REPORT FROM THE U.S.—The development of stylish, contemporary hostels is on the rise in the United States, and the trend is only in its infancy, according to experts.
Forward-thinking developers already have significant projects underway—such as the $32-million Freehand hostel slated for downtown Chicago—but for most institutional lenders and major investors, it’s still uncharted territory. That’s all expected to change.
No longer just an option for cash-strapped teens traveling abroad, new hostels are popping up stateside in key city center locations, in many cases pulling demand away from nearby limited-service hotels. Over time, as lenders grow more accustomed to financing these properties, reporting methods mature and the public acclimates to the modern hostel concept, a broadening pool of products and players are expected to enter the market.
“Because hostels are a relatively new type of investment, there’s not much capital that’s been available, and there’s really been very little institutional capital in the hostel space in America. That’s all starting to change,” said Andrew Zobler, CEO of the Sydell Group, which is developing the Freehand hostels. “It’s definitely harder; anytime you have something that is new it generally takes a while for the capital markets to catch up.”
Leading the charge
The Sydell Group recently partnered with the Yucaipa Companies to launch Freehand, which features upscale amenities such as hotel-quality beds and furniture, as well as high-end food and beverage. Freehand debuted with its Miami property, which was converted from the historic Indian Creek Hotel and has been a strong success, running at 90%-plus occupancy since opening in August 2012. Additionally, its F&B outlet, the Broken Shaker, was a semifinalist for a James Beard Award this year.
Miami was the test run, according to Zobler. Now, in addition to the upcoming Chicago project (a conversion of the former Tokyo Hotel on Ohio Street, which will feature 50% standard guestrooms and 50% group accommodations), Zobler said the fledgling hostel brand is also working on deals in Los Angeles and New York, with the goal of opening up to 10 Freehand properties over the next few years, mostly within former hotels.
“We really look for buildings that are older, with character, that have some history and some good bones but are down on their luck. That’s pretty much what we found in Chicago,” Zobler said. “We see this largely as an adaptive reuse kind of thing, which is not to say we would never build one new, but by and large, we think there are buildings you can buy, or old hotels, where you can convert them to hostel use and that’s where the economics are most compelling.”
Measuring performance
The economics, though, are where hostels become a hazy proposition for many, especially those used to analyzing property performance from a traditional hotel-focused per-room metric. Primarily, hostels use a per-bed analysis instead, while anecdotally factoring average rates from competing hostels. But with hostel development now on the rise these performance metrics are evolving, especially as more potential deals seek underwriting.
“Certainly they’re underwritten on a per-bed revenue analysis rather than a per-room analysis, and the operations are different, because your cost structure is substantially different than the cost structure of a hotel,” said Sean Hennessey, founder and CEO of Lodging Advisors, LLC. “It’s been more local and regional capital sources and smaller developers, so there’s less dollars involved. I suspect we are, at this point, far enough away from the trend maturing to the point where the big boys feel they need to enter the game. But I think it’s certainly possible that it could get there one day.”
Hospitality research firms are also just now getting up to speed with the hostel movement. According to sources, would-be hostel operators won’t find the same breadth of data they rely on for hotel projects, although that is shifting.
“There isn’t a benchmarking service out there like STR for hostels at the moment. It’s just not there right now,” said Harry Douglass, senior associate with HVS London, who recently published a study on growth in the hostel market. “It needs to be done properly. … There are frequent changes in bed numbers throughout the year, according to demand. You can’t really account for that yet, so any system that feeds performance data into a benchmarking service needs to be quite sophisticated if it’s going to be worth it.”
For now, hostel developers like Sydell are finding success with a hybrid approach, taking standard hotel accounting methods and tweaking them to apply to hostels instead.
“We sort of need to be convinced that it’s going to be more profitable to operate these rooms as shared accommodations than as a private hotel room,” Zobler said. “We basically underwrite to a competitive hotel set, and then assume that we should do a little better in terms of the flow-through and rate. Assuming that the rooms are fully occupied, we should be doing a little better than a single-occupancy hotel room.”
Shifting regulations
As awareness of the domestic hostel market spreads among lenders and travelers, in turn spurring more growth, other factors such as changing laws may also either boost or hinder development.
For example, New York City is notorious for laws that severely limit the ability to operate a hostel there, yet some believe legislation will become more favorable in time.
“In New York, there hasn’t been much in the way of hostels, primarily because the city regulations from the building department really inhibit the ability to build a hostel. It’s not like they’re outlawed, but the requirements are such that it doesn’t really work for the hostel market,” Hennessey said.
“But as part of the city’s effort to clean out what they refer to as delinquent hotels, they’ve realized that it’s inhibiting the hostel market, so they’ve proposed regulations that make it more clear what’s acceptable, and those regulations will go a long way toward encouraging market interest in the concept,” he said. “When the laws change, you’ll be able to have many more beds, and offer food, beverage and liquor services, and the other ancillary sources of revenue. In New York, we’ve seen six or so developers coming up to us in the past nine months looking at the hostel market.”
That’s good news for hostel developers, like the Sydell Group, which are targeting existing buildings in New York and other major city centers where demand for hostels is believed to be the highest. Zobler said overall the company is approaching the growth of Freehand hostels in “dribs and drabs,” as the conditions become favorable and specific opportunities arise in select markets. While that’s happening, more operators and lenders are expected to arrive on the scene.
“For an institutional investor to get interested, developers have to say they want to do at least a few (projects), and sometimes it’s hard to say you want to do a few before you’ve done one. So that’s been a little of the challenge, to get institutional capital to wade in,” Zobler said.
“The other part is: (Hostels) haven’t really been tested to a great extent in the American market. However, the Miami project opened and couldn’t have been better received, so we really feel encouraged by that,” he said.