21 September 2019
The Super Hotel chain in Japan offers limited amenities (though a few of the hotels have an in-house hot-spring spa), but service is the equal of that in full-service hotels. Photo:
The Super Hotel chain in Japan offers limited amenities (though a few of the hotels have an in-house hot-spring spa), but service is the equal of that in full-service hotels. Photo:

Why limited-service hotels can be a good investment

A limited-service hotel (LSH) is a hotel without restaurant and banquet facilities, which are part of the defining characteristics of a full-service hotel (FSH).

The LSH’s market position is based on the recognition that, for some travelers, the key requirement is a satisfactory room but few of the other amenities.

Traditional LSHs may be a budget option, where the hotel stripped out as much cost as possible to deliver a low-cost option to travelers.

Clayton Christensen defines disruptive innovations as new services or products that “were technologically straightforward, consisting of off-the-shelf components put together in a product architecture that was often simpler than prior approaches.

“They offered less of what customers in established markets wanted and so could rarely be initially employed there.

“They offered a different package of attributes valued only in emerging markets remote from, and unimportant to, the mainstream.”

The LSH was born from a simpler notion that, among services provided by FSHs, the room experience is the key.

LSH operators have subsequently been innovative in satisfying other requirements through other designs.

While we do not think the LSH can replace FSHs, the more premium LSHs have the potential to increase their market share by competing with four-star FSHs.

The LSH sector, however, diversified as travelers grew to accept the format.

More sophisticated travelers, although cost-conscious, may have higher expectations of the room experience.

Thus, some LSHs started to cater to these travelers by offering a fuller room experience with high-end décor and staff presentation.

Some LSHs also recognize that some amenities are essential. Thus, they also offer basic amenities, often using innovative strategies.

Hotel brands now form a spectrum of brand positions, ranging from guesthouses and traditional LSHs that offer a basic room with no amenities, to premium LSHs that have a room equivalent to those in FSHs, with some basic amenities, to traditional full-service hotels.

There is some overlap between the most premier offering of a category and the most mass-market offering of the next.

In particular, premium LSHs actively compete with other three-star hotels and, in some selected markets, they serve as a complementary or back-up product to four-star FSHs.

The brand positions not only differentiate the hotel types to investors but also change the investment and operating characteristics of each type.

Because LSHs offer only a selected few amenities, more floor area can typically be used for rooms.

But since LSHs typically carry smaller rooms, the per room floor area is typically between a third and half less than in a FSH.

Saving on amenities also reduces the staffing requirement.

According to our analysis, the number of staff at a similar-sized LSH can be less than one-third of the number at a FSH.

On the income statement, this typically translates to a 20 percentage point increase in gross operating profit margin.

That higher margin lowers the breakeven revenue per available room and breakeven occupancy of a LSH.

A LSH also manages seasonality better, as the overall cost during off season is lower than that of a FSH.

In fact, a similar-sized LSH typically has a breakeven occupancy that is about 30-40 percent, versus over 60 percent for a FSH.

Lower investment outlay and operating cost, a feature shared by all LSHs, leads to a more stable investment product versus the FSH, and LSHs can deliver an on-par to slightly better risk-adjusted return than other commercial real estate classes.

This is one of the reasons for the rapid growth of the sector over the last two decades.

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Chief Investment Officer, Admiral Investment Ltd.