It’s true every budget season, but particularly in today’s economic climate: Budgets and business plans must align with the owner’s investment objectives.
In addition to the standard operating metrics that typically are reviewed as part of the business plan and budget review process, the following areas should be discussed in detail between owners, operators and asset managers in order to align for 2020:
1. Debt service considerations
In addition to the more obvious consideration of whether the operating budget results in cash flow that allows for monthly debt service, there should be focus on whether a lender/loan agreement test—for example, a debt service coverage ratio (DSCR) test or a debt yield test—is required to be met during and for the budgeted year.
Does the operating budget submitted by the operator enable the passing of the lender test within the timeline specified in the loan agreement? If not, owners and asset managers should work with the operators to identify the revenue goals and expense adjustments that are required.
Asset managers should carefully review the incentive bonus plan to determine if it is designed to drive operating performance against the key metrics that are critical to the owner’s investment objectives for the year. For example, there could be a situation in which the hotel executive team maxes out the bonus payout, but the owner has not been able to make debt service for the year, or the asset misses a loan agreement covenant due to a shortfall in operating performance. The hotel business plan and operator’s incentive bonus plan should be aligned with the investment objectives for the year, particularly in terms of NOI thresholds and cash flow requirements to make debt service.
2. Operator’s incentive bonus plan
Asset managers should pay attention to the details of the operator’s incentive bonus plan to determine whether the plan is aligned with owner’s objectives for the year. Often, operators have a standardized “cookie-cutter” template for the annual incentive bonus plan across all their hotels. However, that standardized plan may not be applicable for a newly opened hotel or a hotel coming out of a major renovation/repositioning.
3. CapEx considerations
Do the short- and long-term capital plans align with owner’s hold period and targeted all-in basis (acquisition cost + CapEx)? Are the five- to 10-year capital plans designed to drive incremental revenue and NOI? What is the return on investment and anticipated payback on the invested capital? Does the investment in MEP (mechanical, Electrical and Plumbing) result in any operating efficiencies? Does the CapEx plan align with owner’s hold strategy for the asset?
For example, if the asset is slated for a sale in the next one to two years, it may not be accretive to the investment to renovate the asset next year. Conversely, if there is an immediate ROI associated with the capital spend that could boost NOI in the short term and drive incremental value upon exit, those types of projects should be carefully analyzed, implemented and tracked.
Incorporating these considerations into the 2020 business planning process will enable operators and asset managers to get ahead of these key owner issues, and potentially avoid looking back and saying, “hindsight is 20/20!”