Service Apartments - A good real estate investment?

There has been a lot of focus of late on the hotel accommodation sector – emergence of new age options are squeezing the traditionally high end hotel sector. Consider the following statistics

• Airbnb is now valued at more than any global hotel chain at close to USD 50 Bn
• 70% of international hotel travellers (according to OTA surveys) are open to service apartments, guest houses, B&B and even home stays
• 85% of hotel travellers consider lack of space and higher sundry charges a put off for them – an average service apartment costs 40% less than a comparable hotel

All this has hardly gone unnoticed by the real estate companies who are actively looking for higher yield options for their constructions. A sample of the projects under construction

• Ascot has announced a USD 500 MM serviced residences project in Delhi NCR (Due 2017)
• Assotech announces pan India project for 500 apartments (Due 2018)
• DLF and other local players like Central Park are also launching studio apartments in the range of USD 100,000 (Due 2016)
• Ireo is launching 150 apartments in the year 2017 in Delhi NCR
• Perch Service Apartment has set up a professional asset management firm in Delhi NCR

An average cost in a metro would be (Delhi NCR, Mumbai, and Bangalore)

• Land cost – 60%, construction cost – 40%.
• Average price of 1 BHK = USD 150,000 – USD 200,000

Average cost in a non-metro would be

• Land cost – 30%, construction cost – 70%.
• Average price of 1 BHK = USD 75,000 – USD 150,000

• Scale – There are benefits to having multiple apartments in one complex as well as having multiple locations. The operational costs reduce dramatically with scale – employee cost mainly.
• Branding – Branding offers apartments to charge premiums as well as the “network effect” of having a larger inventory on their books.
• Location – Serviced Apartments, not surprisingly, do well close to commercial and holiday destinations. They are better suited to locations where there many companies like in an SEZ or a commercial park, medical centre etc.
• Type – The type varies dramatically with the end user requirement. The choice between 1 BHK and 2 BHK is made looking at the end user profile – tourist, family, long stay?

The revenue model for an average apartment depends highly on the above factors. But the revenue from a USD 100,000 apartment can be in the range of USD 10,000-USD 15,000. That is a “gross” return of 12-15% per annum. Keep in mind that better service apartment can make returns of upto 20% gross per annum.

Now the important part – getting to the net return. The major operating costs are employee and utility cost (electricity, property taxes, maintenance). These can safely be assumed to be 5-7% (being conservative). Hence the net returns will not exceed 8% per annum after costs. But given that current rental yields are only 2% after cost, that’s a healthy 6%!

The big variable in whether you earn 10% gross or 20% plus is the marketing & sales, which can be a fairly tricky affair. Marketing costs are going up every year and the only way that one ensure a healthy rental yield is by having an effective marketing team – which is why going with centralized providers makes a lot of sense. There are a few professional asset management firms that can help maximize the returns from your investment. It substantially reduces the overheads of managing other complex aspects of the business like guest relations & facility management.