HOTEL as the Real Estate segment

Hospitality commercial real estate is designed for end users who require a short length of stay or interim lodging, both for leisure or business purposes. They are usually located at their customer's destination or on the path of their customer's journey.

The hospitality business is capital-intensive and requires significant expertise and experience. The main features of hotel real estate development are the attractive location, uniqueness of each project (especially for high-class hotels), a well-developed concept, and the correct organization of the management. Depending on the size of the construction project, its quality, and general market conditions, the project's payback period can take from approx. 7 to 15 years. Also, such real estate assets are one of the most expensive properties to develop as the square meter price consists of everything - land, building, fit-out, equipment, and furniture costs.?

While the hospitality industry is often the first to suffer during any economic malaise, it is also among the fastest to recover as pent-up demand from consumers returns as they celebrate an economic recovery or, as with the pandemic, finally can travel once again from the enforced isolated lifestyle lockdowns.?

Challenges And Exceptional Opportunities Faced By Baltic Hospitality?During The Past Three Years

During the COVID-19 pandemic in the Baltic States, none of the real estate segments was hit harder than the hotels. During the initial phase of the pandemic, before the introduction of vaccinations, most countries imposed travel restrictions, allowing only diplomats, athletes, and privileged groups to travel abroad. Governments aimed to prevent tourists from entering, and foreigners chose to refrain from touring due to the substantial risk of infection. Subsequently, even as travel gradually resumed, accessibility was still limited, as individuals were required to possess a vaccination passport or undergo PCR tests before and, in certain cases, after their trips.

Besides traveling restrictions, there were also increased sanitation and cleaning costs, consumer health concerns, and local social distancing measures, which have all combined in the short term hurt the profitability of the hospitality industry.

In the last three years, this situation resulted in sizable hotel developments being on pause or at a very low level, and there were also some terminations of such schemes. For instance, at the end of 2022, there was news in the media that Radisson Red wouldn't be opened in Vilnius. It is also uncertain whether Vilnius will have the second Hilton because the Viciunai group is selling the project which initially should have had to be the DoubleTree by Hilton.

These are the only hotel openings in the capitals of the Baltic states in the last three years*:

●??????Tallinn - Nunne Boutique Hotel (2023, 64 rooms), Hotel L'Embitu Tallinn (2020, 131 rooms), Adoryal Hotell (2020, 48 rooms);

●??????Riga – Aston Hotel Riga (2023, 56 rooms), Hampton by Hilton Riga Airport (2022, 191 rooms), Aparthotel Amella (2022, 53 rooms);

●??????Vilnius - Conti Hotel (2023, 79 rooms), CALVARY Hotel & Restaurant Vilnius (2021, 65 rooms), Park Inn by Radisson Vilnius Airport Hotel & Business Centre (2020, 120 rooms).

Looking at the same timeframe, but turning our attention from the capitals to the regions of the Baltic countries, it is seen clearly that the most significant development volumes were located in Lithuanian secondary cities and resort towns while the only one Latvia‘s resort town – Jurmala – attained new hotel opening, while none new developments were done in the regions of Estonia*:

●??????Jurmala - STORIES Design ApartHotel (2020, 30 rooms);

●??????Kaunas - Berman House (2023, 30 rooms), Moxy Kaunas Center (2020, 175 rooms);

●??????Klaipeda – Victoria Hotel Klaipeda (2021, 105 rooms);

●??????Druskininkai - Amberton Green SPA Druskininkai (2020, 133 rooms);

●??????Birstonas – Ese Hotel (2021, 39 rooms), Ego SPA (2020, 59 rooms);

●??????Palanga – Monist Palanga (2023, 30 rooms);

●??????Nida – SPA Nida (2021, 39 rooms).

*Establishments starting from 30 rooms

Diminishing hotel developments directly resulted from dried tourist flows in the three years, impacted by the COVID-19 travel restrictions and the war in Ukraine. Lithuania faced Emergency status from February 2022 to May 2023 due to the Russian invasion of Ukraine. Once foreign travelers visited their local travel agencies and heard that Lithuania was in an Emergency status, it discouraged them from traveling to the region even though Lithuanians enjoyed life as usual in the country without any clearly visible restrictions. A slightly different legal situation was for Latvia and Estonia. Still, both these countries have had direct borders with Russia, which has been perceived as a threat.

The significant income losses have affected hotels of different categories in varying ways. Smaller hotels, mainly economy or medium-income, and primarily owned by private individuals without professional hotel operators, have either sold their properties or invested in converting them into short or long-term residential rental rooms. Following the outbreak of war, Baltic states experienced an influx of Ukrainian refugees, leading to a significant increase in the demand for residential spaces overnight.

These challenging times brought also opportunities. Non-performing hotels that were sold to professional real estate managers have been successfully converted into residential or co-living concepts. For example, the Ecotel Hotel was transformed into Chapters co-living, and the project enjoys high occupancy rates. So there have been cases when investors could have acquired distressed hotels where previous management struggled with operations and have been forced to sell their assets to cover mounting debt burdens. As the economy recovers, such redeveloped assets may lead to successful and profitable exits.

Conversely, larger hotels with wealthier investors, professional management teams, and international brands have attempted to mitigate the crisis. The largest hotels were supported by additional cash injections from the owners. Also, depending on the agreement with the management company, global hotel groups may support non-performing assets in certain regions by utilizing income obtained in other regions.

The pandemic presented an excellent chance for action for hotel owners with capital who were either planning or postponing property renovations and refurbishments. For instance, the SPA Vilnius Druskininkai underwent a renovation project during the quarantine time and presented the renewal of the hotel in February 2022. Additionally, the Radisson Blu Sky Hotel in Tallinn also executed a renovation project during the pandemic, and it reopened in 2022 as the Radisson Collection hotel. A pretty similar case also happened in Vilnius, when in 2022 former Radisson Blu Royal Astorija reopened after renovation under the Radisson Collection Astorija Vilnius name. Furthermore, there are redevelopment projects where hotels with local brands are being converted into internationally branded hotels, such as the new ibis Styles Kaunas Centre.

These difficult times also elevated a new trend in the Baltics, the development of small-scale niche hospitality schemes. Many privately owned glamping, villas, and other lodging facilities have quickly entered the market and have emerged as the pandemic's absolute winners. During the pandemic, when international and sometimes even local borders were closed, domestic tourism experienced a significant surge. People had limited options for vacationing and traveling, so they opted for destinations within their own countries. This trend continued over three years, leading to the establishment of a habit of weekend getaways, creating a strong demand for small villas ideal for such purposes. These facilities, located far from major cities and surrounded by forests or lakes, offer peaceful and quiet getaways from urban chaos. Such properties differ from their ancestors - old-style wooden country houses - with unique architecture, modern interiors, convenient and up-to-date booking systems, and additional services such as jacuzzis, bathtubs, and massages. ?Since each such establishment is a separate building, owners were able to ensure social distancing and proper disinfection. They also promote digital detox as many do not offer wifi intentionally. They are also 100% “instagrammable”. These assets, at least for now, have shown significant occupancy levels throughout recent years, regardless of seasonality. People also enjoy visiting these properties during beautiful snowy winters. We‘ll see how this trend will evolve and whether this business model is sustainable long-term.

Finally, the second half of 2023, is a clear recovery of the hotel believers after a pretty long stop, from a transactions point of view, as institutional investors started to add performing and operating hotels to their portfolios. Union Asset Management is planning to conclude 3 ibis hotel acquisitions (two in Kaunas and one in Riga). While in Tallinn a pretty large transaction of 2 hotels - L'Ermitage and L'Embitu – was closed by the global hotel chain – Accor.

Roles Of Hotel Management

It's worth mentioning that the hotel sector differs from other real estate asset classes because hotels typically do not have tenants. Hotel tenants are usually hotel operators, and for smaller-scale hotels, the owners typically act as the operators, creating their own brands. However, for larger-scale properties owned by developers or institutional real estate owners, the aim is to attract international hotel chains, which would bring not only occupancy but also hotel management expertise.

In the Baltics, global hotel chains are pretty reluctant to sign lease agreements with fixed rent indications, or it's the exception rather than the rule. They typically offer management agreements, which do not have an indexed rent but rather a rent that depends on the hotel's performance, with guaranteed low-income floors or all floating parts. In such situations, the hotel owner becomes a co-pilot of the hotel business, rather than purely the real estate, making it more of a private equity business than a real estate management.

Let's dive a little bit more into the main agreements with the hoteliers:

1. MANAGEMENT AGREEMENT: contract, where the owner of the hotel real estate appoints a management company or other hotel brand to operate the business on the owner's behalf. Some management companies have their own brand so the hotel might be operated under a certain flag.

• BENEFITS TO OWNER:

§?Branded management companies are interested in long-term contracts to secure their brand name,

§?Parties can agree to potential profit sharing upon successful operations and the hotel owner can invest in the sector without any experience in the business,

• DRAWBACKS TO THE OWNER:

§?He/She still takes the hotel performance risk of the downside,

§?He/She has to cover additional costs of the hotel – the fee for the management company;

§?He/She in the majority of cases has very limited rights to terminate the agreement.

2. LEASE AGREEMENT: The owner leases the hotel to the operator/manager on a fairly long-term basis in return for rent payments.

• BENEFITS TO OWNER:

§?This type of agreement provides clear and predictable cash flows (indexed rent),

§?In the majority of cases, there is a long-term lease,

§?There is no hotel business risk,

§?Tenant is the property operator.

• DRAWBACKS TO THE OWNER:

§?There is no or very little turnover sharing (especially if the hotel is performing exceptionally great).

3. FRANCHISE AGREEMENT: contract, where the owner pays an up-front fee to purchase the franchise along with ongoing royalties of the hotel brand for his/her privately owned property. The franchisor provides the brand, know-how, distribution channels, etc., ?but the hotel owner is responsible for the operations and management, subject to the approval of the franchisor.

• BENEFITS TO OWNER:

§?Inherited know-how and ?play-book“,

§?Potential profit sharing upon successful operations,

§?Owner remains in control of operations,

§?Potentially lower fees than in management agreements.

• DRAWBACKS TO THE OWNER:

§?This model requires a higher level of sophistication from the owner.

§ There is no room for creativity, as the brand book provides strict guidance on location, fit-out, service quality, etc.

§?There is no day-to-day guidance on operations.

4. HYBRID MODELS. The lines between the categories are getting blurry, so there might be also different mesh-up variations of the above-listed types and their features. There are a growing number of cases which require complex solutions. A common option is a management agreement with a fixed floor payment from the hotel management company to the owner and a success fee split upon operational results.?

?

What also sets the hotel sector apart from other real estate asset classes is that both the owner and the manager are using operational metrics. They are used for the performance evaluation of the hotel and/or the management team. Most commons are:

●??????Average daily rate (ADR) - measures the average rental revenue earned for an occupied room per day.

●??????Room revenue per available room (RevPAR) - performance measure when calculated by multiplying a hotel's average daily room rate by its occupancy rate.

●??????The GOP (gross operating profit) level for an operating year – gross rental income minus management fee and other operational expenses, equals NOI (net operating profit).

Hotels Classification

Hotels are classified based on several factors driven by various criteria. But there is no one right way to classify hotels because there are many methodologies while speaking about this segment. Hotels can be classified by:

●??????stars (typically 1-5*),

●??????location (downtown, suburban, resort, airport),

●??????number of rooms (small, medium, large),

●??????clientele (group, family, commercial/business, convention/conference),

● length of guest stay (from 1 hour to a month),

●??????ownership (franchise, privately owned, etc.),

●??????level of service (budget, economy, mid-range, luxury).

?

Categorization based on the spectrum of services and product specifics is becoming increasingly prevalent nowadays. However, people/customers still tend to use classification based on stars in their everyday language. Let's review each hotel sub-category in the Baltics based on their level of service, even though the lines between these categories are starting to blur.

The Main Categories Of Hospitality Properties

Budget/Economy hotel

A hotel for a lower price than a regular hotel in the area, and it appeals to budget-minded travelers. This type of hotel provides clean rooms that are safe and meet the basic needs of a guest. Extra amenities may be available but for an additional cost. They are usually small to medium size hotels. Some examples of budget economy hotel chains include ibis Vilnius Centre, Best Western Tallinn, Park Inn, and Moxy.?

Limited-service hotel

Limited-service hotels are a popular choice for value-for-money travelers who are looking for a comfortable and affordable place to stay. These hotels usually don't have a food and beverage component like an onsite restaurant. It may have typical amenities like a conference room, business center, gym, pool, and laundry without unnecessarily paying additional costs for costly services but not necessarily. Examples of limited-service hotel chains include Courtyard by Marriott (even though it has a restaurant and bar onsite), and Holiday Inn.

Full-service hotel

Full-service hotels offer a wide range of amenities and services to guests, making them an attractive option for travelers who are looking for a more luxurious and comfortable stay.?A simple differentiation between full and limited-service hotels is the food and beverage component. The full-service hotel includes room service and has an on-site restaurant. They may also have business centers and meeting rooms, making them a popular choice for conferences and events. Full-service hotel chains include Kempinski (Riga or Vilnius), Radisson Blu Royal Astorija Hotel Vilnius, Hilton Garden Inn Vilnius City Centre, Wellton Riga Hotel & SPA.

Boutique hotel

Boutique hotels are known for their unique and personalized experiences, often featuring stylish decor, art, and architecture. They typically have a smaller number of rooms, which allows for a more intimate and exclusive atmosphere. These hotels cater to travelers who are looking for a one-of-a-kind experience and are often willing to pay a premium for it.?Examples of boutique hotel chains include Pacai Hotel, Palace Hotel Tallinn, a member of Radisson Individuals, Grand Poet Hotel, and SPA by Semarah.

Casino hotel

A casino hotel is an establishment consisting of a casino with temporary lodging provided in an on-premises hotel. That type of hotel provides food and beverages, and their functions are secondary and support casinos (and/or slot machines). Casino hotel chains include Hilton Tallinn Park, Radisson Blu Hotel in Latvia, and Radisson Blu Hotel in Vilnius, Lithuania.?

Extended-stay hotel

A limited-service hotel featuring guest rooms equipped with complete kitchens/kitchenettes and more extensive accommodations for extended stays. Extended-stay hotels are for travelers seeking comfort and an enjoyable feeling like home and who need to stay for an extended period, typically a week or more. Extended-stay hotels are a popular choice for expats, families, and anyone who needs a temporary living space. Extended-stay hotel chains include Park Inn by Radisson Residence Riga Barona, Neiburgs Hotel Riga, Pirita Beach Apartments & SPA (Tallinn), and Bob W Avangard (Tallinn).

Resort hotel

A full-service hotel situated on a big plot of land in a specific resort area (where visitors go for recreation, mainly exotic places, both in warm and cold regions) and connected to a spa, wellness, skiing, golf course, water park, amusement park, kayaking, sailing, and fishing. Resort hotels are typically located in exotic locations away from the cities, such as mountains, seaside, etc. Resort hotel chains include Ziedlejas Wellness Resort in Latvia, Atokampis in Lithuania, and Spa Vilnius Anyk??iai in Lithuania.?

Hostel

It is a form of low-cost, short-term, shared-friendly lodging where guests can rent a bed, usually a bunk bed in a dormitory, with shared use of a lounge and sometimes a kitchen. They may also offer private rooms, as well as common areas such as kitchens, lounges, and game rooms, where guests can socialize and relax. Hostels are a popular choice for backpackers, solo travelers, and anyone looking for a communal travel experience. Examples of hostel chains include Old Town Alur Hostel & Bar, Cinnamon Sally Backpackers Hostel, and Viru Backpackers Hostel.

Villa

A villa is a private standalone home dedicated to hospitality. It is completely self-contained: it includes a living room, dining room, kitchen, and bedrooms – basically, everything you’d expect from a home. The villa also may have a private pool. In addition to these basic comforts, luxury villas can include everything from a private home cinema to a gym and from a massage room to a sauna. Vila hotel chains include Maidla Nature Resort, Do You Place, ?iaurys Resort, Seven Mirrors, etc.?

Lodge

A small (rustic) house where travelers can stay overnight. Depending on the location, it may have unique housing attributes corresponding to a particular region/country. Lodges are typically located in natural settings, such as mountains, forests, or near bodies of water. The lodges do not provide additional services or facilities such as restaurants, room services, SPA, etc. Examples of lodge chains include Gateway to Forest Cab, I? civilizacijos ? gamt?, and Ziedlejas Wellness Resort in Latvia.

Glamping

Glamping, or glamorous camping, is a relatively new form of outdoor lodging that combines the comfort and luxury of a hotel with the adventure and natural setting of camping. It is outdoor camping with amenities and comforts (such as beds, electricity, and access to indoor plumbing) not usually used when camping. Glamping sites often offer unique experiences, such as stargazing, wildlife safaris, and outdoor adventures, and may be located in remote wilderness areas or near popular tourist destinations. Examples of glamping sites include Glamping Lithuania, Glamping inside Karula National Park, and Uz Salas.?

Tiny House

The tiny-house movement is an architectural and social movement that advocates for downsizing living spaces, simplifying, and essentially "living with less". Typically, tiny homes are between 10 and 50 sq.m, but on average 30 sq.m. They can be stationary or on wheels. This segment is all about sustainability. There are examples where incinerating toilets burns waste to ashes. It provides comfort in a minimum space. Everything is about multifunctionality. Examples of tiny housel chains include ?Tinybee – Modern Studio on Wheels.?

Floatels

Floatel combines the words ?float“ and ?hotel“ and can be described as a hotel that is above water or floating, but permanent or attached to stilts, contrary to a cruise ship or boat. Soon Vilnius travellers will be able to book such accommodation floating in the river Neris. Of course, room sizes will be pretty small and may remind a ship cabin, but still will remain as studio-type apartments. The first Vilnius floatel should have 23 rooms with private bathrooms, and panoramic windows to observe Neris river. The bar/restaurant should be placed on the roof. However, travelers should be highly aware of the floatel movement. Because in the summertime, it will be parked next to Mindaugas Bridge while in the off-season, the floatel will continue its activities in the winter harbor in the Zirmunai district.

The Summary?

To sum up, this article covered the segmentation of hotels in the Baltic states. Before we end, let's recall again:

●??????Hotel businesses depend highly on many internal and external factors - economic situation, location, flag, and manager.

●??????There is a huge variety of hotel types and classifications.

●??????Apart from classical hotel types, there is a rise in smaller-scale boutique schemes – lodges, tiny houses, and glamping.

●??????Lease agreement practice in the Baltic hotel market is still fairly uncommon.

●??????The property owner has to think about the operations/management team who will run the operations in the early stage of the development.

●??????Hotel development requires extensive capital deployment. It is a more risky investment but could bring significant profits in the proper economic cycle. If one likes hotels but wants slightly less risk, hospitality REITs could be an option.

?

Hotels come in various classifications to meet travelers' or owners' diverse needs and preferences. As for an owner, understanding the classifications of hotels can help you determine what kind of property you want to develop or invest in because investing in or developing a hotel can be a rewarding but complex process. As for a traveler, whatever your travel needs and preferences are, there is a hotel that can provide the perfect accommodation for your trip.

?

Bon voyage!