What is the ‘micro-hospitality’ market?

While this submarket can be defined in many ways, we have identified the micro-hospitality market to include traditional dorm-style hostels, as well as both economy micro-hotels and more lifestyle-orientated brands which comprise of rooms typically under 16 square metres.

This includes pod-concept hotels, a well-established theme across certain Asia-Pacific markets, which UK-based operators have begun tapping into. Hostel operator, St Christopher’s Inns, introduced 26 ‘capsules’ to their London Bridge property in 2018, being the first of its kind in the UK, which resulted in bed rate tripling following the initial press coverage.

The sub-sector has developed dramatically over the last decade, pivoting towards ever-changing traveller preferences whilst optimising space. More recently, importance has been placed on design-led smaller format rooms (sometimes windowless) alongside more established communal spaces, often incorporating alternative amenities such as F&B, co-working or health and fitness space - with flexible usage through both the day and evening.

Ownership within this sector varies. The larger operators tend to be dominated by budget brands such as easyJet-owned easyHotel, offering a widespread UK portfolio with rooms ranging in size from c.6–14 square metres and Whitbread-backed hub by Premier Inn’s 14-strong London and Edinburgh collection.

Some newer, independent players have focused more on a lifestyle-orientated product, including Selina, which is experiencing global expansion following successful rounds of private equity-backed funding in 2018. Meanwhile, APG-backed ‘affordable luxury’ brand, citizenM also opened its fifth UK site in London Victoria in July 2022.

How has the market developed over the last decade and where are the gaps?

The traditional hostel market has been established for some time but it’s the micro-hotel segment which has driven substantial growth, with property count expanding on average by 16.4% per annum since 2012. However, this is off a low base, with the combined hostel and micro-hotel market still only representing a 3.5% share of total UK hotel properties.

Market share in larger international tourist destinations such as Edinburgh and London exceed the average, representing a 10.3% and 7.5% share of total hotel properties respectively. Meanwhile, key domestic leisure and University cities, including Brighton and Bristol, also exceed the UK average, primarily owed to a broader hostel offer.

Looking ahead, there are only eleven micro-hospitality properties in the committed pipeline to 2027, five of which are scheduled for London. Meanwhile, numerous regional cities appear particularly undersupplied by comparison. Market share in Manchester and Birmingham is just 4.6% and 3.6% respectively, pointing to substantial growth potential within the micro-hospitality market.

Despite a limited pipeline, the sector benefits from the ability to utilize existing buildings and interesting design. Room shape and size within the subsector follows a less rigid structure compared to traditional hotel layouts, which can unlock repurposing opportunities. From a sustainability angle, this has the potential to limit the embodied carbon impact by avoiding complete demolition and reconstruction of properties. For example, Zedwell (with backing from Criterion Capital) repurposed the iconic Piccadilly Trocadero building into a micro-hotel and lifestyle concept, opening over 720 rooms to the public in 2020, while a second, below-ground-level Zedwell site is currently in construction in Tottenham Court Road.

Operationally, the sector looks to be more resilient to economic headwinds than the mainstream hotel market

Data retrieved through Savills Hotel Capital Markets’ client work points to operational strength across the hostel market pre-pandemic, compared to the wider hotel sector. Average bed occupancy for a tracked hostel averaged 90.9% in the five years to February 2020, compared to 87.4% (by room) for the London North Midscale/Economy equivalent.

More recently, Hostelworld bookings in June 2022 reached 80% of equivalent 2019 levels, while group revenue surpassed pre-pandemic levels – largely driven by short-haul demand. That said, long-haul bookings improved to 75% of 2019 levels, led by strong appetite from US/Canadian travellers booking European trips, a theme that could continue in light of the strength of the dollar compared to the pound/euro. The Asia-Pacific segment has faced a slower recovery amidst later lifting of restrictions, with June bookings at 43% of usual levels.

While a rising cost of living is set to dampen general traveller demand as we move towards 2023, there are a few factors that suggest the micro-hospitality market could experience relative resilience:

• Firstly, as inflationary pressures drive up average room rates coupled with elevated airfares, consumers will be increasingly seeking cost-sensitive alternatives. We identified a price differential between a London economy-based micro-hotel compared to an equivalent budget hotel in the same area on the same date, with the former being 22.0% cheaper. A similar price differential (c.11.2%) was revealed when comparing a lifestyle-orientated micro-hotel to a traditional mid-range hotel in the same locality.

• Secondly, recent sentiment indicates ongoing travel appetite amongst younger travellers, in line with less financial responsibilities (such as children, mortgage repayments) and therefore a less negative approach to discretional spending. VisitBritain’s latest survey revealed that 53% of travellers aged 16–34 are expecting to take the same or more overseas holidays compared to pre-Covid levels, outweighing the 45% average.

From an operational perspective, the subsector benefits from generating higher profit conversion on a per square foot basis on average, owed to relatively low overheads and the ability to fit more rooms/people into a property. As a result, higher profit margins could provide a cushion when it comes to rising energy costs and wage growth, therefore the impact on revenues could be less severe than other hotel segments. In turn, this relatively stronger cashflow conversion is likely to enhance the appeal of the sector from an investment point of view.

So, is this likely to generate more investor interest?

A lack of available stock has historically limited investment in this space, however, a growing number of both hotel groups and new independent brands entering the space has begun opening more investment opportunities.

The investor pool remains varied, from owner-operators through to private equity-backed acquisitions, with the latter supported by more branded product in the market. For example, A&O Hostels (backed by TPG Real Estate Partners) acquired the Safestay Edinburgh in March 2021, while a significant share of 2022 investment volumes has been accounted for by Tristan Capital’s acquisition of the Point A portfolio in April, with the aim to double portfolio size over the medium-term.

Further platform acquisitions are likely to boost investment volume in the near term. For example, Queensgate’s transatlantic hostel business, Generator, was brought to the market in August 2022 with a price tag of around €1.5 billion.

Meanwhile, repurposing opportunities continue to exist. Melford Capital acquired London’s SoHostel in 2020, with ongoing plans to replace traditional dorms with 775 capsule beds alongside a large roof terrace.

Despite challenges facing investors in terms of inflation and rising debt costs, we expect demand for the right product within this subsector to remain resilient, driven largely by the relative profitability generated on a square foot basis coupled with more consumer appetite for cost-sensitive hotel options.