When you’re starting a hostel, you’ll inevitably face the question of whether to buy or lease your property. But which one is the better choice?
Let’s have a glance at what other hostel owners have to say about the topic:
It seems to be a no-brainer: Buy your property if you have the money!
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There’s gotta be more to the story, right?
If you’re new to TheHostelHelper, you might be unfamiliar with the fact that I was running my own financial consulting business before I quit in order to pursue my passion for hostels.
Hence, I know a thing or two about real estate investments. In fact, I don’t know any person who’s done more research and read more books on the topic than myself.
I am being so straight-forward here to give you a feeling for the quality of the content that is going to follow. These are first-hand insights from someone whose business was set up around enabling high-end clients to make the right decisions regarding their real estate fortunes.
Now let me set one thing straight from the start: The answer to the question of whether to buy or rent is FAR from black and white.
Hence, we’re going to take a closer look at both alternatives and compare their advantages and drawbacks. Finally, we’ll end up with different scenarios so that YOU can avoid costly mistakes when making the decision for YOUR hostel.
Alrighty, let’s dive right into it!
Buy vs. Lease A Hostel Property
I don’t know any investment form which is surrounded by so many myths like real estate.
- a) “Prices of real estate will always rise because space is finite”
- b) “Location, location, location,…”
- c) “When buying real estate you benefit greatly from rising house prices”
… only to name a few.
Especially the “do-it-yourself”-kind of dudes (like me) tend to think it’s ALWAYS better to buy than to rent. Yet the truth is, most hostels lease their place. But why? What do they know what others don’t?
Let’s start with the pros and cons of buying a property before we go over to the alternative of leasing.
Advantages Of Buying A Hostel Property
There are four major benefits when buying a property to start a hostel:
#1 Building Flexibility
Obviously, when you own the property, you’re able to do all kinds of changes to the building as long as they comply with the local building regulations and zoning laws.
- You want a new wall color? – No problem.
- More roofing is needed in the common areas? – Let’s get to work!
When you own the property, you’re the boss and you can make any changes you want.
#2 Necessity To Save
This is probably the most overlooked advantage of buying a property. Since most houses are funded, you’ll have to pay off your mortgage.
The thing is, no matter what, you’ll have to find a way to pay your bills. The pressure involved by the mere fact that your mortgage bill is rolling in generally leads to more savings overall.
I mean, who wants to be caught in the precarious situation of dealing with the threat of losing a property?
In contrast, people who lease a property often find themselves spending more on consumer goods (e.g. bigger cars, more expensive vacations, etc.) because saving is rather voluntarily.
By buying a property you’re working towards building an asset in the long run. But let me set one thing straight: the real value of your hostel business is NOT the property but a successful and profitable business model!
#3 Chance Of Increased Profits
Real estate is an investment vehicle. Hence, if you’re doing it right, you’re able to increase your overall profits by choosing the right property at the right time. More on this shortly.
#4 Freedom Associated With Ownership
Finally, we shouldn’t forget that we’re human beings – meaning BIG bags of emotions.
It just feels different to tell someone that you “own this house”, right? Surely, this shouldn’t be your primary motivation for making your decision, but it’s still a piece of the overall puzzle worth mentioning.
Owning a property comes with a sense of freedom and people like to express that.
Alright, let’s take a look at the drawbacks.
Disadvantages Of Buying A Hostel Property
There are 4 main drawbacks when it comes to buying a property to start a hostel.
#1 High Costs Upfront
Properties can be super expensive – especially when you’re looking for one in the center of a big city. Just go and try to find a property in the center of New York City or Sydney for less than 3 million bucks. Good luck.
Hence, most properties are funded via a bank loan. Nevertheless, a typical loan demands for a down payment of around 20% of the total amount you’re asking for. Depending on the type of credit, this can vary between 10% up to 40%, but 20% is the more common amount.
Let’s talk plain English. What does that mean?
If you’re opting for a property worth one million dollars, you’ll have to pay around $200.000 upfront. And this doesn’t even account for all the other (often hidden) purchasing costs which we’ll cover shortly.
That’s the reason why the decision to rent is often cut and dried if you don’t have enough equity to cover the down payment.
#2 High Risks
The actual risks are probably one of the major fallacies when it comes to investing in real estate and there are several reasons for that:
- A) The creeping development of real estate crises
A period of 15-20 years of rising house prices are not uncommon. Hence, we often tend to forget that it’s not a matter of IF the next crash comes but WHEN it will happen.
- B) There are different types of crashes
No doubt that you’ve heard about the real estate crash in 2008, right? You could read about it on each and every media channel. That’s because it’s newsworthy when there are fast and heavy changes in the market.
But what about negative developments that happen rather slowly over a long period of time. These kinds of news hardly lead to high click-rates. Hence, we’re often unaware of the fact that our properties lost 20% of their value over the past 15 years.
Furthermore, no one is going to tell you the value of your property! You cannot just login on a website and check the house price for a single day in a way that you can do for stocks, bonds, etc.
- C) Risk of concentration
If you’re building a reasonable portfolio of stocks, what are the two main rules to follow?
- #1 Diversify, diversify, diversify
- #2 See rule #1
And what are you doing when purchasing ONE property in ONE Location? – The exact opposite.
When buying a single property you’re putting all your eggs in one basket. Hence, you’re completely dependent upon how the market develops in your specific location. And that’s not something you have any influence upon.
99% of the global real estate market could be booming, but if you belong to the other 1%, you’re toast.
- D) Risk of future business changes
Imagine you started a hostel and realize after two years that your real passion is something different. Your hostel business could be stopped in an instant but selling your property not only takes plenty of time, it also comes with high transaction costs.
Owning a property can become a millstone around your neck!
- E) Risk of lower house prices
Between 1970 to 2014, the average maximum loss in real estate prices was -36% throughout the following 14 countries: USA, Germany, Norway, Japan, Swiss, UK, Sweden, South Africa, Netherlands, Belgium, France, Italy, Ireland, Denmark. [Source]
That means there was at least one day in this period when the value of your property lost about ⅓ of its initial price.
The lowest maximum loss during this period was -19% in France, the upper limit could be found in Ireland, with -52%. [Source] Hence, even if you bought a property in the country with the lowest risk, there would’ve still been a point at which your property had lost 19% of its value!
And there is no other way to assess risks other than to look at past performances.
I’d love to show you the graphs printed in a German book called “Kaufen oder Mieten” (Engl. “Buy or Lease”) but I don’t have the right to do so which brings me to the next point.
- F) Lack of past data
If you research stock prices, you’ll easily find various sources that show the developments over the last 100 years. It’s often even printed in school books… but trying to find the same data for the real estate market?
If you’re lucky, you’re able to find data for the past 10-20 years but that’s still too short of a period to be able to assess the actual risks. Furthermore, you gotta be super careful who’s providing the information, because…
- G) You find many black sheep in the finance industry
If I learned ONE THING while working as a financial consultant, it’s that the finance industry is littered with dishonest and unethical people. I don’t exaggerate when I say that I met the most disgusting people ever during this time.
The problem is, most financial advisors are rather salesmen than consultants. They only make money if they sell you something (e.g. a property). Hence, they tend to show you wonderful graphs that imply great potential and massive past development.
In reality, these graphs often show the best of the best times and neglect various other factors like costs, inflation, etc. Hence, you either have to be an expert yourself OR need someone that you can truly trust.
- H) Possible occurrences
Ever heard the sentence “life’s a bitch”? – Well, the same holds true when it comes to your property: Shit happens.
When owning your own property, you’re 100% responsible and liable for it. Therefore, if any natural catastrophes happen, you’ll have to deal with it.
Furthermore, you’ll be 100% liable for the health and safety of your guests. Without choosing the right insurances, you can easily get smashed by costly lawsuits.
- I) Risk of changing interest rates
This risk is the reason why millions of people lost their homes. If you’re planning to pay your debt back over a long period of time without having a fixed interest rate in your contract, you can experience a massive hit through growing interest rates.
A seemingly low rise from formerly 1% to now 2% means you’ll have to bear double the amount of interest expenses over several years.
- J) Risk of changing tax laws
Right now, owning real estate is government-funded by tax benefits. But who knows how this is going to look like in 10, 20, or 30 years?
- k) …
You got it, right?
This list could easily be turned into a textbook but the purpose of this article is NOT to train you to become a consultant. My primary goal is to educate you to the point that you’re able to make the right decision for YOU and YOUR hostel. No more, no less.
#3 Low Average Return
For sure, there are exceptions of people who absolutely crushed it with their real estate investment. But the sad truth is, most people achieve only a small return on their investment when purchasing a property.
In point of fact, the average interest rate AFTER inflation from 1970 to 2014 across the 14 countries mentioned above was a disillusioning 0.87% p.a. [Source]
“That can’t be true!” – you might be thinking… and I felt the same. These stats hit me like a sledgehammer.
Again, I’d love to refer to an English-speaking website to give you access to all these stats but there’s none available! Just have a look yourself!
So, why do so few people know this sad truth? – Well, there are three primary reasons for that:
- 1) We underestimate or neglect inflation
Inflation is the rise of the general price levels over time. Hence, you will need more money to buy the same goods in the future compared to today.
Just think about the price of a scoop of your favorite ice cream when you were little and compare it to today’s prize. That’s inflation at work.
Let’s look at a quick example:
Let’s say you bought a house in Germany for $200.000 and sold it 25 years later for $250.000. What’s your first thought when you look at these numbers?
You might think: “Wow! That’s a profit of $50.000! That’s awesome!”
Well, if you do the math it would mean that your property gained $2000 every year in value. That’s about 0.9% p.a. (before inflation).
During this time, the average inflation in Germany was 1.8% per year. Hence, you actually lost -0.9% every year and in total, you made a loss of $18.900 (without taking into account all the costs incurred).
This is called a “phantom profit”: it looks like you won big-time when in reality inflation led you down the garden path.
- 2) Various & high hidden costs
In point of fact, no other common investment vehicle comes with such a variety of costs than real estate. You’ll have to bear costs in every stage of the process:
- a) BEFORE buying a property: Paying professionals for assessing properties, down payment for the loan, etc.
- b) DURING a property purchase: a ton of different transaction costs (4-10% of the property value), etc.
- c) WHILE owning a property: maintenance costs (~2% of the property value p.a.), loan rates, insurances, etc.
- d) DURING a property sale: transaction costs, etc.
It’s a common experience among new house owners to be surprised by the amount of unexpected incoming invoices.
- 3) Our simplicity
Calculating the real profit after taxes and inflation of a stock portfolio is already very time-consuming and complex. But doing the same for a property is freaking difficult.
And I’m telling you this as someone who
- a) holds master’s degree in Engineering,
- b) has been a tutor for physics and higher mathematics
- c) codes excel-calculations and loves to juggle with equations in his spare time, and
- d) intensively studied financial analytics over years.
As a consequence of the sheer complexity, many people tend to oversimplify the matter. This is an example I found researching the topic:
Profit Of Real Estate Investment = Sales Price – Purchase Price
It drives me nuts to read such BS! It completely neglects all the costs mentioned above not to mention taxes and inflation. That can put people in worse positions than blindfolded monkeys throwing darts.
#4 High Opportunity Costs
Opportunity costs are the costs incurred by not enjoying the benefit associated with an alternative choice. [Source] In other words: Instead of spending your time and money on real estate, you could invest it elsewhere.
Let’s take a closer look at both factors:
- a) Opportunity Costs Timewise
Buying a property should take you much longer than leasing one due to the high risks involved. This is not a topic where you want to make hasty judgments.
Nate Bunger, manager of the “Casa Miraflores” hostel and author of “How to Start a Thriving Hostel and Retire in Paradise” (recommended read), is the paragon of it.
He spent two years traveling through Colombia and visited more than 100 properties until he opted for one. In his book, he recommends doing the same to really get a feeling for the market and its prices.
2 YEARS! HOLY COW!
Imagine what you could have done in two freaking years!! That’s insane. And he even came from the real estate industry, i.e. he knew what he was doing!
Furthermore, you’ll have to write a proper business plan for your hostel to obtain funding.
While I definitely recommend writing a business plan regardless of whether you need a loan or not, one that is written for funding is quite different than a private business plan. This will likely take up some additional weeks of time.
Yet, the sad reality is that the above examples only took the BEFORE stage into account. However, the buying-, owning-, and selling-stage will also be way more time-consuming.
Since you’re responsible for everything, you’ll be the one in the trenches. As a consequence, many hostel owners don’t want to deal with the hassle of owning.
- b) Financial Opportunity Costs
Instead of chucking all your money on the down payment and the accompanying costs, you could also invest in other things such as stocks or bonds.
In fact, a well-diversified portfolio of stocks is typically much more likely to generate a higher return on investment over a long period of time. [Source]
Hey, you made it! 🙂 If you’ve read up to here, you already know more about real estate than 98% of other people. That’s awesome!
Let’s summarize that quickly:
- Building Flexibility
- Necessity To Save
- Chance Of Increased Profits
- Freedom Associated With Ownership
- High Costs Upfront
- High Risks
- Low Average Return
- High Opportunity Costs
Okay, now it’s time to get into the nuts and bolts when it comes to the second alternative: leasing a property.
Advantages Of Leasing A Hostel Property
I’m going to break it down to the basics. Promise.
The benefits of leasing are pretty much the opposite of all the drawbacks associated with buying a property:
#1 Lower Risk
If you lease a property, you’re only making a short-term financial commitment. Hence, the risks involved are way lower than buying a property!
Typical leasing periods range from 12 months up to 10 years. However, 3-5 years are the most common time frames when it comes to lodging facilities.
If you notice during this time that another location would’ve been better or your business is not as profitable as planned, you could easily leave the property after the period without huge financial consequences.
#2 Higher Likelihood To Find A Good Location
Typically, it’s easier to find a prime location when you lease a building. Since property prices can come with a huge price tag attached, it often limits the variety of eligible properties when you intend to buy one.
That said, a good location is NOT the primary goal of your hostel. It is – and will always be – maximum profitability.
We’ve already busted the myth “location, location, location,…” in my blog post about how to choose the best location for your hostel if you need further insights here.
#3 Tax Benefits
Both buying and renting entail tax benefits. That said, tax laws are different from country to country. However, in most areas the same principles apply:
If you buy a property, you cannot deduct the full monthly loan payment but only the interest expense of it! You also can’t deduct mortgage-related costs such as origination fees, closing costs, etc.
In contrast, if you lease a property, you’re able to deduct the entire monthly payment. Hence, there are more tax benefits associated with leasing than buying commercial real estate.
Since you don’t have to pay a big lump sum for the down payment, you’ll probably enjoy a higher level of liquidity. This is super helpful at the very start of your business since you don’t know for sure if it’s going to work out the way you planned.
Furthermore, it can be a nice add-on if your landlord has already established a good relationship with the neighbors. Several lodging facilities went out of business or had to close their facility due to having a neighborhood that didn’t want them in their area.
A good relationship with your neighbors becomes especially important when your hostel is in an apartment building rather than a separate house.
Disadvantages Of Leasing A Hostel Property
There are 2 major drawbacks when it comes to leasing your property. Let’s start with the most impactful one.
#1 Less Control Over The Building
Since you don’t own the property yourself, you’re at the whim of your landlord respectively lessor.
Let me be clear about one thing: If you lease your hostel property, you gotta have a great relationship with the owner! That’s an absolute must-have! If he’s a jerk, your life will be hell. No kidding.
The thing is, your options when it comes to design and facilities are restricted by the fact that it’s not your own building. If you ask your landlord about certain renovations, he might agree, but every single dollar you invest in renovating the building is a dollar you spend on somebody else’s house.
Hence, this is only recommended if you really intend to stay there for a longer time. Otherwise, I suggest you keep it simple and make as little changes as possible when other people’s belongings are concerned.
#2 Rising Leasing Rates
Loan payments are typically fixed depending on the model you chose to pay off your debt. However, if you rent a place, the prices are likely to increase over time. Your leasing rates could also be fixed for a certain time but after the first period, the odds are high that they will be higher for the next one.
And this is something you should expect! In fact, the prices HAVE TO increase over time to compensate for inflation.
Having said that, no worries, this price increase is still lower than the average rise in your income! [Source] So yes, you’ll have to pay a slightly increasing lease but you’ll also make more money in that same time frame.
Lastly, some people claim that its a huge disadvantage to not be participating in increasing property prices. However, you’ve seen at what costs this factor comes. Furthermore, you could also invest your money somewhere else and receive a positive return on investment.
Let’s summarize that quickly:
- Lower Risk
- Higher Likelihood To Find A Good Location
- Tax Benefits
- Less Control Over The Building
- Rising Leasing Rates
We already went through all the advantages and drawbacks of buying and renting. Let’s take a look at another piece of the puzzle.
Hostel Business vs. Real Estate Business
Imagine your best bud calls you and tells you about his great business idea:
He wants to start a jewelry company that produces fancy accessories for old women. Since he will need some gold for production, he made research on the topic.
Thousands of people seem to crush it with gold trading. Hence, he also wants to invest extra money in gold in addition to starting his jewelry company. He figured that he could maximize his investments by using other people’s money as well. Thus, he wants to apply for a bank loan to fund his gold investment.
Now, what would YOU say if your best friend tells you about these plans?
Well, here are the two voices that would most certainly immediately pop up in MY own mind:
1) The entrepreneur inside me:
- “That’s awesome! You have a dream? Then go for it!”
2) The best friend inside me:
- “Dude,… that sounds great but don’t you think it’s a bit too risky? It might be better to do one after the other, don’t you think? I mean, if one thing works out you could still add to it later on… the risk in the beginning would be dramatically lower and you could focus all your attention on one thing.”
Now guess what:
In other words: A hostel business and real estate investments are two completely different businesses that demand special expertise, and a lot of time and effort to master it!
By doing both at the same time you increase your overall risks EXPONENTIALLY! And that’s not what any smart entrepreneur would want.
Let’s look at an example to make sure you fully understand:
Josh started a hostel and bought his property on credit. He struggled throughout the first 2 years to build a profitable hostel and barely broke even. In the following three 3 years, he made an average profit of $100.000 per year.
Hence, his overall profits in the first 5 years of running his hostel were $300.000.
The property he bought is located in a great area and cost $1.000.000. The thing is, he noticed too late that the real estate market was already in a huge housing bubble which burst 2 years after he bought the property.
The market hasn’t recovered ever since and his property lost 35% in value, i.e. has a market value of $650.000.
Now let’s apply cowboy math:
$300.000 profits from the hostel business – $350.000 from his real estate investment = -$50.000 overall loss
In other words: All the thousands of hours he spent on building his hostel were not only worthless, they actually yield to an overall loss of $50.000!
And this simple calculation doesn’t include any additional costs, taxes, or inflation.
And the sad truth is: there are so many hostel owners out there who experience this scenario and aren’t even aware of it because NO ONE WILL EVER ring their doorbell to tell them how much their property is actually worth!
Hence, I was glad to see one particular message on Hostelmanagement’s forum:
The following video is super basic but it makes one thing very clear:
Buying a property should only be considered once you’re running an established, successful business!
Running a successful hostel business and operating a successful real estate business are two COMPLETELY different cups of teas. Mastering both areas at the same time is a skill that only a few people are able to do.
Hence, my recommendation for 95% of hostel owners is to lease their property instead of buying it!
P.S. I’ll explain the remaining 5% of exceptions later on.
Up to here, we’ve used “renting” and “leasing” synonymously. However, in reality, I was always referring to a leasing model. Let’s explore what the differences are and how you can get the best deal for your hostel.
Rent vs. Lease A Hostel Property
Among others, there are 5 major differences between renting and leasing a property:
#1 Technical terms of parties
- In rental contracts, we’re talking about “landlords” and “tenants”
- In leasing contracts, we’re talking about “lessors” and “lessees”
- In rental contracts, we’re typically talking about short-term agreements
- In leasing contracts, we’re typically talking about long-term agreements
#3 Contract form
- In rental contracts, we’re talking about agreements that both parties can change anytime
- In leasing contracts, we’re talking about contracts that are fixed for a certain period of time (e.g. 3-10 years)
- In rental contracts, the landlord is typically responsible for the maintenance of the building
- In leasing contracts, the lessee (=you) is typically responsible for the maintenance of the building
- In rental contracts, there’s no buying-option included
- In leasing contracts, there’s a buying-option for the property for a predetermined price and typically set towards the end of the leasing period
When starting a hostel, you want to lease a property instead of renting it.
The same holds true for any other business activities: Hotels, B&Bs, restaurants, retail stores, etc.
That way you have the certainty of a fixed contract that cannot be changed over quite some time. This prevents you from getting kicked out in the middle of your operations.
5 Tips For Leasing Your Hostel
Here’s a collection of additional tips for leasing your property to start a hostel:
#1 Aim for a 3-year contract (min. 2 / max. 5 years)
Steer away from leasing contracts that are longer than 5-year timeframes for your very first hostel. I recommend a period of 3 years.
This is enough time to build a complete and successful business model but also not too long in case it doesn’t work out the way you planned.
If you’re already in business and it’s working, great, there’s nothing wrong with choosing 10-year contracts!
#2 Negotiate the terms and conditions
Oftentimes you’ll find properties that don’t offer a leasing contract. That does NOT mean that it’s not possible to lease the building!
The owners are often unaware of the opportunity. Hence, I recommend you talk to them personally. If you’re in contact with a realtor, insist on the owner’s contact details and be stubborn until you have them.
Realtors are seldom motivated to organize a great leasing deal since they only get paid for a successful transaction.
By the way: Since “hostel” is often negatively associated, it might be useful to start the conversation with “B&B” and then later add that the business model is turning more towards that of a “hostel, and you know,… suddenly you are one”. 😉
Also, don’t take “no” for an answer. It’s ALWAYS – without exception – a matter of “what would have to happen…”
That said, there will come a point when you want to include professionals which leads me to the next point.
#3 Don’t close a leasing contract without a lawyer
Even if you have a good relationship with the owner, you don’t want to risk your business due to room for interpretation throughout the terms and conditions of your leasing contract.
It has to be written in a formal and legally valid manner. All jokes aside!
#4 Study the terms and conditions
This is the part that many lessees skip. However, you want to make sure you know EXACTLY who’s responsible for all the different aspects of your property:
- Who’s responsible for snow removal?
- Who’s responsible for lawn cutting and landscaping?
- Who’s responsible for insurances, utilities,… etc.?
Grab the biggest mug of coffee you can find and spend one afternoon on the actual contract. Make notes and ask in case you need further clarification.
This time investment is well worth it and can save you thousands of dollars as well as time in the future.
#5 Think twice before buying the property
Again, profitable real estate investing is very different from operating a hostel business. You either need to be a real estate expert to make such a decision OR you have to hire experts that will help you out.
But don’t just think that your profitable hostel business model is your guarantee to buy the property!
Read that again.
Hey, congratulations! I’m impressed. You made it to the end 🙂
Now, let’s quickly summarize the main points.
Bottom Line: Buy vs. Lease vs. Rent A Hostel
As we went through the pros and cons of buying a property, we saw that it entails a huuuge list of drawbacks compared to leasing a property.
The fact that running a hostel and investing in real estate are two completely different businesses explains why the overall risks doing both increase exponentially.
When starting a hostel, 95% of hostel owners will be better off leasing the property instead of buying it.
The exceptional 5% are people who’ve either worked in the real estate industry or gained serious knowledge about it BEFORE they decided to run a hostel.
Stay away from renting contracts and go for a leasing contract that will leave you home and dry for a fixed period of time.
DISCLAIMER: The above information is for informational and educational purposes only. It does not constitute financial, tax or legal advice and does not establish any kind of financial-client relationship with me. The information provided has been prepared without taking into account your objectives, financial situation or needs. Before acting on the advice, you should consider its appropriateness for your situation. I am not liable or responsible for any damages resulting from or related to your use of this information. Read my full disclaimer here.
Before you leave: Answer this quick question and help our community.
What did YOU decide upon: Buying or leasing?
Share your opinion in the comment section below!