's also a popular model in the Caribbean.

But as with anything new, there's often an inherent scepticism to be overcome. "GuestInvest does seem to have worked OK so far, it's still in business, some of the rooms have traded since the initial guarantee came to an end, and many of the owners have since made a small profit. Guesthouse West seems to be trading well, with reasonable levels of occupancy," says Camble.

Occupancy levels are one of the most critical components of any buy-to-let model, he adds. At Guesthouse West the guaranteed return to investors, for instance, can be met only if rooms are occupied 75% of the time. With occupancy running at about 90% that hasn't been a problem so far.

But occupancy, Camble suggests, was one of the factors that undermined an early move by GuestInvest to expand outside London. In 2005 the company bought Alias Hotels, which had four properties in Exeter, Brighton, Cheltenham and Manchester in a £30.4m deal from Luxury Hotel Management. But the deal subsequently fell through because of lack of demand. Sandelson now points to places such as Amsterdam, Milan, Paris or Istanbul as possibilities for expansion.

Similar scheme

The lesson would seem to be that buy-to-let is unlikely to work outside high-volume major cities. Certainly, GuestInvest is no longer the only kid on the block in London. Property firms Galliard Homes and Frogmore Property Company are developing a similar scheme for two hotels, the 395-bedroom County Hall Park Plaza, due to open next year, and the 930-bedroom Westminster Bridge Park Plaza, set to open in 2010.

The fact the developments will be operated by Park Plaza Hotels Europe, a recognised and well-established hotel group, is important, stresses Andy Georgiou, sales manager for both hotels. Park Plaza, he adds, will not own any of the properties itself and will be just the operator. The owners are the investors who, when they buy their unit (and unlike GuestInvest), also buy a 1% stake in the management company.

"It will be up to Park Plaza how it operates the hotel, but it will be the management company that will make sure it's doing the job correctly," says Georgiou. "If Park Plaza underperforms it can be sacked by the management company, but we don't think that will happen. We're trying to educate buyers to look on it as a long-term investment. It's not a product that you can really turn over in a very short time."

Sandelson bats away industry worries about what happens when he wants, or is forced, to spend money on renovating a property. A key part of the agreement is that GuestInvest is free to make operational decisions about the running of the hotel, he stresses.

"The nightmare would be that it became like an annual general meeting every time you wanted to change the lift," he says. "The job of the investor is simply to receive a cheque every quarter. They don't want to know about renovation work.

"And if they don't like that, well, they can always sell their room," he stresses, adding that at the moment investors are buying about 10 to 15 rooms a week.

Investors pay £100 a year into a renovations fund, which is matched by GuestInvest. If, say, after 10 years, a large capital outlay were required, it would be decided on a square footage basis. If investors couldn't pay, the sum would be deducted from their rental income.

Only time will establish the credibility of the model, predicts Camble, although the fact that Bank of Scotland early last year was prepared to pump £140m into GuestInvest through a joint venture speaks volumes.

"These companies are really the first ones into the market and, as with all pioneers, there are a lot of people waiting to see how it works," Camble says.

But, he concedes, buy-to-let, at least for the time being, looks as if it's here to stay and the industry may yet be won round.

"If Galliard gets up and running too, and and owners are getting a healthy return, I think people may start to see it as a concept that does work and then the pace will pick up," he adds.

Guestinvest

2004

• Founded by property entrepreneur Johnny Sandelson (below), GuestInvest starts by selling rooms in Guesthouse West in Notting Hill (below right).

2005

• A £30.4m deal to expand through acquisition of Alias Hotels from Luxury Hotel Management falls through and Alias is put back on the market.

2006

• GuestInvest agrees £140m deal with Bank of Scotland Corporate, creating a joint venture.

• Unveils £35m second hotel, Nest, in Paddington, and announces plans for £55m third hotel in Chiswell Street in the City on site of the Grade II-listed former Whitbread Brewery.