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 Therefore finding trusted guidance and information on how to buy and sell hotel real estate can be difficult or outdated.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:
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.
Hotels are further categorized into different types of properties according to their services and available amenities.
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…).
READ: How to evaluate hotel performance?
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.
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:
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.
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:
By tweaking hotel operations and implementing the right value-adds, a hotel’s potential can be maximized to improve cash flow and increase value.
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.
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.
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:
References:
Diaz, J. , Hansz, J. A. (2010), Chapter 1: An Introduction to Environments and Activities in Real Estate. In Real Estate Analysis: Environments and Activities (pp. 3–21).
Hotel Market Analysis and valuation : International Issues and Software Applications, John w. O’Neill, Stephen Rushmore
Segel A. and Woodbury D. 2017 Hotel Industry Harvard Business School
Hospitality Properties, How much to pay if you’re buying; how much to ask if you’re selling Jack B. Corgel