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The market for the purchase of lodging properties is ever changing. Those of us who have been “in the business” for longer than the short term, have seen the market transition from a buyers market, where we were inundated with lodging properties of all shapes and sizes for sale, to our current sellers market where buyers cannot find a property to purchase, even if it is a “bad” buy. Over the past three years in the 20 to 150 room category, there has been an abundance of foreclosed properties. But as the average buyer found out, unless you are filthy rich with your own financing and very good banking connections, the typical 75-percent to 80-percent SBA financing was almost nonexistent.
During the recent downturn, banks were burned when financing foreclosed “turn around” properties or newly constructed properties that had not yet established a mature income stream. Another large group that experienced a number of foreclosures were properties purchased at the top of the market prior to the crash. Their debt service was too high to be covered by their income which had decreased dramatically from their peak years.
Now we are seeing the market turn again and when we review everything on the market today, we again see an abundance of lodging properties in default or REOs. But the majority of properties on the market with an existing history of good income are at very high prices compared to the income. Instead of seeing capitalization rates at the 11 percent to 12 percent rates lodging properties normally sell at, we are seeing only six percent and seven percent cap rates. Those are not good investments for a lodging property.
The buyers who are not able to pay cash for the purchase of a new property now find that there is almost nothing on the market that makes financial sense. If they attempt to purchase a lodging property at the offered capitalization rates of six percent, the income is not strong enough for the buyer to obtain new financing without a down payment of 30 percent to 40 percent. Without the leverage of a 20-percent downpayment, the new purchase results in a minimal cash on cash return and detracts from the attractiveness of an investment in the hospitality industry. This kind of return falls into the lower return category of an investment in an apartment or a commercial building.
So how do buyers purchase a larger property or move to better locations and find something that makes financial sense? To me, the answer is simple—find a property with problems and add value. Sounds easy, doesn’t it? While there is a fine art to accomplishing it, the process is straightforward, if you use the tools available today.
Let’s look at the steps, one at a time:
ASSES VALUE POTENTIAL
First, quit thinking about four times (or three, or five, or six) gross room income as a valuation of lodging properties. “Times gross” doesn’t mean anything in the short or long run and it is not a true indication of value. We have seen good buys at 10 times room gross and bad buys at 2 times room gross. An under performing property in a good location in a strong market could be a good buy. Also, a 100-unit property showing an annual gross room income of $500,000 and a price of $1,000,000 might be a very poor investment. Even a property showing a decent income with a price of four times gross could be a terrible deal, if all the FF&E is leased instead of owned, or if it is at an airport with the airport shuttle costing the property $100,000 per year. Instead, look for properties that have been mismanaged, have no franchise or the wrong one, or are in poor condition with bad reviews.
How do you analyze the upside of a prospective purchase? For example, when you see an 80-unit motel with a room income of $800,000 listed for $4,400,000 or about 5.5 times room gross, should you just pass it by and look at the next property on the market or do you stop and examine it more? Without a doubt, you stop and look a little further. Does it have a franchise? No. Is it in good condition? No. Are the rooms clean? No. Is the staff well trained and friendly? No. Is the market area strong? Yes. If these are your answers, then you may have found a winner.
In a properly managed hotel with $800,000 room gross revenue for 80 units, the NOI (Net Operating Income) should be above breakeven and might even cover the debt. This income would give you a Revpar (revenue per available room) of about $27. Now, you need to know how to improve the property and which franchises may be available. Go online to Smith Travel Research, or phone them at 615-824-8664. Request a Trends report and then a customized report. Insert the property zip code into the search window and see what the 50 closest properties are. If a couple of the major franchises are not listed, then one of those may be available. If the flag would fit this property and possibly increase business, we move on to phase two.
LOOK AT PROPERTY CONDITION
If the property condition is average or below, then maybe improving the property condition can help it rise to the top of the local market. Go to www.tripadvisor.com and look at the reviews of this property. If the hotel has negative reviews, some buyers might write this property off. But, if this property is in poor or below average condition and still showing a Revpar of $27 or an income of about $10,000 per room per year, what kind of income will it have if it is cleaned up, with a franchise behind it? If the property was only showing positive reviews on Tripadvisor and was showing its current income, the property would already be taking its share of the market and there would be little left to entice a buyer.
So now you have a property performing below the market, in less-than-average condition, with public reviews that would drive even the most price conscious guest away, and there is a major franchise available that fits this property. That takes us to the third step.
EVALUATE THE PRICE PER ROOM
If you are buying this property at $50,000 per room and recent comparable sales in the area show the sam, then you don’t have any room for improvement. But if it shows that the most recent average sale in this market is $90,000 or $100,000 per room then you have the makings of a good deal. You should ask how much it would cost us to build a new property in this area. If the figure would be above $90,000 to $100,000 per room and you can buy this property for about $30,000 per room less, then is it reasonable to assume that you can buy this 80-unit property at about $50,000 or $55,000 per room and improve the property condition to acceptable standards for $10,000 per room ($800,000). You would then be in ownership at $60,000 to $65,000 per room with the average selling price in the area at over $90,000 per room. This means the property would increase in value at about $25,000 per room or about $2,000,000 (80 rooms at $25,000 per room).
The next step is to contact the franchise companies you think are available in the area to see if they feel this property fits in their system. You may find that they are familiar with the property and already have a good idea of what has to be done to put a flag on it. If not, the franchise representatives are usually very cooperative and will do a cursory drive by or quick walk through and give you a good idea of their interest. If their response is positive then keep going.
VISIT PLANNING OFFICES
Then, go to the city or county offices where the property is located. Visit the planning department and the building department. Find out what new hotels are planned or under construction in the immediate area. If there is not a major lodging property coming into the area then go ahead, if three new properties are being planned, then pass on the deal.
INVEST IN REPORTS
All of these steps are relatively free and you haven’t paid any fees yet. If all of the above steps have yielded positive results then you need to start spending a little money. Go online and purchase a custom STAR report. See what the actual income is for the four or five closest reporting properties that are comparable to the subject property when the improvements are complete and it has a national franchise. If the STAR report shows the ADR of these competitive properties is somewhere around $46 to $50, that would give you an income of over $1,400,000 on this prospective 80-unit property. Quite possibly the future value would be about $7,000,000 with the total cost at about $5,000,000.
To order the STAR report, go back to the Smith Travel website and customize the report by inserting the property zip code. As you look at the reporting information for the properties near your prospective property, you see that they have each property categorized to their market tier ranging from economy to upper upscale. You will be creating what STAR calls the “competitive set”, a list of properties that are direct competitors. You must have a minimum of four properties. One franchise or one property cannot be over 35% of the properties chosen for your competitive set so the information can not be dominated by any one property or group. Study these properties carefully, pick properties that are similar in size, location and market tier to your subject property. It doesn’t do you much good to buy an economy property and compare it to a luxury property. It will take two to three days to receive the report through email.
Once you have finished the preliminary steps, the STAR report is probably the most important tool in making your judgment for the purchase. This $400 report will tell you what the average occupancy, ADR and Revpar is for the properties you choose as your “competitive set” on a monthly basis for the past four years. To analyze a hotel purchase, this is the best money you will ever spend. If the report shows the income for the competitive set is substantially above what your property is showing, and you can see that with some reasonable building improvements, a franchise and a marketing program you could bring your property income up to what the competitive set is showing, then you are ready to proceed with your purchase.
There may be other factors to consider, but the process for shopping for a property in a slow or depressed economy is much different than during robust period. In the boom times, you can rely on the rising tide to lift you, but it is different when the economy is flat. Consider how you can add value to the property through facility improvements, marketing, or repositioning. That is where you make your money.
Howard Mathews of National Hotel Motel Brokers can be reached at 925-634-2299 or howard@nhmb.com.
READER COMMENTS
Sunday, March 03, 2013 by amazing site
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