There are certain employee "perks" and protections that would not apply to a contracter, just as you mentioned. One big consideration for the business would probably be related to taxes. As a contractor they can write off your wages as expenses rather than salaries, which would save them money. There might be other tax bracket or legal requirements based on the number of people employed by the company that could make the owners not want to expand the team. Or there could be complications related to hiring foreigners, depending on where you would be working. It could just be that HR paperwork can be a royal pain in the butt that they simply aren't prepared (or qualified) to handle.
It's not necessarily a bad thing for you, though. What works against you can also work for you. As an employee, they give you a contract with their terms and you can either negotiate, sign it, or walk away. If you are an outside contractor, then you work based on a contract that you can design, and the owner can negotiate with you. You have the opportunity to specify things like your schedule, time off, what happens if you are sick, who is responsible if you get injured, how and when you will get paid, what your responsibilities will be, etc. Aside from terminating your contract (according to the terms you laid out) there isn't much that can be done to you if you don't want to do any work that falls outside of the terms of that contract. In a way, that protects you from being abused. The biggest advantage for you is your limited liability for the business. If you are not a member of the team, and specifically not a team member in an administrative position, then the weight of legal responsibility falls on the owner's shoulders, not on yours. If an inspector comes in and determines that laws have been violated, or if some terrible incident were to occur in the hostel, you wouldn't be legally liable even though you are there in a management capacity.*
*IMPORTANT NOTE: I am not a lawyer! This is intended as a discussion and should not be construed as legal advice in any way. Please check with a lawyer regarding your rights and responsibilities as a contractor in the country in which the hostel is located before entering into a contractual agreement.
Since your original post was a little while ago, have there been any advances in the story? Did you ask the owners about their motives for bringing you on as a contractor instead of an employee? Did you accept the position?