How to Buy A Hotel Based on Data; Not Emotion

I'm an emotional buyer. If you remember, I bought a company based on emotion last year which lasted for precisely 8 months. It hurt.

Hotels aren't something you could or should buy based on how you feel. Unless you have a lot of money to burn and you are determined to buy a hotel no matter what it costs you (and it will), EHL, the world’s No.1 hospitality business education institution, has put some extremely valuable information for you so that you can prime yourself before you go ahead and purchase or sell that hotel asset.

As you read through the following key areas, think about your situation and how it relates to your property.

Hotel Real Estate Property is Different

Think of someone renting a house or condominium from an owner, compared to someone staying at a hotel. There are some key differences that have an important impact on the overall cost / valuation of a property.

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. Check out this article on Asset Management for a more detailed discussion on this.

There are also demands that vary. 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.

When Considering Investing, What Should Your Analysis Include?

To make an investment decision you should take two things into consideration; the hotel’s Proximity to venues like hospitals, arenas, office buildings, and 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 do you Determine a Hotel's Value?

Sellers always want more money than they should, and buyers always try to get it cheaper than the market price. So what's the real price?

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.

Key Concepts:

The Hotel Price is the amount an investor pays to buy a hotel;

The Hotel Market Value is the likely price of a hotel in a fair market on a certain date.

A fair market is competitive and has balanced negotiating power between buyer and seller. The 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.

If you've read up until here, and have been able to internalize it, you should be able to answer the following questions which should be the foundation for any decision you make whether or not to buy or sell that hotel asset:

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?
• Don't forget that hospitality isn't just bricks and mortar. It is a people business.

If you are considering buying a hotel and running one, you might also want to consider continuing your education with EHL’s world-renowned MBA in Hospitality program. Another place to get your feet wet would be doing an online certificate based on components of EHL’s world-renowned MBA Hospitality program, such as the Hotel Development and Real Estate Investments certificate.

For more information on the MBA program, click here.

For more information on the online certificate, click here.

This article is adapted from EHL's Hospitality Insights blog.