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Upmarket hostels edging in on the US market

27 May 2015
27 May 2015 -
Hostel sign

Some investors are betting the next big market in hospitality will be the scruffy, cost-conscious backpacking crowd.

AllianceBernstein LP, Invesco Ltd. and billionaire Ronald Burkle’s Yucaipa Cos. all are pouring money into upscale youth hostels, a new kind of lodging that has been growing in Europe and is starting to crack the U.S. market.

These accommodations look nothing like what travelling college students of years ago are likely to remember. Back then, a youth-hostel stay usually meant sharing dingy, cramped quarters with a dozen strangers and waiting to use a communal restroom.

The modern hostel still offers the social lubricant of shared rooms, though generally for fewer people. But in other respects it more closely resembles a fashionable boutique hotel. Such properties feature private bathrooms, vibrant bars with specialty cocktails, yoga classes on rooftops, and mahogany-filled rooms from interior designers like Roman & Williams. Most also offer the option of private rooms with one or two beds.

This month, Freehand, one of the first of these brands based in the U.S., is opening a Chicago hostel. It is its second U.S. property, following one in Miami Beach that has 278 beds and opened in 2012. Generator Hostels, the operator of nine European hostels with 6,200 beds, is close to a deal to acquire a building on Collins Avenue in Miami Beach for its first U.S. hostel, say people familiar with the matter.

Josh Wyatt, a partner at Patron Capital Partners, the London-based private-equity firm that is the majority owner of Generator, says the high-end hostel concept represented a new niche. “We looked at the boutique space and said, ‘No one really does this with hostels,’ ” he says.

The budding interest in a sector historically dominated by modest mom-and-pop operations shows how well the hospitality market is doing, but also how crowded the more-traditional segments of the market have become. It also shows how any business model that attracts the much-coveted millennial generation, often defined as the group born between 1980 and 2000, holds a particular investor appeal.

A recent report from real-estate broker CBRE Group Inc. says this generation of travelers has about €200 billion ($220 billion) in annual spending power, stays longer when travelling than other age groups, and didn’t much slow its travelling during the recession. “The millennials want something cheap, but they want it to be cool,” says Bert Crouch, a portfolio manager at Invesco, which last year paid €60 million for a 23% stake in Generator.

The hostel model typically relies on high per-room occupancy and lower costs, such as providing only light housekeeping in the shared rooms. It also counts on strong food and beverage sales. Mr. Wyatt says Generator’s average bed rate is €25 and that guests typically spend at least half that amount at the bar or restaurant or on travel items sold at the hostel.

Hostel owners say their products attract budget-minded travelers to cities they might otherwise not be able to afford. A spot in an eight-bed room at the Freehand Miami has rented on average in 2015 for about $42 a night, Freehand says. By contrast, a hotel room in Miami this year charged on average $242 a night, according to data tracker STR Inc.

Some analysts caution that the track record for these modern hostels is short and predicting the future tastes of the younger generation can be difficult. In the U.S., there could also be a perception problem to overcome, since hostels are still often associated with concerns about safety, noise and cleanliness.

“We’d be naive to think the concept will be accepted right off,” Invesco’s Mr. Crouch says. “But it won’t take long with social media for the word to spread about the experience.”

Hostels have to compete with other low-cost options, including budget hotels and home-rental companies like Airbnb Inc. Operators looking to open hostels in New York also face potential legal issues. A local law limits the number of people who aren’t traveling together that can stay in a room at the same time.

“We have the capital ready to go and a few sites in mind, but we need to be legal to be ready to operate,” says Robert Savage, spokesman for Beds & Bars, a U.K.-based hostel company that operates in 10 European cities. He says the company is avoiding the U.S. until it can start with a foothold in New York.

Not everyone is deterred. Andrew Zobler, chief executive of hotel developer Sydell Group, which owns Freehand with Yucaipa and AllianceBernstein, says he plans to open a downtown Manhattan property within three years, tweaking his formula to focus more on private rooms.

Freehand also expects to open a Los Angeles hostel in about 18 months. Mr. Zobler says he and his partners are spending $250 million on the four projects.

Generator got its start in 2007 when Patron bought hostels in London and Berlin, with part of the €40 million Patron allotted to this investment idea. The company expects to have 13 hostels open by the end of 2016, and it is looking in Los Angeles, Washington and other U.S. cities.

“It may be a few years for the U.S. to fully embrace hostels,” Mr. Wyatt says. “But there is momentum building.”

Source: Craig Karmen, Wall Street Journal