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Rebuilding Value: Hotel Investors and Operators are Shifting Attitudes
from Value Preservation to Value Enhancement

By Bryan E. Younge, MAI, ASA
July 2010

Within the real estate arena, lodging investors were among those thrown furthest and hardest from a fast-moving train. Still tumbling, these professionals intend to soon stand up, dust off and find other means of locomotion. Hotel investors are entering mid-year 2010 with the hope that the values of their real estate holdings will sustain prolonged and prolific improvement. Over the past several months, the uncertainty of the longevity of the ongoing financial crisis has abated considerably, and elements of a sustained economic recovery are, one-by-one, emerging. And while many industry professionals are weary of being over-educated about how badly the hospitality sector has fared in the past 18 months, there will still be a number of non-obvious issues to overcome. 

…there has been a shift in attitude and focus that the cost containment measures will soon no longer be value salvaging, but value enhancing.

On an obvious note, however, hotel values across the world plummeted from the peak reached in 2007. Many hotel real estate properties and investment vehicles succumbed to severe demand attrition, double-whammied by a collapse in ADR integrity. Recent catastrophes such as the great Nashville flood and the Gulf oil crisis could be the backbreaking straw for a number of markets. Further, economic barriers to entry were ineffective just long enough for new supply to contribute to dilution, and compression from convention activity (which typically lags 12 to 18 months in top-tier markets) has dissolved considerably. Hotel values for branded properties throughout the U.S. have plummeted anywhere from 30 to 50 percent, on average, from the 2007 peak, and three-quarters of the decline occurred in 2009 alone.

On a less obvious note, significant and astute adjustments by competent asset and/or property managers over this time period mitigated value losses considerably. In fact, their heads-up actions likely salvaged a larger percentage of net asset value than nearly every other major asset class during the financial crisis. Owning largely to these moves, hotel investors and managers are well poised to actually control elements of value recuperation in the early part of the new decade. In order to do so, they will have to maintain operational leanness, protect competitive positioning, and increase non-rooms departmental income.

Maintaining Operational Leanness

Hotels are both asset and labor-intensive enterprises; they require endless maintenance, management, service and marketing efforts. There is no question that operational efficiency was one of (or simply, the) most attended-to pressure point in the past two years. In an effort to survive the recent economic turmoil, hotels were characteristically leanly staffed, minimally manicured and in some cases, completely reorganized or repositioned downward. These changes were meant to be temporary, and if and when the market posted a rebound, they would eventually be methodically phased out. While some assets were ravaged by all of the operational adjustments that were voluntarily or involuntarily implemented, the well-managed properties that have survived the downturn are now in a position to prioritize and re-implement certain strategies in the rebooting process. 

Managers today ought to be well seasoned in identifying fat-trimming opportunities. Certainly by now, most of the cost management initiatives are in effect and have been for some time. Recently, however, there has been a shift in attitude and focus that the cost containment measures will soon no longer be value salvaging, but value enhancing. For instance, non-union hotels are being staffed from a competitive and swollen labor pool with individuals who are well trained and well educated, but come cheaply. Properly staffed and balanced hotels will be operated by a team of talented and eager professionals that are willing and able to wear multiple hats. For example, concierge employees more often are overlapping as bellstaff, housekeepers are learning how to contribute to maintenance tasks most often handled by outsourced engineers, and MODs at limited or select-service properties can be seen working the front desk, performing a night audit or even assisting in housekeeping, accounting, or marketing efforts. This all serves to decrease the number of full-time employees, cut costs and increase net income.

Sustainability and LEED initiatives are proliferating throughout the industry. The irony is that a large portion of these programs were initially designed to be part of newly-constructed hotels to help them better compete in quickly expanding markets. Now that supply growth is stymied, many initiatives have been re-tasked for retrofit within existing properties. The challenge has been to develop sustainability products (which are for the most part significantly more expensive than conventional ones) and prove that there will be a full recovery of the cost of each item in a more condensed time period. Popular sustainability items include energy efficient light bulbs, efficient HVAC systems and motion sensitive lighting systems. LEED efforts are making progress, although managers continue to admit that, unless there are clear monetary benefits, whether via lower utility bills or tax incentives, there is limited ambition to implement these potentially costly initiatives. However, this is becoming an increasingly rare case as the costs of these initiatives are relatively low.

For newly constructed properties, designs involving LEED and sustainability items are easier and more feasible to incorporate. In the early 2000s, developing a structure with energy-efficient materials and systems seen in LEED-certified or equivalent hotels of present could cost as much as 10 percent more than a traditional prototype, depending on the brand, location and size of the guestrooms or public space. Owners of smaller developments found that such designs would rarely pencil adequately. Yet in recent years, particularly with the increased awareness of global warming, the demand for sustainability products and designs has increased considerably. Most of the major hotel companies have spawned hotel brands that specifically identify themselves as “green,” including Element, NYLO, and 1 Hotels and Resorts. 

Various existing brands that do not specifically identify themselves as LEED certified are making strides to improve sustainability. While there is yet to be a demonstrated improvement in top-line fundamentals from this type of concept, the bottom lines are certainly benefiting. According to Donald Griner, AIA, LEED AP of Choice, the incremental cost to develop a meaningful energy-efficient asset is now within eight or ten percent of traditional hotel designs. The approximate cost recovery for all of the “green” designs incorporated into a project is now less than four years, well within a conventional investment holding and payback period and more palatable for investors and potential lenders. Even classic brands that are not typically associated with high sustainability marks are constructed using green roof designs and/or air conditioned from off-premise district cooling systems.

After every visible stone has been turned over and every strip of fat has been trimmed, managers have looked outward to entities such as suppliers and service providers to renegotiate service terms. Of course, many suppliers and providers reserved the right to lean on contract law and enforce existing terms, but this position could actually have been detrimental to both parties. Negotiations that were successful may have been tilted to the benefit of the hotel operator, but in the long run the majority of the parties involved should benefit. There is quite a long list of services, products and other items of which hotel managers have focused renegotiations, but the most common in recently-conducted interviews have included premium TV programs, outsourced maintenance and housekeeping, dry and perishable food, property insurance, franchise fees in the form of abatements, employee insurance and benefits, and in some cases even utility units such as steam, telephone and natural gas. 

According to Joe Smurdon, Executive Managing Director of Cushman & Wakefield’s Valuation & Advisory Services Group, “there are substantial opportunities for owners of commercial real estate to lower operating costs in this economic climate, particularly with labor-intensive sectors such as hospitality. Even though it may seem that every possible leak has been patched, there could be additional means of containing costs by way of recognizing the competitive nature of a firm’s service providers and contract holders. Now is the time to renegotiate and restructure in ways that allow all parties to benefit. We have employed a series of cost containment strategies that have helped our clients reduce expenses in a number of areas and significantly improve cash flow on a short and long term basis.” 

While it is clear that cost containment efforts were at the top of the list of priorities for managers of hotel properties over the past few years, simply trimming the fat may not have been enough to survive. By closely studying the expense structure of an operation, one may have been able to identify a number of non-obvious solutions to help seal the major leaks. If performed well enough, such efforts to identify operational leanness may have even rendered positive returns to the property owner.

Protecting Competitive Positioning

New supply additions in the U.S. market have slowed considerably in the past 18 months. Although there were signals of an economic slowdown and related capital scarcity in late 2007, the over-exuberance of hotel owners and developers allowed for significant capital to be funneled into development projects even when they were only marginally feasible. A large percentage of the projects that made it into the planning pipeline prior to the financial crisis that commenced in October 2008 were started. The strength of the financial wherewithal of the developers (versus the direct feasibility of the project) often decided whether or not their properties ultimately came to fruition. Projects of all scopes ended up hemorrhaging well into the construction process and sit unfinished, waiting for the right time and an infusion of cash to restart.

As a result, developers and providers of capital are extraordinarily cautious when considering development projects. While virtually non-existent until recent months, capital sources insist on some level of control over the process. The current state of the supply pipeline includes primarily proven, or “safe” brands and prototypes that consistently penetrate the market strongly in terms of RevPAR. Furthermore, these assets could up-compete with existing properties (i.e. new limited-service hotels compete with existing select-service ones, new select-service properties compete with full-service or even first-class hotels, etc.) in terms of rate positioning. Not to mention, the product improvement plans of virtually every major brand has recently become more stringent. Therefore, existing hotels must recognize that new supply additions in the future will be of higher quality, and each such newly-constructed property will have a stronger set of competitive strengths and that measures must be taken now to prepare for this increased competitiveness.

In general, the new hotel construction projects, particularly those located in urban cores, are beginning to heed to the ultra efficiency trend. Perceived savings in operating costs may thus be capitalized in a way that encourages the developer to provide higher levels of finishes and amenities that (say for a mid-rate or upscale asset) approach those seen in higher-rated properties. One aspect of the recent (and, in some markets, still ongoing) downcycle is that hotel guests have been conditioned to accept lower levels of personalized service. As previously discussed, since average rates have plummeted across the country, hotels were in many cases forced to reduce services and personnel to salvage operating profits or minimize deficits. By dropping rates so drastically, hotels forfeited room rate integrity. According to Smith Travel Research, ADR dropped 8.5 percent for all surveyed hotels in the United States in 2009 while demand still dropped nearly six percent. In some markets, ADR spiraled by more than 20 percent. We note that the largest percentage drops were caused by existing properties attempting to capture demand from lower-rated properties. However, the waterfall effect of aggressive downward rate positioning has caused the middle market to swell with inventory and a larger array of options for budget-minded travelers. This attrition in rate potential has caused some property values to drop up to 50 percent or more. 

While such a decline was never welcomed by owners, it will serve as a solid backstop for new investors to acquire properties at a basis well below replacement cost. In fact, a turnaround in lodging fundamentals appears to be shaping quickly. Smith Travel Research reports that ADR declines through the first few months of 2010 has tapered to less than negative four percent, and demand posted a solid increase of more than four percent compared to the same period in the previous year. 

Although there is still much uncertainty of which to be cognizant, managers are recognizing the importance of shifting towards an attitude of value enhancement as the worst appears to have passed. As the economy rebounds over the next several quarters and hopefully as these hotels maintain sufficient quality standards, careful rate management (as evidenced by the decline in ADR despite demand growth in the first quarter of 2010) will serve to be a strong barrier to entry for new construction, particularly in the middle-rate markets. Strengthening existing assets’ competitive position in its market will be crucial while enduring the remnants of the recent economic downturn; more importantly, it will help stave off the negative effects of new supply additions in the near future.

Increasing Departmental Income

There has been a strong proliferation in the past ten years of new hotel brands and concepts that has not been seen in more than a generation, primarily as part of an objective to expand income potential from operating departments other than rooms. Marriott pioneered the focused/select-service market in the 1990s with its Courtyard prototype. It was answered shortly thereafter by Hilton Garden Inn and a handful of other regional flags. Perhaps the most prominent spawning of recent years was Hyatt Place, an upscale focused-service concept that offers a swanky yet professional experience with a concentrated food and beverage program. Prior to this launch, Hyatt was regarded as a large-box player, limiting its products primarily to convention and resort-oriented superstructures with a predictable guest service program. Hyatt Place properties are less than 130 units on average per property but aim to satisfy the needs of those business travelers accustomed to patronizing the larger first-class assets. The benefit is a smaller, less complex operation that is nearly as simple to manage as a limited-service asset, yet sales in peripheral departments such as food, beverage and catering, while not major departments, are generally profitable.

Focused-service properties in recent quarters have enjoyed the ability to provide quality foodservice items to their guests in a relatively cost-efficient manner. According to Donnelly Nariss Maysey, Director of Sales at the Hyatt Place Scottsdale/Old Town, “The brand's design and amenities combined with the hotel's location and friendly staff helped our property build a strong reputation for excellent service and an upscale experience while still providing our guests with value. Guests have told us they feel comfortable spending time in the hotel's Gallery, or public space, enjoying free WiFi access, a glass of wine or a coffee.  Our associates, or Hosts, are all specially trained to engage guests in conversation but we find that the Gallery's open atmosphere makes it easy for guests to socialize with each other as well.” This sort of activity may be a contributing factor to the trend that hotel guests are spending more time in public spaces and happily adding to the incidentals on the hotel room bill.

Some of Hyatt’s global competitors answer to Hyatt Place include brands within Starwood, who in 2005 launched aloft, also an upscale focused-service model aimed primarily at business travelers with a tighter expense budget than those visitor staying at, say, a Westin. Both aloft and Hyatt Place have revolutionized the concept of expanding departmental income streams to include food, beverage and catering service income within a smaller package while not sacrificing basic business or leisure needs.

Because of the development of prototypes such as these and their publicized success in exceeding market share throughout the country, existing brands found it necessary to make modifications to their business models to effectively compete. It has become apparent that hotels are doing away with compartmentalization (quiet, private corners in public spaces, focus on total guestroom comfort, etc.) and re-establishing themselves as public forums. That is, guests are being drawn out of their rooms and the corners, whether they are part of large groups or if they are free independent and transient travelers and into hotel lobbies. As such, global brands like Marriott are scrambling to implement PIP programs to transform lobbies from reception grounds into actual gathering spots (Great Rooms) and expanding the surface area and improving accessibility to F&B and retail outlets. Public spaces are becoming open and inviting for individuals wishing to relax, do business, eat, take advantage of technology or simply to feel relevant. The PIP often addresses taking down walls between these gathering spots and the restaurants, lounges, retail stores, activity desks and, if offered, golf and other resort-oriented operations.

Larger leisure resort properties have also begun to capitalize on this shifting paradigm. Although most resort facilities were originally developed for the sole purpose of accommodating guests almost entirely in the public areas throughout the day, expensive modifications are being made to bring together segments which were typically segregated or secluded. For example, the Hyatt Regency Maui Resort and Spa recently transformed its foodservice operations from a formal approach to a more integrated experience. Where fine dining, concierge, retail and spa services were located at separate and designated areas of the property, they are now drawn together near the heavily-trafficked pool and beach venues. A property representative indicated that “guests, much more so now, want to be near the action most of the time. It was the hotel’s responsibility to reformat the public space so that guests could experience all aspects of the resort no matter how he or she was dressed.” As part of this reformatting, the hotel’s cliff-top fine dining restaurant, which is topographically segregated overlooking the pool area with (intentionally or not) a perceived dress code barrier, was completely removed from the F&B operations and converted into function space. Certainly this strategy would not work for all resort concepts, but what these adjustments were able to do was narrow the gaps between the day’s routine events (i.e. eliminating the need to return to the room to prepare for dining) thereby improving the surface area and exposure to F&B and various other department outlets.

Expanding departmental income requires more than simply reconfiguring a hotel’s layout. In order to properly market this campaign, managers must be in-tune to the buzz of a local market and train his or her employees to act the part. In Kentucky, for instance, friendly staff involvement would be critical to draw guests into a public area that might include a paddock theme. Or in Vail, a non-skier guest might not understand how indulging the après-ski life can be even if that person never hit the slopes. The reality is that peripheral departments of a hotel have the potential to add tremendous incremental income on a per-unit basis. If management and ownership alike of a hotel operation can ultimately recognize these paradigms, then it is likely that departmental income growth will soon follow resulting in substantial value enhancement of the property’s going concern.


Hotel investors and managers are well poised to control value recuperation in the early part of the new decade. Objectives and opportunities to navigate include maintaining operational leanness, protecting competitive positioning, and expanding departmental income. A primary focus in the damage control efforts from late 2008 through 2009 was to control costs since there was a severe decrease in demand. However, through the first half of 2010 it has become apparent that lodging fundamentals are commencing a rebound from an extreme downside position. There are certainly concerns that the signs of the recovery process may be temporarily thwarted. The competitive landscape of many hotel markets is quickly evolving, and there are various additional means for hotels to improve guests’ exposure to profit departments. Accordingly, it is ever so paramount that hotel managers and investors focus on all line items—top and bottom—and recognize early in the rebooting process that a value-enhancing perspective will be equally or more relevant than that of a value-salvaging one. 

Mr. Younge is a Director in the Hospitality & Gaming Group, a full-service hospitality organization within C&W specializing in valuation  and consulting. Mr. Younge has completed appraisal, consulting and litigation related assignments on a wide range of hospitality assets throughout North America, Central/Latin America, Europe and the Pacific Rim. He has been active in real estate valuation and consulting since 1998, and has a Bachelor of Science Degree from Cornell University, as well as a Masters in Business Administration from Northwestern University's Kellogg School of Management.

Bryan Younge, MAI, ASA
Director | Valuation & Advisory Services
Cushman & Wakefield of Illinois, Inc.
6133 N. River Road, Suite 1000
Rosemont, IL 60018
+1 847 720 1345 dir

Also See: Hotel Transactions: Investors are Feeling the Heat at the Prospect of a Lodging Economy Turnaround / June 2009
The Role of Hotel Brands in the War of Survival / Bryan E Younge / May 2009

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