Hotel asset value and owner returns are influenced not only by cash flow from operations, but also by many other considerations. These include acquisition cost, capital expenditure requirements, capitalization rates, the amount and cost of debt, brand and operator encumbrances, physical condition, and upside opportunities. All of these factors must be actively managed within a Total Hotel Investment Plan.
A Total Hotel Investment Plan (THIP) is a comprehensive plan designed to A) maximize asset value and owner returns, and B) minimize risk, across multiple areas that have a direct impact on a hotel real estate investment. A THIP document identifies and addresses the internal and external elements that will potentially impact the overall investment performance of a hotel development or acquisition. A THIP lists the various strategic elements that can either be accretive to, or detract from, asset value, and includes a related tactical action plan to address each of these elements. A THIP is a dynamic document that is adjusted throughout the life of the investment, and enables the stakeholders to acheve their targeted investment returns, while managing and mitigating any risk associated with the investment. A THIP can also enable all stakeholders (Owner, Operator, Brand, Lender) to get aligned on strategy, tactics and key objectives associated with the hotel investment.
This article focuses on areas outside of operational asset management that can be used to enhance the value of a hotel and drive owner returns.
Assessing brand and operator encumbrances
Both the brand affiliation of the hotel and the management agreement for a hotel directly affect the value of the real estate. A Franchise License Agreement and/or a Hotel Management Agreement can either add to or dilute asset value, depending on how these agreements are structured and how “owner-friendly” the key commercial terms are in each of these agreements.
Key considerations affecting hotel value and owner returns include: the term of the agreement, its fee structure, strength or weakness of brand/operator contribution to performance, performance test timing and thresholds, operator’s cure rights, owner’s ability to actively “manage” the operator, and options available to owner to terminate the contract. For full-service hotels, a new buyer would likely pay a premium for having more liquidity in the contract – that is, the ability to terminate and the ability to actively manage the operator. That said, buyers of select service hotels tend to place greater value on brand encumbrance at time of sale.
Performance tests and related thresholds are also important, as are operator’s cure rights. A new buyer’s underwriting of the various contract terms directly impacts the value of the asset and therefore the owner’s exit proceeds.
Managing physical condition: CapEx and ROI opportunities
Capital expenditure (CapEx) considerations directly impact hotel asset value. Actively managing a property’s CapEx plan is critical to ensuring that there are no deferred maintenance issues, preserve the economic value of the asset, and maintain the overall competitiveness of the hotel in its marketplace. Lifecycle considerations for areas related to brand standards, as well as useful life considerations for building, mechanical, electrical and plumbing (MEP) areas, must be taken into account. When CapEx is executed strategically, it can reduce operating costs, thereby providing a return on expenditure.
In addition, potential ROI opportunities, such as facility expansion to add rooms, meeting spaces, and other amenities, as well as program reconfiguration and reconceptualization of F&B offerings, can enhance overall asset value.
Opportunities to increase ROI can either be fully executed by a hotel’s current owner or presented as additional upside opportunity during the sale process – that is, presented as underwritten, programmed and planned in advance, ready for execution by the property’s buyer. The choice of strategy is driven by the owner’s hold period, the availability of funds for CapEx purposes, the owner’s appetite for risk, and the investment return requirements.
How a hotel development or acquisition is financed directly influences value, because it affects the post-debt service cash flow that is available to return to the equity investor, including the return of and on the equity investment. The overall combination of various sources of financing to develop or acquire the hotel is termed “the capital stack.” The quality of the capital stack (that can include a first mortgage, mezzanine financing, and preferred equity) is measured by the level of risk – including debt-to-equity ratio, loan-to-value ratio, debt service–coverage ratio.
Financing strategies vary. They depend on factors such as the type of asset, location, market, underwriting risk, hold period, brand affiliation, owner’s risk profile, cost of capital, and equity return requirements. For certain new-build hotels or redevelopment projects, several lower-cost financing options are available. These include public–private financing, opportunity zone financing, ICAP tax credits, key money contributions, and sometimes, below market mezzanine debt from a brand or operator. Whatever financing strategies are used, they should align with the asset’s overall investment and business plans.
Monitoring capital markets
Hotel capital markets are cyclical and generally considered a leading indicator of the overall hotel industry cycle. The availability and cost of debt direct affect a hotel’s value in that the refinancing proceeds or exit proceeds are directly correlated to these factors. Refinancing or selling a hotel in a favorable capital-markets environment will results in greater valuation, pricing, and proceeds, while refinancing or selling in an unfavorable capital-markets environment will limit owner returns, even if the hotel is performing well and achieving underwritten cash flow.
Monitoring capital markets and timing financing strategies accordingly are critical tactics for maximizing hotel real estate value and owner returns.
Timing the disposition
Timing a disposition is the final element of a property’s Total Hotel Investment Plan. It is important that the exit timing be aligned towards maximizing sale proceeds. For example, selling a hotel before it is stabilized may not only be premature, it may result in the seller receiving less than the full value potential of the asset.
Key factors to consider when determining optimal timing of a disposition include the owner’s Hold Period, macroeconomic outlook, market forecast, asset stabilization, where the asset is in the investment lifecycle, CapEx needs and anticipated ROI on that CapEx, supply additions, timing of unencumbrance by the brand and/or operator, debt coming due, and the health of hotel capital markets (availability, cost and amount of debt available for the transaction).
This article underscores the several factors that directly impact hotel value beyond operating performance and cashflow. Proactively managing these considerations as part of a Total Hotel Investment Plan can enable an asset manager to create superior asset value and maximize owner returns.