Backpack to the Future

Once derided as dirty, dangerous dosshouses, a new breed of hostel is fast emerging as the latest hot asset class

Overcrowded dormitories, questionable cleanliness and sleeping with your backpack clutched to your chest. For a traveller, staying in a hostel often means having to forgo even the smallest of luxuries just to ensure a cheap night’s sleep.

Despite their sometimes dubious reputation, hostels are undergoing a revival that is being billed as the birth of a “revolutionary” new asset class for the property industry.

“The hostel market is where the boutique hotel market was 30 years ago,” says Keith Breslauer, founder and managing director of Patron Capital, the investment company that has just committed €125m to creating seven new hostels in Europe.

“Ian Schrager and Steve Rubell created Morgans hotel in New York in 1985, and at the same time created a new asset class: the world of boutique living. That is where hostels are today – a revolution which, in the next five to 10 years, will be accepted as the mainstream.”

Patron bought family-run hostel chain Generator in August 2007 and is expanding it from an 1,800-bed operation in London and Berlin, into one of the largest private hostel brands in Europe. It aims to have 4,500 beds by early 2012.

The almost €125m of equity Patron has already put into developing Generator’s portfolio comes from its Patron Fund III. It anticipates committing at least €125m more this year, making it the single largest investment out of the €1.7bn of equity Patron has under management. The first hostel of its expansion plan will open in Dublin in May, followed by Copenhagen in June and Hamburg in October.

Patron has an extensive expansion and acquisition plan, and wants to follow a business model akin to the world’s largest luxury goods company, LVMH, which owns brands such as Louis Vuitton, Christian Dior and Moët & Chandon.

The idea may seem grand for a sector only at the beginning of its life but Patron is not alone.

Beds & Bars operates St Christopher’s Inns, which has 18 hostels in Europe. Run by group managing director Keith Knowles and chairman Tim Sykes, and backed by a mix of equity and private investors, the chain will open a 600-bed second hostel in Paris in September. A 400-bed hostel in Barcelona will follow in 2012.

Another operator, Journeys, aims to open 15 hostels throughout the UK in 2011 by converting disused buildings. Developer D’Rui Group, run by Dean D’Eye, renovates the buildings and then seeks franchise partners to run the hostels, many of which occupy redundant pubs, retaining a bar below with bedrooms above. Struggling landlords take note.

Break with tradition

Hostels have never been a traditional investment for property investors. Many are run as small-scale independent or family operations with minimum investment, which allows overheads and customer charges to be kept low – sometimes as little as £8 a night. Without a large portfolio behind them, investors have often shunned hostels in favour of more promising assets in the hospitality sector, such as hotels.

More recently, however, this has changed, as Josh Wyatt, Patron Capital’s director of leisure and hospitality explains.

“The recession has allowed the sector to come into its own right. Right now you have a bunch of buildings that are vacant and very difficult to develop. While the residential market is what most developers turn to when offices and retail projects fail, that is not possible at the moment as housebuilding is at an all-time low. Hostels present an alternative use that is compelling.”

Sykes agrees: “The sector does not have a lot of competition and investors are finally able to see viable potential in hostels in today’s market.”

The likes of Breslauer and Wyatt at Patron and Sykes at St Christopher’s Inns are not recreating the cramped and low-quality hostels of the past, however. Although the tradition of shared dormitories is maintained in their hostels, what differentiates them are services such as free breakfasts, laundry services, “chill-out” lounges, internet cafes and city walking tours.

Generator, for example, places significant emphasis on fun, reflected through its exclusive events for residents – from Hawaiian-themed nights to karaoke contests, which are held at the bars and clubs incorporated into its hostels. It has reinvented the female-only dorm concept with dressing room-style mirrors to offer a “girls’ night in” experience, complete with free movies.

Private bedrooms are available at St Christopher’s Inns’ hostels and its trademark and often raucous Belushi’s bars are a way for its guests to drink with the locals. Perhaps most significantly, the services are all included in the price, which can be as little as £12 a night.

“The hostel customer is very savvy today,” says Wyatt. “Most of the people walking into a Generator or St Christopher’s Inn are using iPads and iPhones, sharing information on social media. Whether they are our target customer of 18-to-32-year-olds, or a couple in their fifties looking for a cheap stay, they expect more from a branded hostel. It is not about chocolate box beds with no personality, so it is no longer ok for an operator to go to Ikea and buy a bunch of cheap makeshift beds.”

All Generator’s furniture is custom made. “We have hired very well-known designers, such as those that work on the designs at the Four Season and Kingdom hotels, for all of our sites,” says Wyatt, who adds that every Generator hostel is also regionally specific. Its hostel in Hamburg for example, will be in the St Pauli district that was home to the Beatles in the early stages of their career. The designer, therefore will reflect this history in the building’s interior. It is estimated such fit-outs can cost up to £5m.

Room buddies

Although many hostels operate on a small scale – 200 beds or less – Patron seeks only sites of up to 100,000 sq ft in prime city centre locations. It will lease or buy – but only with planning permission. Hostel developments fall under the same planning laws as hotels and Generator specifically searches for the “big box” formats, which makes developing and running the hostel more cost effective. St Christopher’s Inns works on a similar model and, like Generator, relies on local development partners in Europe to secure sites.

Local developers are more keen to work with the likes of Patron because of the significant investment it has already made into the sector, claims Wyatt, and more so because it is equity rich. Patron’s equity in Generator is geared at around 17% and its third fund, which closed at €867m in June 2007 before the global downturn, still has significant investment capacity. Similarly, St Christopher’s Inns is backed by several private investors.

“We don’t have to go around raising money if we see a new site we like, as we have the equity ready,” says Wyatt. “Moreover, working for Patron means I have access to more than 5,000 assets across Europe. So when we work with Benjamin West, a purchasing agent in Europe for the likes of Blackstone, he is not just liaising with us on our hostels project, but with Patron and the €19bn of assets we bid on in 2010. We get a great purchasing power through our scale.”

Tiers before bedtime

Despite the substantial investment programme these operators have embarked on, the sector is not without its risks as a new investment asset class. Generator and St Christopher’s Inns biggest competition remains the independent operators, many of whom do not operate to the standards of Patron and St Christopher’s Inns.

A two-tier branded and unbranded market is beginning to emerge. They both also have to contend with the power of the internet, which allows many hostels to offer much more compelling rates to customers in seconds.

“It is an industry with a lot of independents that cut a lot of corners and that is a risk for the industry,” says Wyatt.

“But finally those that have been in business for a while know what they are doing and run good operations are beginning to outweigh those that don’t. The challenge for the industry now is to continue to put up investment to open a new, high-quality brand of hostels that will reinvigorate the sector.”

(Source: http://bit.ly/hLTmVE)