By Catherine Rey
It’s not on the average person’s to-do list to buy a hotel, or sell one, for that matter. Therefore finding trusted guidance and information on how to buy and sell hotel real estate can be difficult or outdated. Whether you’re interested in this topic because you’re doing research on how to go about buying a hotel property in the future, or whether you’re actively buying or selling a hotel at the moment and need to answer some burning questions, or you’re simply curious about the hotel real estate market and the hotel industry itself – this guide will put you on the right track.
This article aims to answer the key questions that emerge when conducting research on hotel real estate and investment:
- What are the main factors to consider when it comes to a hotel investment?
- Why do you need to approach a hotel investment differently than any other real estate investment?
- What should you understand first about hotels?
- What drives the success of a hotel?
- Where should I get started?
- How do I value a hotel?
Main factors to consider when it comes to hotel investment
1. Hotel real estate property is unlike any other
The first thing anybody needs to know about hotel investment is that hotels are unlike any other properties. It is a real estate property but it is so different from any other property type.
What exactly is ‘real estate’? The definition says that it is tangible assets such as land parcels and improvements on the land (e.g. buildings or fences) which are immovable and permanently attached to the land. When a real estate asset is purchased it comes with a bundle of rights. Mastering real estate concepts, valuation in particular, is one of the key ingredients for industry leadership in the hotel industry.
Hotels have a complex operational aspect and depend highly on guests to decide a lease per night (accommodation rental per night) compared to a one-year lease apartment or even a 20-year lease of an office for example. This makes hotels unlike other properties and highly responsive to changes in the market. They can take full advantage of a busy period or diminish the risks of a low season period. Hotels can also organize capital or operational improvements in a faster way compared to other sectors.
Of course, this also implies that hotels may be the first ones to suffer from huge disruptions in the market.
2. What are the different types of hotels?
Hotels are further categorized into different types of properties according to their services and available amenities.
- Full-Service Hotels: From luxury brands and resorts to upscale and midscale brands. These hotels offer many services and amenities like on-site retail, spas, meeting rooms, restaurants. These hotels will generally require a large volume of staff and depend heavily on the existing competition on the market. This category includes hotels like Four Seasons, St Regis, Aman, Marriotts, Hiltons and Wyndhams.
- Select-Service Hotels: This is a category between full and limited-service hotel offerings. They have some limited services like in the Limited-Service properties but still have a subset of the services you could find in a full-service property. This category includes Aloft, Hilton Garden Inn, Hotel Indigo, Courtyard.
- Limited-Service Hotels: Hotels without a restaurant or banquet facilities but they may still provide certain services and amenities like swimming pools, limited space and fitness centers. e.g., Comfort Inn, Hampton Inn, Fairfield Inn
- Extended Stay Hotels: They provide temporary housing and cater largely to families undergoing relocation and business travelers on long assignments. They offer larger suite-style rooms with at-home features such as kitchens and access to laundry. They also offer discounted rates on longer stays. This category includes hotels like Embassy Suites, Extended Stay America, Hilton’s Homewood Suites
- Budget Hotels: They purely keep costs down and therefore offer fewer amenities and services. This category includes Days Inn, Travelodge.
3. Some key data about hotels to understand
To track the performance of a hotel there is some key data that are relevant. Average Daily Rate or commonly referred as ADR and Revenue Per Available Room or RevPAR. ADR is the measure of the average nightly rate paid for rooms at a hotel and is calculated by dividing room revenue by rooms sold over a particular period of time
ADR= Room Revenue/Rooms Sold
RevPAR, or revenue per available room, is calculated by multiplying the ADR by the occupancy rate. Investors can also think of it as the total room revenue divided by the total number of available rooms.
RevPAR complements ADR because while ADR only considers the average rate of rooms sold, RevPar takes into consideration the number of rooms that were actually occupied at that rate over a given period.
RevPAR=ADR x Occupancy Rate
Hotel owners and operators use daily, weekly, monthly and annual RevPAR trends to gain insights into factors impacting the hotel’s performance. Even better, comparing a hotel’s RevPAR over the last year to the RevPAR of competitor hotels can provide a powerful metric for analyzing the performance and competitiveness of any hotel over a given period.
Hotels focus a lot on the performance of their “competitive set”. This is because guests tend to make lodging decisions in real-time and weigh factors such as cleanliness, service, amenities and location relative to certain moving demand drivers (events, offices, restaurants…).
4. What drives hotel success?
Two main groups of consumers drive the majority of hotel demand: business travelers and tourists. Business travel tends to boost demand from Sunday through Thursday. While tourists drive demand on weekends and during peak holiday seasons.
Demand is also seasonal like ski resorts that will experience peak occupancies during winter, while hotels near convention centers can expect high demand during key events. Therefore, ensuring quality operating partners is essential to drive top-line revenues and create the optimal mix of business in any specific market. Equally important will be a hotel’s ability to convert top line rooms and food and beverage revenues into bottom line net operating income.
How to get started investing in hotels?
An obvious starting point could be the personal perspective, however, investors need to resist the urge to make investment decisions solely based on what hotel experiences they find attractive.
To identify the strongest investment, investors should start by:
- Conducting a comparative analysis using ADR and RevPAR metrics among a group of similar hotels in the same market.
- Assessing the operating efficiency (profit margin) which can vary significantly from one property to another
- Looking at price matters. A budget hotel at a great price may be a far more successful investment than paying top dollar for a world-class hotel.
So before investing in a hotel you should review demand drivers, make sure the hotel brand is the right fit for you, evaluate the hotel’s management and consider potential cash flow and tax benefits.
As an investor you should consider the risks associated with investing in hotels. Indeed, to begin with a hotel is not like any other real estate property. You need to do your homework and gather the right data.
Developers do not build a hotel and then think about how to fill it with guests. Instead they design hotels around customers.
What should your analysis include?
- The hotel proximity to venues like hospitals, arenas, office buildings.
- Projection on construction/renovation timeline and costs.
This will allow you to make an informed investment decision. It is also essential to understand the current positive economic forces: employment situation, consumer confidence, the rising of retail consumption.
The main drivers for hotels are business travel, tourism and group demand (sport teams, convention attendees). Therefore, hotels that appeal to more than one type of guest will help ensure demand and reduce their dependence on only one target audience.
The ideal property will be an attractive market that appeals to travelers for business or pleasure. You will also want to look at the growth of those demand drivers. Is it easy to come and go?
The brand matters because each brand has a different value proposition for its specific target guest. The type of hotel can have a significant impact on performance during different market cycles.
A full-service hotel sees increased demand when the economy is strong, and tourism and business travel peaks. Alternatively, in a recession, market demand for luxury hotels drops as travelers look to cheaper lodging accommodations.
Having the right hotel operator to manage a hotel can also make a significant difference in the success of an investment. Poorly operated hotels can result in weak cash flow and higher operating costs.
Hotel business structures have the potential to offer investors favorable cash-flow levels for several reasons:
- Guests often pay for rooms in advance.
- Other services can help generate revenue, like hotel bars and restaurants.
- Proper management can increase occupancy and contribute to the bottom line.
- Unique tax benefits can also increase the appeal of hotels. Furniture and fixtures in hotel developments are subject to accelerated depreciation, which can be used by investors to reduce their tax liability.
By tweaking hotel operations and implementing the right value-adds, a hotel’s potential can be maximized to improve cash flow and increase value.
How to value a hotel?
Whether you are looking into buying a hotel, selling one or just considering either. One of the biggest questions you will come to is how do you value your hotel?
The hotel value fundamentally means how much money one is willing to pay when buying or receive when selling a hotel. Even if when you think of a hotel some of the images that will come to your mind are building, customer service, ambiance, quality, food, people, hospitality when approaching valuation and hotel investment you will need to consider a hotel as a series of cash flows.
A hotel’s value is primarily determined by how much financial risk it comes with and how much money an owner could potentially generate by owning that hotel.
Price, market value & investment value
- Hotel price is the amount an investor pays to buy a hotel.
- Hotel market value is the likely price of a hotel in a fair market on a certain date (applicable to all investors). A fair market is:
- balanced negotiating power between buyer and seller,
- buyer and seller are knowledgeable and take prudent financial decisions
- substantial time is allowed for the transaction
- the hotel offer is well publicized
- buyer and seller are at an arm’s length distance (no conflicts of interest)
- Investment value of a hotel is the value perceived by a specific investor. Each investor has a particular view on the value of a hotel, and may have different operating projections and cost of capital, different cash flow projections.
The 3 broad approaches to hotel valuations
- Income Capitalization Approach: The value of an income-producing property is determined by the present worth of future benefits or a multiple of its net return. There are several techniques in this approach. Valuing the hotel as an operating business using the Discounted Cash Flow method (DCF) and valuing the hotel and land as real estate.
- Cost Approach: Mostly useful in determining if it is better to buy or to build. This is not the most retained methodology because it does not consider income or economic factors. Just the cost of buying an existing property vs. building one.
- Sales Comparison Approach: This focuses on determining ranges and pricing momentum based on prior sales of comparable hotels.
The Discounted Cash Flow model is valuing the hotel as an operating business. It is one of the most considered models when it comes to valuing a hotel. It relies on estimating future cash flows from the hotel business and then applies a discount to calculate the present value of those future cash flows. Here you need to work on the basis of the financial information for the whole of the financial year you are considering.
This forward-looking valuation involves a number of assumptions. You need to pick the base year for your calculations and have projected cash flows for the hotel forward over a 5 to 10-year period generally. In creating these cash flow assumptions, you need to consider what it will be reasonable to assume in the light of the information about your market conditions and forecasts available to you; also the potential improvement of the management and operation of the hotel in the future. The real estate model values the hotel as land and buildings, considering the potential for redevelopment.
Final takeaways: key considerations when buying or selling a hotel?
For those in the position of buying a hotel, there is no adventure more exciting than this one. Hotels are a sizable investment of time, effort and money, but success in the hospitality business is financially lucrative and satisfying on a personal level too. To summarize the guidance given in this article, if you believe you have the right skillset to run a successful hotel you should consider the following points:
- Location, location, location.
- Work, more work and then some more work.
- Brand is important.
- Guest experience is key.