Hotel Online  Special Report

Don't Overpay For Hotel Sites
Reprint - By: Steve Rushmore, February 2002 - 
HVS International - New York

August 2006

The Canadian Lodging Outlook is a joint monthly publication 
of Smith Travel Research and HVS International, 
Vancouver and Toronto, Canada
Developing a new hotel is an exercise in balance. The cost of the land, building and furnishings must balance out with the ultimate value of the completed project. If one or more of the cost components is excessive, the entire hotel development might become unfeasible.

In a number of Asian cities, as well as Paris, London and New York, where land costs have been extremely high, it has often been difficult to justify new hotel development because the cost/feasibility balance is out of kilter.

What is meant by feasibility? To achieve economic feasibility, the hotelís value upon completion must be greater than the cost of developing the project. For example, if a 200-room hotel cost US$20-million to build, it would need a market value upon completion of more than US$20-million in order to be feasible. No developer would want to have to sell a hotel upon completion at a price less than the money expended to build it, plus a developerís profit.

The acquisition of the site is generally the first step in developing a hotel. Overpaying for land is one of the easiest ways to adversely affect the projectís overall feasibility. For example, when the land component in Hong Kong represented more than 50% of the hotel projectís cost, it should have been evident this type of improvement would not be viable.

There are ways to check to see how much a particular hotel project can afford to pay for land. The process starts with a calculation of the rooms revenue at the point in time when the hotel achieves a stabilized occupancy.

Using the 200-room hotel example described above, it was estimated that this property would have reached a stabilized occupancy of 72% with an average room rate of US$85 by its third year of operation. This calculates to a total rooms revenue of:

200 rooms x 365 days/year x 72% x US$85
= US$4,468,000 rooms revenue

The next step is to make a locational adjustment based on the desirability of the siteís location. The following percentages provide a range of locational adjustments that will then be multiplied by the projected rooms revenue:

Highway Location 3% to 4%
Suburban Location 4% to 8%
Center City Location 5% to 9%
Trophy City Location 6% to 10%

Letís assume that the subject property is situated in a good center city location and the appropriate locational adjustment is 7%. The adjusted rooms revenue would be:

US$4,468,000 x 7% = US$313,000 adjusted
rooms revenue

The land value is estimated next by dividing the adjusted rooms revenue by a percentage rate of return that generally approximates the interest rate for local hotel mortgages, In this example, the local hotel mortgage interest rates are 8%. The land value is calculated as follows:

US$313,000/.08 = US$3,900,000 land value 

If the developer is able to acquire the land at a price either equal to or below this value, then the land component is in balance. The developer should proceed with caution if the cost of land is significantly above US$3,900,000.

A rough rule of thumb for full-service hotels: Land should not comprise more than 15% to 20% of the project cost. For some limitedservice and extended-stay hotels, land can represent as much as 20% to 25% of the total cost. In this example, the land component is approximately 19% of the US$20-million cost, which is on the high side of the acceptable range.

As you can see, a hotelís rooms revenue is the deciding factor in this approach for balancing the land cost component. If a developer is faced with an out-of-balance land cost, the two logical options are to increase the number of rooms (if zoning and market conditions permit) or enhance the quality of the facilities and service so the property is able to achieve a higher average room rate (again if market conditions permit). These adjustments are evident in the Asian markets with their high land costs. There is an over abundance of 5-star hotels and practically no 2- or 3-star properties.

While location, location, location is considered one of the primary traits for a successful hotel, the economics of the land acquisition cost is an important factor that must be balanced before proceeding with a new hotel development. 


August 2006

August 2006 YTD

.© Smith Travel Research, 2005. Reproduction or quotation in whole or in part without permission is forbidden. *INS - Insufficient Data

Selina Lai
HVS International Ė Canada
2120 Queen St. East, Suite 202
Toronto, ON M42 1E2
(416) 686-2260, ext 21
(416) 686-2264 FAX

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