Hotel development is a complex and expensive process involving multiple stakeholders with unique and often conflicting objectives. Since investors, operators, lenders and consultants all use distinct criteria to evaluate a hotel’s projected value, they may green-light projects that are unlikely to satisfy the other parties' financial goals. In order to minimize such subjectivity, investment in a new hotel’s development is typically preceded by a feasibility study, the stated purpose of which is to provide the relevant stakeholders with the information and analysis necessary to estimate the project's financial viability.
So what’s the problem with feasibility studies?
Although ubiquitous in the hotel development process, and generally performed and provided by professional consultancies that specialize in this area, the industry’s conventional wisdom holds that feasibility studies are rarely accurate at predicting the performance of new hotels. The consequences regularly plague the industry: ill-informed design choices, brand mismanagement and failed real estate projects. The culprits are well known: outdated templates, inaccurate data, and serious methodological limitations. Yet neither the format nor the content of feasibility studies has changed much.
What’s holding back change?
If both consultancies and investors acknowledge there is considerable room for improvement then why haven't things changed? We set out to investigate some of the potential reasons why the standard feasibility study became institutionalized and what could possibly be done to improve the situation. We did so by interviewing 28 industry experts who regularly use or produce feasibility studies, including representatives of consultancies, lodging companies, banks, investment funds, real estate investment trusts, real estate advisories, brokers and academics.
What did we find?
Our interviewees identified and largely agreed on three major reasons driving the lack of progress, innovation and improvement in feasibility studies. (1) The consultants who produce feasibility studies have limited incentive to change or improve the typical hotel feasibility study approach and structure, and little to no liability for producing inaccurate studies; (2) Those who commission feasibility studies have a relatively low perceived value of the product and its usefulness; (3) The firms producing feasibility studies are under intense cost and time pressure which prohibits them from creating a more sophisticated and reliable product. Let’s look at each of these three issues in a bit more depth.
(1) Incentives and Accountability
According to our interviewees, the property developers and operators tasked with bringing the project to fruition rarely, if ever, challenge - let alone review - the study's projections, analysis or conclusions. Similarly, feasibility study providers are not asked to review their projections once the study has been completed and accepted. At best, such reviews and potential revisions - as several interviewees maintained - occur before the investor provides the study to third parties such as commercial lenders and hotel operators. In such cases, it is the study's results rather than methods that are discussed and occasionally amended (so as to better appeal to the third parties). Furthermore, most end users noted that they do not consider past accuracies (or inaccuracies) when considering a provider's current work. Instead, they recommend and rely on the more well-known consultancies rather than those who are more ‘accurate’.
Assessors are quick to reach for excuses when projections don't pan out: fluctuating market conditions, geopolitical/economic disruptions or even management and construction decisions. In turn, end users are reluctant to force them to reevaluate or justify their earlier projections. Moreover, firms that produce feasability studies are rarely held accountable by the companies that commission the reports. Thus, mistakes are perpetuated. No repercussions, no change in methods or professional conduct.
(2) Don’t believe everything you read
Interviewees readily acknowledged that feasibility studies are most often used simply to provide the ‘rubber stamp’ necessary in the project planning stages and when financing approval is being sought. This has direct implications on why improvements to feasibility studies have not materialized since they are considered ‘the lowest priced commodity’ in the hotel real estate development value chain. According to one operator, "No one looks too closely at the study since really we just want to make sure there isn't a huge and obvious reason not to go forward with the project."
Our interviewees noted that many developers approach feasibility studies with an already predetermined mindset and have no interest in them save for a mere confirmation of their own projections. Consultants are thus often presented with a ‘fait accompli’ because the developer has probably already decided on the location, product, concept and design of the hotel and thus commissioned the study only in order to satisfy lenders and investors – in other words, the feasibility study is seen more as a ‘necessary evil’ and ‘required but not necessary’ rather than as a source of valuable and insightful analysis. Because the recommendations and conclusions are often ignored, the studies tend to be filed away once they have served their real purpose and the investments and financing are in place, thereby providing little if any motivation for providers to improve their underlying work.
(3) Time Is Money
The deadline for submitting the feasability study is usually very tight because the developer has a very short investment window. In addition, the fee for feasibility studies is generally quite low given the large number of companies providing them and their apparent limited value for most clients. These time and cost issues were cited as key reasons why providers do not invest more in carrying out higher quality studies. These are also the reasons why they rely almost exclusively on secondary data, templates and junior staff, even though they acknowledge that all three contribute to a less than optimal end product.
Secondary data which is available to the general public, for example, has always been prevalent in feasibility studies and our findings suggest that its use continues to increase even though experts have regularly noted that primary data would improve the accuracy and reliability of feasibility studies. Secondary data is notably less expensive than primary research, which is more labor intensive and requires a more sophisticated research methodology and staff to carry it out.
If they didn't rely on secondary data, firms would have to hire expensive research specialists or train junior associates. The latter tend to move on after after a year or two of feasibility work, which is seen as a 'stepping stone' to bigger things. Why invest in training staff members who are likely to bolt? Similarly, the industry-wide reliance on automated writing programs, boilerplate templates and preexisting text and analyses from previous feasibility studies are other ways firms save time and money.
Value, however, is in the eye of the beholder
Although the hotel developers in our study expressed waning confidence in the decisions they make based on feasibility studies, they largely agreed that the studies still provide them with a valuable crutch to lean on when negotiating with lenders and management/franchise companies who were generally used to this kind of end product. While often criticized for employing a ‘cookie cutter’ approach rather than tailoring each study to the specific customer, project and development scenario, the resulting studies appear to meet the needs of many end users. The developers and lenders we interviewed suggested that the standardized boilerplate approach used by most firms reduces the time and effort needed to read and analyze the reports.
So now what?
While a less-than-perfect standard feasibility study has become institutionalized amongst the relevant stakeholders, there are still ways to correct this and thus hopefully improve the success of new hotel development projects. First and foremost, end users need to stop seeing feasibility studies as an exercise in box-ticking. Studies can be a valuable tool for end users who ought to stand up and demand more sophisticated methodologies, better training and more customization. Firms need to convince their clients that paying a bit more is worth it: better reports, better results. This virtuous circle would become a sales argument for firms that invest in providing quality reports. As one consultant noted, firms such as his have not improved their work:
“Because no one has asked us to change anything. A change in this practice is only going to be achieved if investors and lenders are starting to ask the right questions and challenge us. Unless you start to question things, there is an assumption that what you get from a feasibility study is what you need. The drive for change has to come from the guys who put in the money.”
This article is based on the following publication:
Hodari, D. and Samson, D. (2017). Settling for Less: The Institutionalization of the Hotel Feasibility Study, Journal of Hospitality Financial Management, 24 (2), 97-110.