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| by: John Keeling, October 2006
There is no doubt that hotels are hot commodities today. Buyers are
coming out of the woodwork to become first time buyers of hotels. Cap rates
are lower and room revenue multipliers are higher than at any time in the
history of the hotel industry. The full-service upscale hotels are getting
most of the attention but what about the economy sector? The following
table compares the performance of economy properties with less than a $50
average room rate.
While economy hotels had difficulty keeping up with their more upscale brethren in 2001 and 2002, they recovered nicely in 2003 and tend to hover around the average for all limited service hotels. The well-managed and maintained economy hotel performs well in the market and can demand higher selling prices than in the recent past. Some institutional buyers have discovered the economy segment and are actively seeking opportunities to invest in economy hotels, although usually as portfolios rather than individual assets. The problem with individual assets for larger buyers is that their underwriting costs are rather high and they seek to spread them over more properties. Additionally, as part of a roll up, they can achieve management efficiencies by purchasing similar properties clustered in one area. But economy hotels are not easy to purchase. Not because of the lack of barriers to entry or other obvious concerns, but because of the problems created by the owners when they built, bought, or refinanced them. The biggest culprit is the conduit loan. When buyers first entered into a conduit loan, they looked very attractive. Low interest rate, no recourse to the borrower - what could be wrong with that? Plenty, as frustrated sellers are beginning to learn. Conduit loans are not unmixed blessings. They almost always come with yield maintenance requirements and even outright prohibitions against prepayment. The amounts required to terminate a conduit loan are often a significant percentage of the loan amount. Sellers often consider that the problem can be solved by having the buyer assume the loan. Seems logical until you determine that the hotel has appreciated in value and the existing loan will not cover the amount needed. The buyer either then has to come up with a disproportionate amount of equity, which rarely or even never happens, or take out a second mortgage. The difficulty with the latter case is that most lenders will not provide a second mortgage loan and those that do want a premium in interest rate to compensate them for the additional risk that they are taking. To add insult to injury, many conduit loans specifically prohibit second mortgages. Ouch! So, what is a seller to do when considering the sale of his economy hotel? First, prepare the hotel for sale. Make sure your income statements are current and accurate. If possible, they should follow the Uniform System of Accounts for the Lodging Industry. If not, they should be organized in a logical fashion. Remove any balance sheet information and debt service from your financial information unless the buyer must assume the mortgage. In that case, consider seller financing for the second to expedite the sale and maximize the price you can achieve. When preparing the property for sale, don't spend money on decoration.
You never know if the buyer has your taste - he probably doesn't. However,
go ahead and fix any mechanical or life safety issues or recently imposed
chain requirements. If you do not have the money or do not want to invest
in the hotel that you are selling, pay the franchisor to prepare a Property
Improvement Plan and have it professionally costed out. Having information
about the cost to renovate the hotel will make it easier for the potential
seller to pull the trigger.
PKF Fall 2006 Hotel Outlook forecast Based on actual through 2Q 2006 For limited-service hotels, the 2001 - 2003 industry recession was not as deep as the fall-off in performance experienced by full-service hotels, but it did last for one extra year. Looking forward, we project limited-service hotel occupancy to experience relatively strong growth and eventually exceed full-service occupancy in 2008 and 2009. However, as expectations of steadily improving performance wanes, buyers will begin to leave the market, cap rates will rise, room revenue multipliers will fall and the price you can achieve from your asset will decline as well. Of course, this is a national average and some local areas will thrive while others decline. Since economy hotels have fewer variable costs than full-service hotels, increases or decreases in performance have a disproportionate effect on the bottom line. Yes, nothing lasts forever and sellers markets will become buyers markets
if you wait long enough.
John Keeling is a Senior Vice President and Executive in Charge of the Houston office of PKF Consulting, where he works in the areas of both hotel brokerage and consulting. He can be contacted at (713) 621-5252, ext 20, or [email protected]. |
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John Keeling
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