You have purchased, or may be considering the acquisition of a hotel at significantly less than its replacement cost. You believe the location remains sound, the brand is right or can be fixed, and management is generally effective. You are optimistic that when pricing power comes back and demand strengthens, it will do well for you. But the “good ole days” may still be far off. Though margins should improve substantially from present, many costs are still going to continue to rise. Financing market terms are likely to lead to higher exit cap rates. And brand standards catch-up requirements and building “surprises” are likely to require greater capital investment than projected -- unless you provided a generous contingency. What then could and should you do to increase net operating income so that greater value is created? Following are some actions you should consider:
1. Assure that the manager and asset manager, if in place, have touched all the bases to wring excess costs out of the operation. You especially need to look at:
a. Organization structure and staff utilization -- Have former training and development and other “nice to have when times are good” positions been wrung out of the Executive Committee and is the management staff right for current business? Are sound business volume forecasting procedures in place, good staffing guides utilized, overtime tightly controlled and staff productivity closely monitored?
b. Have amenities, services and service levels, hours of operation, and the rest been adjusted to reflect guest expectations and actual customer use? Have outsourcing opportunities been explored and exploited to cut fixed costs and possibly increase revenue? Have potential activity traps such as an extra restaurant outlet, Sunday Brunch and the like been evaluated and ended if unprofitable?
c. Have leases and service agreements been thoroughly gone over and renegotiated where appropriate? Have new “make or buy” analyses been performed and acted upon? With earnings down sharply, have property tax assessments been appealed? It is surprising how many hotel owners have not done this. Are personal property records up to date or is the hotel still paying taxes on items that have been removed from service? Have recent audits been performed in areas such as telephone equipment service charges, high-speed Internet costs, sales taxes, preventive maintenance and energy conservation opportunities? Have all low-cost or high-ROI energy-saving measures been carried out? Many of these are simple procedural changes. Have competitive price surveys been conducted to assure that food and beverage prices and charges for ancillary services are in line with competition and hotel positioning?
2. Improve the hotel’s appeal and make sure the facilities are highly competitive in the marketplace.
a. Take a hard look at the sense of arrival given to customers. Visit the competitors and see how you compare. A few planted flowers, a steam cleaning and perhaps some paint can often make a world of difference at the entrance. A new floor surface, some lighting changes, replacement of tired-looking furniture and new staff uniforms can provide a new lift to the lobby. Get rid of the negatives, they are distractions that serve to lower guest expectations and increase their sensitivity to price.
b. Moving to the guest rooms and bathrooms, get the greatest possible customer impact with the renovation money you have available. Whole-room renovation generally has greater affect, even if done in fewer rooms, but if budget and condition necessitate piecemeal renovation of all, be sure it is done against a master plan so that when the remaining elements are tackled the newly added parts will still fit. A few observations from experience:
i. Do not overlook the sleep sets; they are the number one priority. Those that are sagging have to go.
ii. The room and bathroom need to be light and bright. Fortunately, this can now be done with low watt CFL bulbs.
iii. Even if the brand has extended the deadline for flat screen televisions, be mindful that many select service and even budget hotels already offer them. They should be high on your action list. If the standard is below 42 inches, I suggest exploring with the brand and looking at the potential payback on going to the next larger common size to provide a competitive edge. If the rest of the case goods in the room are good, the tops can be cut off existing armoires and a piece of granite put in to provide a base for the new television.
iv. After replacing the carpet, if needed, which is one of the necessities, if the look of the guest room still needs refreshing, a good deal of punch can be achieved by revinyling the headboard wall.
c. Follow the same strategy in the public areas: work against a master plan and first fix the items that stand out as distractions. Of course you will put a multi-year capex plan in place.
3. Make Sure the Sales Department and Revenue Management Function are Hitting on all Eight Cylinders
a. Are pace and sales production reports carefully watched? Are ROI or at least ROS calculations developed for incremental sales activities, including trade show attendance, local corporate programs, weekend promotions, etc.?
b. Is participation in brand marketing programs challenged for potential benefit to the property and are results checked?
c. Has the sales department been shopped recently for effective and timely response to group inquiries? It is a good idea to shop reservations, be it internal or outsourced, as well. A surprising number of balls are dropped here. Upselling at the front desk, another old, but valuable “chestnut” is another area that should be tested.
d. Is the property web site an effective sales tool? Has search engine optimization been put into effect and has it been updated? Are E-mail and social media campaigns being used? If not, should they be? If they are, is adequate effort being devoted to them and is that effort cost-effective?
e. Are revenue management actions mostly proactive, or are they merely reactive? Are the total spend and total profitability of groups carefully considered when rates are quoted? Are sales people striving to get maximum penetration of a company or a group or other target market before dumping off forecast excess rooms to a deeply-discounted third-party site? Are packages and special events being created to take greatest advantage of features or activities in the community, so generating new demand, or is there over reliance on the standard brand offerings?
4. Start to “Dig for Gold” at the property.
The late Conrad Hilton was one of the earliest proponents of this and was highly successful at it. The vitrines he created in hollow columns at the Waldorf=Astoria and the store leases he negotiated to provide ongoing streams of revenue at Hilton Hotels are legend. After the “quick hits” have been dealt with, it is time to start digging into the physical property and the hotel operations for “veins of NOI” that earlier owners and managers have overlooked, or that have been made newly feasible by changes in the market or technology or incumbent manager performance. The prospecting should include:
i. Physical Property
Scour the hotel for unutilized or underutilized space. I have seen and/or been a part of turning a former maintenance storage area into a concierge lounge, freeing up prime guest rooms formerly devoted to this; adding new meeting space by converting unutilized building areas, leasing rooftop areas to cellular service providers, outsourcing a business center, creating a new banquet room from a formerly unprofitable restaurant, carving out additional shops or a Starbuck’s counter from unneeded lobby area, creating a feature pool, transforming a low-volume gift shop into a popular restaurant, leasing out unappealing and poor performing restaurant to an operator with a local following and relocating a remote production kitchen to a high-traffic area. These are but a few examples of steps that can be taken to produce a high return on investment, and provide points of difference that add to the hotel’s competitive advantage.
ii. Operations
A former boss likened this process to “turning over rocks.” Hotel Operations should be systematically and repeatedly scrutinized to unearth new opportunities for additional revenue or greater efficiency. I’ve increased cash flow and raised NOI through reviews of billing and collection procedures, labor management systems, house laundry, telephone equipment and network fees, energy management, maintenance department performance, broadband provision agreements and others. I have also increased top line revenue and NOI by updating competitive price comparisons, adding sales people against targeted markets, strengthening hotel web sites and Internet marketing. Many other opportunities are available; the potential and the payback will vary with the property.
Even if the trend line of improvement is below what the optimistic forecaster’s project, your efforts and your investments to add value may still be very rewarding. At a 10-cap, an extra $100,000 you added in NOI translates into nearly $1 million in added hotel value.
Wednesday, November 10, 2010
Monday, May 17, 2010
Distressed Hotels: Picking Up The Right Pieces
The hotel industry is finally getting some long-awaited good news. Business and leisure demand are rising, and so occupancy is increasing. Group pace is picking up, rate cutting has leveled off and hotel financing is starting to become available again. Groups and Funds have raised billions to acquire distressed commercial real estate, including hotels, and many other unpublicized investor groups are ready to get in if the opportunity appears right. I believe there are few who truly wish to buy distressed hotels. What they are looking for is distressed hotel deals.
A distressed hotel is one whose location has become inferior; whose position in the market has declined and whose physical condition has become substandard. Not every property will suffer from every failing, but it only takes one if the shortcomings are severe. And these problems are likely to be accompanied by deficiencies in service levels and amenities, in management and marketing. A few such distressed properties may be able to be brought back with time and massive capital investment. But for most, the answers lie in downgrading, in conversion to alternative use and even demolition for an eventual land sale. Yes, there is money to be made, but the continuing income stream will be limited and there is little upside potential.
What is in demand is the distressed hotel deal: a property that is generally well-located, in good condition, well-managed and expertly marketed that was over financed and cannot meet its debt service requirements. Even if RevPAR returns to former levels, and if aggressive cost cuts made during the downturn are maintained, the NOI (actual and forecast) will be insufficient to amortize debt, provide comfort to a lender through an adequate debt service coverage ratio and produce an acceptable return to the owner. While the tsunami of distressed properties that some expected may not develop, more high-leverage CMBS loans are coming due and lenders are becoming more aggressive about foreclosure so more “distressed hotels” will become available. Prices will be well below replacement cost and cap rates higher or EBITDA multiples lower than what prevailed during the bubble years. The challenge is to choose the deal that has the greatest upside potential and which offers the best return.
Identifying tomorrow’s winners involves a six-step process. It is not necessarily the discount to replacement cost, as a strike price may still be too high to get a target return. It is also not necessarily the cap rate, as the income stream upon which it is predicated may reflect cuts in vital areas like marketing and maintenance that will have to be restored. And it may be necessary to impute an addition to the sales price to allow for deferred maintenance, PIP costs, roof or major mechanical equipment replacement or critical MEPS (mechanical-electrical-plumbing systems) overhaul. Also, a build-up period should be figured into operating income forecasts to return the property to a “stabilized” earnings position.
The critical first step is to examine the market: what is happening in it and how the hotel is performing against the competitive set. The property’s location in relation to the major room demand generators and what is happening with those sources of business is fundamental. The market may have declined temporarily because of political and economic conditions, but the question that needs to be answered is if a rebound can reasonably be expected or if systemic changes – plant closings, mergers, loss of popularity of attractions or convention facilities will lead to reduced lodging demand for the foreseeable future.
Next is a review of the property and its performance within the market. Is the location still good or is the neighborhood declining? Has the hotel kept its share of the business available or has it lost it? If the latter, the reason or reasons should be pinpointed. Have the physical facilities been allowed to get into disrepair? Has management cut service levels to a point that customer satisfaction has been affected? Have sales and marketing budgets, and sales efforts, been cut so much that present and future inflow of customers into the hotel have been reduced? Are the positioning and branding of the hotel best suited to current and expected future demands? Is management effective? An operational review and a SWOT (strengths-weaknesses-opportunities-threats) analysis for each major market segment can pinpoint problems and opportunities. Answers here could yield fixes that could quickly turn the property around. But time and costs must be factored in. You could be looking at liquidated damages to end a franchise agreement. And a termination payment or a period of conflict (legal fees, performance test issues, rejecting proposed budgets, etc.) may be involved in order to replace the manager. Major renovation will take time and money, and could lead to displacement of NOI if part must be finished during peak business periods.
A property condition assessment by an expert is needed to determine building and system needs that are going to have to be met soon. This review should necessarily encompass any outstanding code violations or certificate of occupancy issues. I have personally had to deal with roof replacement, cooling tower replacement, building tuck pointing, replacement of obsolete fire alarm system panel, ADA compliance modifications and other costly items after experts had reported condition to be satisfactory. Get the most qualified expert you can find to reduce such surprises; add the cost of major repairs to the acquisition price and provide a capex contingency to provide for others.
Now a strategic plan to add value can be devised. Beyond fixing what needs to be fixed, how do you plan to increase revenue and net operating income? I will save the details for a future article but the plan should cover:
• Physical Plant: renovation, reconfiguration of space, facility and services additions, exterior and sense of arrival
• Operations: labor cost controls, suppliers and services review, closing unprofitable outlets, outsourcing, lease opportunities, pricing and revenue management
• Property and Business: Repositioning and Branding, Management, Marketing
• Financing and Sale Opportunities: Sophisticated operators who are buying for all-cash are projecting refinancing, with cash out, at a future date to improve their yield. At some point, the asset is usually forecast to be sold. Do not fool yourself with an overly-optimistic terminal cap rate that will inflate the (on paper) projected return.
Due diligence runs coextensively with other steps and investigation will lead to the development of the strategic plans. I strongly recommend that you find and hire a law firm with hotel experience to help you work through franchise and management agreement issues, potential labor issues and in putting together the purchase and sale agreement. The agreement needs to specify clearly what is being bought and sold outright and what is to be prorated. Are you, for example, buying the FF&E reserve? How are inventories, other than food and beverage defined? Are you getting the operating equipment, maintenance supplies and marketing materials? A purchase and sale agreement that is not clear can add hundreds of thousands to cost at closing. What you are not buying, if needed, must be added to your all-in costs.
The final step is financial modeling. Pull all your assumptions regarding the market, your strategies to add value, your purchase deal and your sources and cost of money together into a proforma that covers at least five years – longer if suggested by your planned holding period. You may find it helpful to prepare a sensitivity analysis that considers varying assumptions for occupancy and ADR, for time needed to deploy capital and carry out strategies and for completion of any planned sale or refinancing. If the results show a return on investment that meets or exceeds desired hurdle rates, you have a probable winner and will wish to go ahead. If the estimated return comes up short, you will need to develop different strategies, or decide to “keep your powder dry” until you find a troubled hotel that is the right situation at the right price.
A distressed hotel is one whose location has become inferior; whose position in the market has declined and whose physical condition has become substandard. Not every property will suffer from every failing, but it only takes one if the shortcomings are severe. And these problems are likely to be accompanied by deficiencies in service levels and amenities, in management and marketing. A few such distressed properties may be able to be brought back with time and massive capital investment. But for most, the answers lie in downgrading, in conversion to alternative use and even demolition for an eventual land sale. Yes, there is money to be made, but the continuing income stream will be limited and there is little upside potential.
What is in demand is the distressed hotel deal: a property that is generally well-located, in good condition, well-managed and expertly marketed that was over financed and cannot meet its debt service requirements. Even if RevPAR returns to former levels, and if aggressive cost cuts made during the downturn are maintained, the NOI (actual and forecast) will be insufficient to amortize debt, provide comfort to a lender through an adequate debt service coverage ratio and produce an acceptable return to the owner. While the tsunami of distressed properties that some expected may not develop, more high-leverage CMBS loans are coming due and lenders are becoming more aggressive about foreclosure so more “distressed hotels” will become available. Prices will be well below replacement cost and cap rates higher or EBITDA multiples lower than what prevailed during the bubble years. The challenge is to choose the deal that has the greatest upside potential and which offers the best return.
Identifying tomorrow’s winners involves a six-step process. It is not necessarily the discount to replacement cost, as a strike price may still be too high to get a target return. It is also not necessarily the cap rate, as the income stream upon which it is predicated may reflect cuts in vital areas like marketing and maintenance that will have to be restored. And it may be necessary to impute an addition to the sales price to allow for deferred maintenance, PIP costs, roof or major mechanical equipment replacement or critical MEPS (mechanical-electrical-plumbing systems) overhaul. Also, a build-up period should be figured into operating income forecasts to return the property to a “stabilized” earnings position.
The critical first step is to examine the market: what is happening in it and how the hotel is performing against the competitive set. The property’s location in relation to the major room demand generators and what is happening with those sources of business is fundamental. The market may have declined temporarily because of political and economic conditions, but the question that needs to be answered is if a rebound can reasonably be expected or if systemic changes – plant closings, mergers, loss of popularity of attractions or convention facilities will lead to reduced lodging demand for the foreseeable future.
Next is a review of the property and its performance within the market. Is the location still good or is the neighborhood declining? Has the hotel kept its share of the business available or has it lost it? If the latter, the reason or reasons should be pinpointed. Have the physical facilities been allowed to get into disrepair? Has management cut service levels to a point that customer satisfaction has been affected? Have sales and marketing budgets, and sales efforts, been cut so much that present and future inflow of customers into the hotel have been reduced? Are the positioning and branding of the hotel best suited to current and expected future demands? Is management effective? An operational review and a SWOT (strengths-weaknesses-opportunities-threats) analysis for each major market segment can pinpoint problems and opportunities. Answers here could yield fixes that could quickly turn the property around. But time and costs must be factored in. You could be looking at liquidated damages to end a franchise agreement. And a termination payment or a period of conflict (legal fees, performance test issues, rejecting proposed budgets, etc.) may be involved in order to replace the manager. Major renovation will take time and money, and could lead to displacement of NOI if part must be finished during peak business periods.
A property condition assessment by an expert is needed to determine building and system needs that are going to have to be met soon. This review should necessarily encompass any outstanding code violations or certificate of occupancy issues. I have personally had to deal with roof replacement, cooling tower replacement, building tuck pointing, replacement of obsolete fire alarm system panel, ADA compliance modifications and other costly items after experts had reported condition to be satisfactory. Get the most qualified expert you can find to reduce such surprises; add the cost of major repairs to the acquisition price and provide a capex contingency to provide for others.
Now a strategic plan to add value can be devised. Beyond fixing what needs to be fixed, how do you plan to increase revenue and net operating income? I will save the details for a future article but the plan should cover:
• Physical Plant: renovation, reconfiguration of space, facility and services additions, exterior and sense of arrival
• Operations: labor cost controls, suppliers and services review, closing unprofitable outlets, outsourcing, lease opportunities, pricing and revenue management
• Property and Business: Repositioning and Branding, Management, Marketing
• Financing and Sale Opportunities: Sophisticated operators who are buying for all-cash are projecting refinancing, with cash out, at a future date to improve their yield. At some point, the asset is usually forecast to be sold. Do not fool yourself with an overly-optimistic terminal cap rate that will inflate the (on paper) projected return.
Due diligence runs coextensively with other steps and investigation will lead to the development of the strategic plans. I strongly recommend that you find and hire a law firm with hotel experience to help you work through franchise and management agreement issues, potential labor issues and in putting together the purchase and sale agreement. The agreement needs to specify clearly what is being bought and sold outright and what is to be prorated. Are you, for example, buying the FF&E reserve? How are inventories, other than food and beverage defined? Are you getting the operating equipment, maintenance supplies and marketing materials? A purchase and sale agreement that is not clear can add hundreds of thousands to cost at closing. What you are not buying, if needed, must be added to your all-in costs.
The final step is financial modeling. Pull all your assumptions regarding the market, your strategies to add value, your purchase deal and your sources and cost of money together into a proforma that covers at least five years – longer if suggested by your planned holding period. You may find it helpful to prepare a sensitivity analysis that considers varying assumptions for occupancy and ADR, for time needed to deploy capital and carry out strategies and for completion of any planned sale or refinancing. If the results show a return on investment that meets or exceeds desired hurdle rates, you have a probable winner and will wish to go ahead. If the estimated return comes up short, you will need to develop different strategies, or decide to “keep your powder dry” until you find a troubled hotel that is the right situation at the right price.
Tuesday, June 2, 2009
You Need to Reset Your Exit Strategy
Last year I posted a blog to remind hotel owners that they needed to have an exit strategy that embraces the circumstances and probable timetable under which they plan to exit their hotel investment. Since then, major and dramatic – some say seismic changes have occurred in the domestic and international economy and in the hotel capital markets. It is appropriate and advisable to revisit the exit strategy and revise it to reflect the current environment and foreseeable circumstances.
First the good news:
The hotel industry is and remains cyclical and demand is closely correlated with GDP. So when the national economy becomes strong again – some are already calling an end to the recession; the demand for hotel rooms will improve.
Supply growth has been sharply constrained by changes in the financial markets so little new product has entered most markets and not much is foreseeable for a while. So when demand strengthens, an existing hotel that has been well-maintained and well-operated through the down cycle will be likely to benefit.
A property whose capital stack was put in place before the high-leverage, low cap rate era should, with aggressive asset management in place to tighten costs, be able to survive until the upturn.
Now the bad news:
Average daily rates are going to take a while to come back. We saw this after the September 11th event and this time around it may take even longer for hotels to regain enough pricing power to achieve the rates that were in effect in mid-2008.
Between tightened underwriting standards and increased interest rates, most five-year term loans that come due this year, or in 2010 or 2011, will not be able to be fully rolled over. The hotel’s value is going to have to be reset and, in most cases, additional equity injected. The “experts” are forecasting “haircuts” ranging from 25-60% of 2005 – 2007 value. And a number of vulture capital funds are waiting patiently for weak owners who fall by the wayside.
Let us review and update some of the circumstances that indicate that it is time to leave a hotel investment:
• You are out of money [“the well is dry!”]
Either the hotel isn’t doing well or financing to replace outstanding debt that is maturing isn’t available. The hotel needs an infusion of equity and you don’t have it, cannot get a return sufficient to warrant investing it or cannot raise it. This is what the bankers call a troubled asset and brokers refer to as “a distress sale.” The selling price is going to be favorable only for the new owner.
• The picture isn’t pretty [“it soon will be raining on my parade!”]
A new competitor is coming in – the brand is out of favor – the location is no longer prime – demand is declining -- the property is older and needs much upgrading and refurbishment – a union agreement (or the threat of one) or a legislative mandate such as a “living wage” or retroactively applied building code change has changed the economics – and so on. For whatever reason or reasons, a large outflow and/or a small inflow of cash are foreseeable. Clearly, this hotel will not produce the desired return on investment in the near or medium-term future.
• My ship has come in [“here’s my pot of gold!”]
There are at least two versions of this: One is the “Greater Fool Theory” where a prospective buyer wants the hotel so badly, for whatever reason, that he is willing to overpay for it, giving you a handsome profit.
The second is where the land the hotel occupies has become so valuable that it makes economic sense to buy the property, tear the building down, and replace it with a different, more profitable use –shopping center, mixed-use development, offices, condos and the like.
Believe it or not, these “ships” will be sailing again in the future. But presently they are far out at sea, or perhaps even in dry-dock. The challenge is to forecast how long it will take, and how much additional cash outlay will be required before they arrive at the pier.
• The time is right (again) [“timing is everything!”]
The bulk of the tax benefit has been realized – Opportunities considered more attractive (or safer) are available – cash is needed for other purposes -- estate planning (or estate settlement) needs dictate a sale – the partners are arguing about objectives or future strategies. These are just a few examples.
If a potential or planned exit strategy is thought out, it can be modeled in a pro forma and the effects of various strategies considered and refined. The forecast and an asset management approach can then be utilized by the owner to increase his total return on the investment by:
Managing the outflow of capital expenses (and maintenance costs) appropriately.
Structuring financing and lease versus buy decisions for greatest benefit.
Making short-term decisions on a host of other items, including service contracts, booking agreements, sales & marketing activities.
Creating an audit trail of exceptional expenses to make a case to a prospective buyer as to why the net operating income (NOI) should have been higher.
Several hotel owning companies periodically do an exercise called a “re-buy analysis” on the hotels they already own. Considering present property and market conditions, availability of financing, new opportunities or potential threats that have arisen, capital needs, return on investment objectives and alternate opportunities available, would they buy that hotel asset today? Would they now revise their strategies from what was originally put in effect? This is a great asset management discipline that should be applied by any hotel owner on an individual asset basis.
If you model the likely income and realistically project the amount of debt that can be supported for at least the next five years, you will quickly pinpoint opportunities and roadblocks. If the hotel was highly-leveraged and its debt is maturing in the next few years, this would be a very good time to reset your exit strategy. Will it be on your terms or someone else’s? If you plan to stay in the hotel, you will need to restructure your capital stack. If you can come up with strategies to add value, perhaps you can convince the lender to write down the loan by less than he would be facing if he put the property into foreclosure and sold it to a new owner at market rates. Even though the loan decision is likely to be made on the basis of trailing twelve-month’s earnings, and not the proforma, if the future scenario is presented carefully and thoughtfully, it can enhance the prospects for a favorable outcome.
If the conclusion is to exit the investment, you need to become knowledgeable about today’s cap rates and the amount of financing potentially available to a buyer. Couple that knowledge with a current cash flow forecast and you can easily determine how long you can hold out, and what a realistic value is for your equity.
A sound exit strategy, put in place and then reset to current conditions, will greatly increase the likelihood that when you exit your hotel investment it will be on the most favorable terms available, and that your return during the holding period will be optimum for the circumstances.
First the good news:
The hotel industry is and remains cyclical and demand is closely correlated with GDP. So when the national economy becomes strong again – some are already calling an end to the recession; the demand for hotel rooms will improve.
Supply growth has been sharply constrained by changes in the financial markets so little new product has entered most markets and not much is foreseeable for a while. So when demand strengthens, an existing hotel that has been well-maintained and well-operated through the down cycle will be likely to benefit.
A property whose capital stack was put in place before the high-leverage, low cap rate era should, with aggressive asset management in place to tighten costs, be able to survive until the upturn.
Now the bad news:
Average daily rates are going to take a while to come back. We saw this after the September 11th event and this time around it may take even longer for hotels to regain enough pricing power to achieve the rates that were in effect in mid-2008.
Between tightened underwriting standards and increased interest rates, most five-year term loans that come due this year, or in 2010 or 2011, will not be able to be fully rolled over. The hotel’s value is going to have to be reset and, in most cases, additional equity injected. The “experts” are forecasting “haircuts” ranging from 25-60% of 2005 – 2007 value. And a number of vulture capital funds are waiting patiently for weak owners who fall by the wayside.
Let us review and update some of the circumstances that indicate that it is time to leave a hotel investment:
• You are out of money [“the well is dry!”]
Either the hotel isn’t doing well or financing to replace outstanding debt that is maturing isn’t available. The hotel needs an infusion of equity and you don’t have it, cannot get a return sufficient to warrant investing it or cannot raise it. This is what the bankers call a troubled asset and brokers refer to as “a distress sale.” The selling price is going to be favorable only for the new owner.
• The picture isn’t pretty [“it soon will be raining on my parade!”]
A new competitor is coming in – the brand is out of favor – the location is no longer prime – demand is declining -- the property is older and needs much upgrading and refurbishment – a union agreement (or the threat of one) or a legislative mandate such as a “living wage” or retroactively applied building code change has changed the economics – and so on. For whatever reason or reasons, a large outflow and/or a small inflow of cash are foreseeable. Clearly, this hotel will not produce the desired return on investment in the near or medium-term future.
• My ship has come in [“here’s my pot of gold!”]
There are at least two versions of this: One is the “Greater Fool Theory” where a prospective buyer wants the hotel so badly, for whatever reason, that he is willing to overpay for it, giving you a handsome profit.
The second is where the land the hotel occupies has become so valuable that it makes economic sense to buy the property, tear the building down, and replace it with a different, more profitable use –shopping center, mixed-use development, offices, condos and the like.
Believe it or not, these “ships” will be sailing again in the future. But presently they are far out at sea, or perhaps even in dry-dock. The challenge is to forecast how long it will take, and how much additional cash outlay will be required before they arrive at the pier.
• The time is right (again) [“timing is everything!”]
The bulk of the tax benefit has been realized – Opportunities considered more attractive (or safer) are available – cash is needed for other purposes -- estate planning (or estate settlement) needs dictate a sale – the partners are arguing about objectives or future strategies. These are just a few examples.
If a potential or planned exit strategy is thought out, it can be modeled in a pro forma and the effects of various strategies considered and refined. The forecast and an asset management approach can then be utilized by the owner to increase his total return on the investment by:
Managing the outflow of capital expenses (and maintenance costs) appropriately.
Structuring financing and lease versus buy decisions for greatest benefit.
Making short-term decisions on a host of other items, including service contracts, booking agreements, sales & marketing activities.
Creating an audit trail of exceptional expenses to make a case to a prospective buyer as to why the net operating income (NOI) should have been higher.
Several hotel owning companies periodically do an exercise called a “re-buy analysis” on the hotels they already own. Considering present property and market conditions, availability of financing, new opportunities or potential threats that have arisen, capital needs, return on investment objectives and alternate opportunities available, would they buy that hotel asset today? Would they now revise their strategies from what was originally put in effect? This is a great asset management discipline that should be applied by any hotel owner on an individual asset basis.
If you model the likely income and realistically project the amount of debt that can be supported for at least the next five years, you will quickly pinpoint opportunities and roadblocks. If the hotel was highly-leveraged and its debt is maturing in the next few years, this would be a very good time to reset your exit strategy. Will it be on your terms or someone else’s? If you plan to stay in the hotel, you will need to restructure your capital stack. If you can come up with strategies to add value, perhaps you can convince the lender to write down the loan by less than he would be facing if he put the property into foreclosure and sold it to a new owner at market rates. Even though the loan decision is likely to be made on the basis of trailing twelve-month’s earnings, and not the proforma, if the future scenario is presented carefully and thoughtfully, it can enhance the prospects for a favorable outcome.
If the conclusion is to exit the investment, you need to become knowledgeable about today’s cap rates and the amount of financing potentially available to a buyer. Couple that knowledge with a current cash flow forecast and you can easily determine how long you can hold out, and what a realistic value is for your equity.
A sound exit strategy, put in place and then reset to current conditions, will greatly increase the likelihood that when you exit your hotel investment it will be on the most favorable terms available, and that your return during the holding period will be optimum for the circumstances.
Thursday, January 15, 2009
Surviving the Coming Hotel Deleveraging Storm
If the grimmest of the prognosticators turn out to be correct, the old fundamentals probably are not going to work for a while. Scarce availability of financing, reduced loan to value requirements, tighter loan terms and higher interest rates are combining to substantially reduce hotel values. Using the mortgage/equity approach to underwriting, as pioneered by Steve Rushmore and associates at HVS, it is not difficult to predict that, if everything else stays the same, a hotel that was financed with 75% debt a few years back may qualify for perhaps 60% of the original loan amount when the note comes due. Then factor in a drop in NOI because of market conditions and it is easy to understand why some experts are forecasting reduction in hotel values of up to 50%.
As CMBS and other term notes come due in 2010, 2011 and 2012, hotel owners and hotel lenders could face a host of disagreeable choices:
The Hotel Owner may need to consider:
· Raising more equity
· Replacing a part of the debt with high-cost mezzanine financing
· Renegotiating and substantially reducing the amount of debt
· Entering bankruptcy, either voluntarily or involuntarily
· Providing the lender with a deed in lieu of foreclosure
· Other alternatives
The Hotel Lender, who could be facing major losses, would look to mitigate them. His options may include:
· Restructure the loan and leave the facility and debtor in place
· Foreclose on the loan and eventually sell the property. Before the sale:
o Keep existing management and brand
o Secure appointment of a receiver
o Replace management and or rebrand
o Demolish or market the land value
o Convert to alternate use
· Pursue other actions
In choosing the course to pursue, the lender needs to consider several variables, most of which he will not be an expert in. These include:
· Property condition
· Market potentials and hotel competitive position
o Location is a major factor here
· Highest and best use determination
· If the best use remains a hotel, then:
o What immediate actions should be undertaken to limit losses by increasing revenue and/or reducing costs?
o What are the opportunities to add value?
The workout of a troubled hotel loan needs careful study and analysis. A strategic review must cover all the bases, as a miss could lead to invalidation of the determined action plan. The assessment needs to encompass the following major areas:
Financial Review:
This is straightforward, and includes a summary of the loan terms, any payments past due, the resources available to the borrower and an updated proforma, based on a current business reforecast, not the annual budget, to decide the debtor’s ability to repay.
Property Condition Review:
This phase consists of three elements. The first, perhaps best performed by one of the engineering firms that specialize in this area, consists of a physical inspection and evaluation to assure that no uncorrected building violations exist and that the building systems (HVAC, plumbing, electrical) and major mechanical equipment are all in satisfactory condition. Roofs should be included here, as should compliance with the Americans with Disabilities Act requirements. The purpose is to be certain that there are no immediate problems that need to be corrected and that any near-term fixes necessary are identified and costed.
The second phase is compliance with brand standards and a review of the most recent property inspection report should help. The consultant will also need to determine the status of work on any property improvement plans that have been agreed to.
The final phase is an assessment of the appearance and condition of the guest rooms and public areas of the property compared to its direct competitors. If the subject hotel is inferior, the occupancy level and rates it can command are likely to be substandard as well.
Market Potentials and Hotel Competitive Position Review:
Almost anyone with access to Smith Travel Research Data can prepare a hotel market study. But one of the firms with experience and a track record in this field is needed to assure that 1) the competitive set for the subject hotel is really the right competitive set; 2) that the property’s performance within that set, as expressed in penetration of occupancy, average rate and RevPAR levels, accurately reflects its position in the market and 3) that potential growth in area demand generators and competitive supply is weighed against the location and the strengths and weaknesses of the hotel to develop the most likely forecast of potential market position of the property in the market. Expected annual occupancy and average rate should be set forth for at least the next five years.
Highest and Best Use Determination:
Should the property remain a hotel, and if so, should it keep its current brand? Part of the answer to these questions will be clear when the property condition and market reviews are finished. But it may be necessary to bring in appraiser or to talk with the local economic development or planning agency. A proforma showing expected hotel net operating income, after normal and any extraordinary capital replacements should be compared to the cash flow foreseeable from other potential uses to make this determination.
The recent announcement that the Century Plaza Hotel in Los Angeles is to be razed to make way for two high-rise condominium towers proves that the highest and best use may not always be a hotel, even in the 2009 economy. In prior cycles, hotels have been demolished to be replaced by shopping centers, condominium developments, mixed-use projects and even newer, larger and more vertical hotels.
If the hotel’s location is no longer strong; if the market it is competing in is weak or if physical property issues are too severe, alternative uses may need to be considered. If the brand affiliation is not adding value, rebranding may be appropriate. Or, it may be workable for the hotel to become unbranded. If the existing flag is no longer a good fit with the property and its market potential, a new, either down or up market brand may produce more revenue. Keep in mind that large changeover costs may be incurred; besides new signage, logo items and property management system, most franchisors will look for liquidated damages if the license is surrendered before the end of the franchise term.
Immediate Actions to Reduce Losses
In perhaps most cases, the highest and best use will continue to be a hotel and the brand and management company now in place will be considered suitable for the future. If so, immediate actions to reduce losses should be undertaken. A host of these have been identified from past cycles, and recent developments have provided other opportunities. In considering areas where costs can be cut, it is important to remember that the hotel guest experience should not be noticeably reduced. For other hotels in the market, whether troubled or not, are aggressively competing for their business. So if service is greatly cut or property physical condition is allowed to deteriorate, those customers are likely to go elsewhere and 100% of the revenue formerly produced by their business will be lost.
Happy hotel staff is a key to customer satisfaction, and preserving a favorable environment in times of a sharp reduction in business levels is a major challenge for the general manager. Reorganization and layoffs are unavoidable, but these should be completed with as much openness and as much decisiveness as possible. Ongoing communication with the staff is critical and actions to celebrate success, when achieved, are important. With the specter of Employee Free Choice Act legislation, which would make easier hotel unionization, managers need to be especially careful to keep a positive work environment. If they do not, Unite HERE organizers could soon be in the hotel executive office with a fistful of signed union cards.
Opportunities to Add Value
A physical property inspection, combined with a P & L review and interviews with key managers will usually disclose several opportunities to add value. Some possibilities will require capital investment, and will need to be evaluated on the expected ROI within the planned holding period. But others can be carried out at little or no cost. The low-cost, quick payback items should be put into effect at the same time as critical loss reduction measures.
Why Cayuga?
Some of the most able experts available to assist owners and lenders with a troubled hotel may be found at an organization I am a part of, Cayuga Hospitality Advisors. Its web site is: Cayuga Hospitality Advisors
Thursday, November 6, 2008
Differences between Owner and Brand Management Company Goals
Hotel business is slipping, owner profits are falling and asset values are declining. This is an especially good time to be sure you fully understand how your Management Company’s goals may differ from yours and determine how you will work with them to achieve the best possible results; greatest available profits and highest asset value for your hotel.
Hotel investors have long believed that a property that is encumbered with a long-term management agreement is worth about ten percent less at sale than one that is not. But if an owner lacks substantial hotel management experience, most lenders will require a professional manager to be in place before they will commit to financing. Brands with flagship or luxury marquees insist on tight control and most will seldom put their name on a property they do not manage. Many owners prefer to focus on the development and entrepreneurial parts of the business and leave the details to someone else. For these and other reasons, if you have a sizeable property it is likely that a third-party is managing your hotel under a long-term agreement.
There are differences if you are dealing with one of the third-party managers like Crestline or Interstate, which manage properties across multiple chains and brands. In this article, I’d like to focus on the big brand managers; the companies like Hilton, Hyatt, InterContinental Hotels Group, Marriott, and Starwood, all who manage several different branded hotels within their own organizations. So, they are managing the brand, they are managing the system and they are managing your individual hotel. They wear several “hats” in the process and you need to recognize is that at times the “brand hat” or the “system hat” may not necessarily be a good fit with the needs of your property. Let’s look at a few of the areas of potential conflict:
System Standards and Bureaucracy
A management company is a bureaucracy, with hierarchical organization and formal rules put in place to assure standards of performance and service. Those characteristics are good, to a point, but they are accompanied by difficulty of making changes quickly, limitations on risk-taking, and a tendency to let inertia continue, at least for a while. Most managers appear to drink heavily of the company “Kool-Ade” and if you speak with them you will find that they honestly think their brand is the best, that the hotel owner should almost feel privileged to have them managing for him and if the company did not already “invent” it, it is either unnecessary or not very good.
Brands now get input from “owner advisory councils,” but some of the brand standards seem to be capricious, and to have little foundation in customer-based research. Things like ice buckets and bathroom amenities seem to be forever changing, resulting in shortened useful life and increased owner cost. Has anyone documented that these make any significant difference in customer choice or satisfaction, or did the change occur because a brand official was tired of the old ones, or received a great sales pitch from a supplier?
The business downturn that followed the events of September 11 brought new willingness by the brands to reconsider some of the standards of operation, at least during bad times, but many of them remain arbitrary. A hotel that has virtually no demand for its restaurant after 2:00 p.m. may still be required to keep it open until 2:30 or 3:00 p.m., and absorb the extra costs to do so, in order to comply with brand standards. The “me-too” approach followed by the airline industry is in evidence, with “improvements” made by one of the major brands quickly matched by the others, without apparent study of actual guest impact. The point of difference temporarily created is quickly lost, and higher marginal costs are institutionalized. Take a look at the varieties of new bedding, wireless high-speed Internet, flat-screen televisions and Starbuck’s coffee for a few examples.
An owner, however restrained, typically wants it “now.” He expects the manager to instantly identify problems and opportunities and to act on them with all dispatch to reduce costs and increase sales. It is easy to lose sight of the reality that the management company rules and chain of command must be followed, and frequently it is necessary for communication to move up and down the line before action is approved and can be taken.
An owner wishes to provide guests with what they want, and are willing to pay for, but not more. Change for the sake of change costs him money.
Fee-based Revenue
The manager typically gets a base fee based on a percentage of total revenue and an incentive fee based on profits. The base fee is not dependent on the revenue being profitable to the owner and sometimes it is not. The manager can drive revenue at both the hotel and the brand level, thus increasing fees, without providing a profit to the hotel or a return to the owner. A few examples:
• Unprofitable brunches and holiday parties; more food outlets open than needed, uneconomic local food and beverage promotions.
• Marketing programs that produce new business, but at disproportionately high cost.
• Changes in system standards previously discussed, from logos and signage to bedding and flat-screen televisions to new lobby schemes. The owner is required to provide capital for them in order to continue to meet brand standards. Some may increase room rates and revenue, and so fees to the brand, but they may not produce an acceptable return on the extra owner investment needed.
Cost Recovery for System Services
An owner expects to bear a share of system costs. But does the allocation method distribute them fairly, or, in the words of George Orwell, are “some pigs more equal than others?” Some points to consider:
• Revenue-based assessments place the greatest burden on the larger, high-rate city and resort hotels. The cost to deliver the service may not be any greater than the cost to deliver the same service to a smaller, suburban hotel.
• Several of the brands run with an area manager or Area V.P. organization, where a person who is responsible for several managed properties is also the General Manager of a hotel. There are also shared services agreements, under which accounting, sales and revenue management, to name three, are performed for several properties and costs distributed among them. You may assume these arrangements work out well for the brand. You need to be sure they are effective and fair for your hotel.
• Costs for new programs put in place are usually recovered through allocation to the properties then in the system. Once a program is up and running, a hotel added to the brand comes in under the umbrella. If it is lucky, a hotel that helped fund the start-up gets some benefit of the economies of scale in the form of a lower unit cost. The “goodwill” accrues only to the brand, and becomes another system advantage that can be used to attract new properties – which may be potential competitors.
• When new brands are introduced under the “family umbrella,” they share much of system marketing, the frequent traveler program, and the like. But they may not pay the same rates or any start-up fees.
• A hotel may be required to participate in and pay for programs it does not need, or which it may be able to get at least the equivalent of locally at a lower cost. The timetable for implementation of a program at a property may lead to displaced revenue or increased costs.
System Growth
Growth and vitality of the brand has far greater benefit for its owner than does any single property, however large and grand. More rooms means exposure to more customers and increased brand awareness. It also means more franchise/marketing/ management fees, greater clout for shared marketing programs, more frequent traveler card carriers and more hotels to share costs among. Therefore, one of the top priorities for brand managers is to grow the number of properties in the system. The newest property may be down the street, or around the corner from your hotel.
The brand CEO’s reasoning is disarming: “The new brand facility is not being built to compete for your hotel’s customers; we are putting it into place to attract guests your property is not now serving and to take business away from other competing brands. It will have little or no affect on your hotel.” But let’s have a dose of reality: unless the new-build is a convention hotel or a destination resort that creates (or at least relocates) demand, the new property will feed off the customers already in the market. Some will be ones who formerly stayed at your hotel. And they will have equal access to what were formerly your competitive advantages: the brand affiliation, its reservations system and the frequent traveler program. The new property will be completely new (or totally redone if it is a conversion). Some of the amenities and services you now charge for (breakfast and high-speed Internet are notable) may be free. And its room rates may be lower. So it should not surprise if you then see your occupancy falling, your room rates under pressure, or a little less contribution to occupancy from the family reservation system and the brand frequent traveler program.
There is a huge financial incentive for a brand to put a new hotel into your market, especially if it is a franchised one. Take the case of 2007 performance cited for mature hotels of one brand in a family cited in its franchise offering circular: occupancy at 71.9% and average rate of $121.15. For a 120-room facility, at average performance, this would suggest rooms revenue of more than $3.8 million. Such a property would produce total fees to the brand over $375,000, of which perhaps roundly half would be profit, suggesting incremental brand net income of at least $190,000. Assume the brand manager was earning incentive management fees from your hotel at 15% of cash flow over a given hurdle rate. It could “give up” $50,000 in incentive fees and remain $140,000 ahead. But such a loss of income would translate to lost profits of more than $333,000 to the managed hotel owner.
That brings us to the asset manager’s secret. The (say) $333,000 in lost income may be only a short-term headache. The real financial impact is the reduction in hotel asset value. If the “cap rate” for the property is 8.0, those lost profits translate into over $4.1 million in lost value, or in the potential selling price of the hotel.
If you have a territorial restriction in your Management Agreement, about the only protection it gives you is that another hotel with the same name as yours won’t be built within the named radius. But wait – the brands have many other “arrows in their quiver.” If you own a Marriott Hotel, you could find yourself in competition with a Renaissance; if you have a Hilton, you could see a DoubleTree; if you have a Westin you might have to compete with a Sheraton; if you own a Crowne Plaza you might wind up with an InterContinental nearby.
The threat of another “big box,” though these have happened in larger cities, may be the least of your concerns. What you need to watch out for are the “ankle biters” that are part of the same brand family and which share a common reservation system and the same frequent traveler card. Let’s look at the possibilities from the major brands who manage:
Those are just the main brands. Several have a suite product (Hilton Suites - Marriott Suites - Sheraton Suites) besides the separate all-suites brands listed. Most also have a Resorts designation; several have vacation ownership tag-on’s and spa sub-brands are beginning to emerge. Several of the brands above are relatively new – at least under their current owners. And more are coming.
There are other areas where the goals of the owner and the manager may be very different. Let’s look at a few of them:
Managers Job Growth, Career Path, Bonuses and Benefits
As long as there is good performance, an owner would prefer the hotel’s executive team to remain in place for a long time. That way they become involved in the community and are familiar to key customers. The owner expects to see them compensated competitively, but does not expect to pay for packages that are much greater than what prevails in the local market. The manager is trying to provide relatively consistent levels of pay throughout the company, and is compelled to be competitive in major markets. This may lead to inflated management salary levels in smaller cities. Management companies aspire to provide job security for their managers and tend to be slower in ordering layoffs or delaying the fill of a vacant position than an owner may feel is warranted by the current activity levels or economic conditions.
The manager also strives to create career paths for employees who wish to pursue them; moving department heads to management positions and key managers at smaller hotels to larger ones. The turnover tends to create temporary gaps in managed hotel service delivery and cost efficiency, and usually results in billing the property for relocation and sometimes recruitment costs.
Bonus plans are better than they once were, with several of the managers using some form of a “balanced scorecard” to work out eligibility, but there still may be disconnects between annual owner profitability and long-term viability of the property and the amount of bonuses paid. Bonus is usually calculated based on the annual budget, so there is opportunity for an “enterprising” manager to “sandbag,” (purposely understate expected profits) or “milk” a property by temporarily cutting back in areas like sales and maintenance to reach a greater bottom line and earn a higher bonus. Eventually, these “savings” need to be repaid. Usually, the catch-up cost is higher, and, with the loss of revenue that occurs while this is being done, leads to significantly reduced distributions to the owner. Finally, the brand wishes to be an employer of choice and to compare equally or favorably with other brands in benefits. This tends to create a condition known as “a rising tide that floats all boats,” with brand managers who are paying little of the benefit costs themselves, passing on the costs of what seems like a “Cadillac” benefits program to hotel owners.
Marketing Programs
Brand managers tend to focus on participation levels and economies of scale when these are developed and managed. This may result in a hotel being placed under a particular marketing “umbrella,” and paying its share of the costs for a program that is not suitable, and which does not add value. There are also questionable and probably unproductive advertising “rollups” where an in-season hotel winds up offering a “value rate” like $279 in an ad, next to an off-season property in a different locale that is advertising a rate like $99. Brand programs advertised that feature extras like free breakfast to stimulate weekend occupancy may take dollars away from a hotel whose weekends are already strong. “Participating hotels only” gives a property an opportunity to opt out, but the brands highly encourage participation and customers, who usually do not look at the fine print until it is shown to them, tend to become displeased at an exception.
Hotel web sites that are designed by the manager are typically designed with the brand in mind, not the individual hotel. An independent competitor, and/or possibly another branded hotel in the same market may have a web site that loads more quickly, is more graphically powerful and user-friendly and which has been better optimized for search engines than yours. The groups and meetings tab on your hotel web site will take you back to the brand screen in several cases. The planner who wishes to get an RFP from your property may have to enter its name all over again. Sometimes, they will be invited to consider alternatives from other hotels within the brand.
System Roll-outs
These range from things like a new property management system to maintenance tracking systems to new training programs to a new amenity package. Most seem to be developed to fit an “average” property, and there is often little provision for individualized hotel needs, goods already on hand or guest demand. New installation and training costs almost always have to be paid. Like early settlers of the west, the hotels that pioneer systems installations tend to collect “arrows,” as the system is refined on the fly. Unless there is an urgent need at the property level, or the owner is angling for other favors from the brand managers, there is little advantage to being on the front end of one of these rollouts.
Purchasing Programs
These are also designed to fit a “typical” brand hotel and participation by the management team is strongly encouraged, if not mandated. This may not produce the best possible cost savings in a property for several reasons including:
• A hotel may have specialized needs that cannot be met on a cost effective basis
• A named supplier, who is considered best across the system, may have inferior operations in the area where the hotel is located. I have seen this in the area of elevator maintenance.
• Other hotels of other brands that are in the same market create opportunities to use local suppliers to get equal or better quality at lower prices. I have personally experienced this in the Orlando, Florida market.
• Minimum order requirements, that are necessary to limit delivery costs, may not be a good fit with the use patterns and economic order quantity of a particular hotel.
• Food purchase specifications may not be optimized for intended use of the product or what customers are willing to pay for. A hotel may find itself overpaying for quality it does not use and which its customers do not expect.
Reconciling the Differences
The successful hotel owner who has one of the big brand managers directing the operations of his property needs first to understand the manager’s goals and how they differ from those of ownership. He or she then needs to become a healthy skeptic about actions the brand takes and programs it proposes. Next steps include:
• Challenge the status quo. Request managers to prepare mini-P & L’s to prove the profitability, or lack of it, of multiple food and beverage outlets, brunches, holiday dinners and other special promotions.
• Strive to cut through the bureaucratic “maze” by regular and thorough reviews of hotel performance – from revenue and cost variances to market share to sales production and booking pace. Get explanations for, and thoroughly understand the reasons for “positive” variances, as well as negative ones. Push for actions and timetables to solve problems identified and exploit new opportunities surfaced. Do not accept “business as usual” unless it truly is, and you are completely satisfied with your cash flow and investment return. Participate in brand advisory councils, or at least provide input to other “representative” owners who do.
• Study, understand and question the annual operating and capital budgets. Get information about trends from industry experts and other owners and compare to what is happening at your hotel and in the local market. Get very good explanations for differences or request changes to be made.
• Delve into brand programs. Determine what, if anything, they do for your hotel, how success and ROI (return on investment) are measured and how fees are determined and assessed. If people or services are shared, be sure that the arrangements lead to favorable results at a fair cost for your hotel.
• Unless there is an urgent need, try to keep your hotel in at least the second of three waves for system rollout timetables. That way the system put into effect at your property will be more fully tested and modified.
• Go on record with challenges to new hotels of a brand family that are proposed for your market area. Document current and future contribution from the brand’s reservation system and frequent traveler program for follow-up with senior brand executives.
• Get your own hotel web site, or at least a “splash page” if the brand will let you have one. Most brands now oppose this, but many exceptions exist. Have that web site professionally designed and search engine optimized. Recognize that this is not a static process; the site needs to be checked and updated often. If you cannot get your own hotel web site, lobby for and insist that the one developed by the brand be upgraded.
• Demand to see the benefits to your hotel from joining in buying programs. Government regulation has required this to be voluntary and if they are not paying off for you, you may get out.
• Regularly monitor conformance of the manager to the terms of the management agreement and document instances of non-compliance. This may not be more earthshaking than (for example) a brief letter saying that the monthly financial statement that was due on the tenth of the next month was not received until the 14th and that it is expected by the tenth in the future. This puts you on record as not tacitly condoning non-conformance by silence. It also provides the owner with a “gotcha,” which may, with others, become useful when a serious divergence occurs between the interests of the owners and that of the brand managers, and remedies available under the agreement are considered or possible renegotiation of the management agreement seems called for.
Unfortunately, hotel demand is currently weakening in most markets; room rates are under pressure and hotel profits are declining. Reduced leverage and higher cost of debt will reduce the prospect of new brand competition for a time, but will also lessen the value of an existing hotel asset. The disparity between the goals of the brand manager and the hotel owner is likely to widen and stress levels are apt to increase. An owner needs to understand those differences, and take aggressive action to restore or maintain balance and assure that the management company fully understands and remains focused on the owner’s goals. In that way, he will retain the maximum amount of cash flow and investment return possible and preserve more of the asset value.
Hotel investors have long believed that a property that is encumbered with a long-term management agreement is worth about ten percent less at sale than one that is not. But if an owner lacks substantial hotel management experience, most lenders will require a professional manager to be in place before they will commit to financing. Brands with flagship or luxury marquees insist on tight control and most will seldom put their name on a property they do not manage. Many owners prefer to focus on the development and entrepreneurial parts of the business and leave the details to someone else. For these and other reasons, if you have a sizeable property it is likely that a third-party is managing your hotel under a long-term agreement.
There are differences if you are dealing with one of the third-party managers like Crestline or Interstate, which manage properties across multiple chains and brands. In this article, I’d like to focus on the big brand managers; the companies like Hilton, Hyatt, InterContinental Hotels Group, Marriott, and Starwood, all who manage several different branded hotels within their own organizations. So, they are managing the brand, they are managing the system and they are managing your individual hotel. They wear several “hats” in the process and you need to recognize is that at times the “brand hat” or the “system hat” may not necessarily be a good fit with the needs of your property. Let’s look at a few of the areas of potential conflict:
System Standards and Bureaucracy
A management company is a bureaucracy, with hierarchical organization and formal rules put in place to assure standards of performance and service. Those characteristics are good, to a point, but they are accompanied by difficulty of making changes quickly, limitations on risk-taking, and a tendency to let inertia continue, at least for a while. Most managers appear to drink heavily of the company “Kool-Ade” and if you speak with them you will find that they honestly think their brand is the best, that the hotel owner should almost feel privileged to have them managing for him and if the company did not already “invent” it, it is either unnecessary or not very good.
Brands now get input from “owner advisory councils,” but some of the brand standards seem to be capricious, and to have little foundation in customer-based research. Things like ice buckets and bathroom amenities seem to be forever changing, resulting in shortened useful life and increased owner cost. Has anyone documented that these make any significant difference in customer choice or satisfaction, or did the change occur because a brand official was tired of the old ones, or received a great sales pitch from a supplier?
The business downturn that followed the events of September 11 brought new willingness by the brands to reconsider some of the standards of operation, at least during bad times, but many of them remain arbitrary. A hotel that has virtually no demand for its restaurant after 2:00 p.m. may still be required to keep it open until 2:30 or 3:00 p.m., and absorb the extra costs to do so, in order to comply with brand standards. The “me-too” approach followed by the airline industry is in evidence, with “improvements” made by one of the major brands quickly matched by the others, without apparent study of actual guest impact. The point of difference temporarily created is quickly lost, and higher marginal costs are institutionalized. Take a look at the varieties of new bedding, wireless high-speed Internet, flat-screen televisions and Starbuck’s coffee for a few examples.
An owner, however restrained, typically wants it “now.” He expects the manager to instantly identify problems and opportunities and to act on them with all dispatch to reduce costs and increase sales. It is easy to lose sight of the reality that the management company rules and chain of command must be followed, and frequently it is necessary for communication to move up and down the line before action is approved and can be taken.
An owner wishes to provide guests with what they want, and are willing to pay for, but not more. Change for the sake of change costs him money.
Fee-based Revenue
The manager typically gets a base fee based on a percentage of total revenue and an incentive fee based on profits. The base fee is not dependent on the revenue being profitable to the owner and sometimes it is not. The manager can drive revenue at both the hotel and the brand level, thus increasing fees, without providing a profit to the hotel or a return to the owner. A few examples:
• Unprofitable brunches and holiday parties; more food outlets open than needed, uneconomic local food and beverage promotions.
• Marketing programs that produce new business, but at disproportionately high cost.
• Changes in system standards previously discussed, from logos and signage to bedding and flat-screen televisions to new lobby schemes. The owner is required to provide capital for them in order to continue to meet brand standards. Some may increase room rates and revenue, and so fees to the brand, but they may not produce an acceptable return on the extra owner investment needed.
Cost Recovery for System Services
An owner expects to bear a share of system costs. But does the allocation method distribute them fairly, or, in the words of George Orwell, are “some pigs more equal than others?” Some points to consider:
• Revenue-based assessments place the greatest burden on the larger, high-rate city and resort hotels. The cost to deliver the service may not be any greater than the cost to deliver the same service to a smaller, suburban hotel.
• Several of the brands run with an area manager or Area V.P. organization, where a person who is responsible for several managed properties is also the General Manager of a hotel. There are also shared services agreements, under which accounting, sales and revenue management, to name three, are performed for several properties and costs distributed among them. You may assume these arrangements work out well for the brand. You need to be sure they are effective and fair for your hotel.
• Costs for new programs put in place are usually recovered through allocation to the properties then in the system. Once a program is up and running, a hotel added to the brand comes in under the umbrella. If it is lucky, a hotel that helped fund the start-up gets some benefit of the economies of scale in the form of a lower unit cost. The “goodwill” accrues only to the brand, and becomes another system advantage that can be used to attract new properties – which may be potential competitors.
• When new brands are introduced under the “family umbrella,” they share much of system marketing, the frequent traveler program, and the like. But they may not pay the same rates or any start-up fees.
• A hotel may be required to participate in and pay for programs it does not need, or which it may be able to get at least the equivalent of locally at a lower cost. The timetable for implementation of a program at a property may lead to displaced revenue or increased costs.
System Growth
Growth and vitality of the brand has far greater benefit for its owner than does any single property, however large and grand. More rooms means exposure to more customers and increased brand awareness. It also means more franchise/marketing/ management fees, greater clout for shared marketing programs, more frequent traveler card carriers and more hotels to share costs among. Therefore, one of the top priorities for brand managers is to grow the number of properties in the system. The newest property may be down the street, or around the corner from your hotel.
The brand CEO’s reasoning is disarming: “The new brand facility is not being built to compete for your hotel’s customers; we are putting it into place to attract guests your property is not now serving and to take business away from other competing brands. It will have little or no affect on your hotel.” But let’s have a dose of reality: unless the new-build is a convention hotel or a destination resort that creates (or at least relocates) demand, the new property will feed off the customers already in the market. Some will be ones who formerly stayed at your hotel. And they will have equal access to what were formerly your competitive advantages: the brand affiliation, its reservations system and the frequent traveler program. The new property will be completely new (or totally redone if it is a conversion). Some of the amenities and services you now charge for (breakfast and high-speed Internet are notable) may be free. And its room rates may be lower. So it should not surprise if you then see your occupancy falling, your room rates under pressure, or a little less contribution to occupancy from the family reservation system and the brand frequent traveler program.
There is a huge financial incentive for a brand to put a new hotel into your market, especially if it is a franchised one. Take the case of 2007 performance cited for mature hotels of one brand in a family cited in its franchise offering circular: occupancy at 71.9% and average rate of $121.15. For a 120-room facility, at average performance, this would suggest rooms revenue of more than $3.8 million. Such a property would produce total fees to the brand over $375,000, of which perhaps roundly half would be profit, suggesting incremental brand net income of at least $190,000. Assume the brand manager was earning incentive management fees from your hotel at 15% of cash flow over a given hurdle rate. It could “give up” $50,000 in incentive fees and remain $140,000 ahead. But such a loss of income would translate to lost profits of more than $333,000 to the managed hotel owner.
That brings us to the asset manager’s secret. The (say) $333,000 in lost income may be only a short-term headache. The real financial impact is the reduction in hotel asset value. If the “cap rate” for the property is 8.0, those lost profits translate into over $4.1 million in lost value, or in the potential selling price of the hotel.
If you have a territorial restriction in your Management Agreement, about the only protection it gives you is that another hotel with the same name as yours won’t be built within the named radius. But wait – the brands have many other “arrows in their quiver.” If you own a Marriott Hotel, you could find yourself in competition with a Renaissance; if you have a Hilton, you could see a DoubleTree; if you have a Westin you might have to compete with a Sheraton; if you own a Crowne Plaza you might wind up with an InterContinental nearby.
The threat of another “big box,” though these have happened in larger cities, may be the least of your concerns. What you need to watch out for are the “ankle biters” that are part of the same brand family and which share a common reservation system and the same frequent traveler card. Let’s look at the possibilities from the major brands who manage:
Those are just the main brands. Several have a suite product (Hilton Suites - Marriott Suites - Sheraton Suites) besides the separate all-suites brands listed. Most also have a Resorts designation; several have vacation ownership tag-on’s and spa sub-brands are beginning to emerge. Several of the brands above are relatively new – at least under their current owners. And more are coming.
There are other areas where the goals of the owner and the manager may be very different. Let’s look at a few of them:
Managers Job Growth, Career Path, Bonuses and Benefits
As long as there is good performance, an owner would prefer the hotel’s executive team to remain in place for a long time. That way they become involved in the community and are familiar to key customers. The owner expects to see them compensated competitively, but does not expect to pay for packages that are much greater than what prevails in the local market. The manager is trying to provide relatively consistent levels of pay throughout the company, and is compelled to be competitive in major markets. This may lead to inflated management salary levels in smaller cities. Management companies aspire to provide job security for their managers and tend to be slower in ordering layoffs or delaying the fill of a vacant position than an owner may feel is warranted by the current activity levels or economic conditions.
The manager also strives to create career paths for employees who wish to pursue them; moving department heads to management positions and key managers at smaller hotels to larger ones. The turnover tends to create temporary gaps in managed hotel service delivery and cost efficiency, and usually results in billing the property for relocation and sometimes recruitment costs.
Bonus plans are better than they once were, with several of the managers using some form of a “balanced scorecard” to work out eligibility, but there still may be disconnects between annual owner profitability and long-term viability of the property and the amount of bonuses paid. Bonus is usually calculated based on the annual budget, so there is opportunity for an “enterprising” manager to “sandbag,” (purposely understate expected profits) or “milk” a property by temporarily cutting back in areas like sales and maintenance to reach a greater bottom line and earn a higher bonus. Eventually, these “savings” need to be repaid. Usually, the catch-up cost is higher, and, with the loss of revenue that occurs while this is being done, leads to significantly reduced distributions to the owner. Finally, the brand wishes to be an employer of choice and to compare equally or favorably with other brands in benefits. This tends to create a condition known as “a rising tide that floats all boats,” with brand managers who are paying little of the benefit costs themselves, passing on the costs of what seems like a “Cadillac” benefits program to hotel owners.
Marketing Programs
Brand managers tend to focus on participation levels and economies of scale when these are developed and managed. This may result in a hotel being placed under a particular marketing “umbrella,” and paying its share of the costs for a program that is not suitable, and which does not add value. There are also questionable and probably unproductive advertising “rollups” where an in-season hotel winds up offering a “value rate” like $279 in an ad, next to an off-season property in a different locale that is advertising a rate like $99. Brand programs advertised that feature extras like free breakfast to stimulate weekend occupancy may take dollars away from a hotel whose weekends are already strong. “Participating hotels only” gives a property an opportunity to opt out, but the brands highly encourage participation and customers, who usually do not look at the fine print until it is shown to them, tend to become displeased at an exception.
Hotel web sites that are designed by the manager are typically designed with the brand in mind, not the individual hotel. An independent competitor, and/or possibly another branded hotel in the same market may have a web site that loads more quickly, is more graphically powerful and user-friendly and which has been better optimized for search engines than yours. The groups and meetings tab on your hotel web site will take you back to the brand screen in several cases. The planner who wishes to get an RFP from your property may have to enter its name all over again. Sometimes, they will be invited to consider alternatives from other hotels within the brand.
System Roll-outs
These range from things like a new property management system to maintenance tracking systems to new training programs to a new amenity package. Most seem to be developed to fit an “average” property, and there is often little provision for individualized hotel needs, goods already on hand or guest demand. New installation and training costs almost always have to be paid. Like early settlers of the west, the hotels that pioneer systems installations tend to collect “arrows,” as the system is refined on the fly. Unless there is an urgent need at the property level, or the owner is angling for other favors from the brand managers, there is little advantage to being on the front end of one of these rollouts.
Purchasing Programs
These are also designed to fit a “typical” brand hotel and participation by the management team is strongly encouraged, if not mandated. This may not produce the best possible cost savings in a property for several reasons including:
• A hotel may have specialized needs that cannot be met on a cost effective basis
• A named supplier, who is considered best across the system, may have inferior operations in the area where the hotel is located. I have seen this in the area of elevator maintenance.
• Other hotels of other brands that are in the same market create opportunities to use local suppliers to get equal or better quality at lower prices. I have personally experienced this in the Orlando, Florida market.
• Minimum order requirements, that are necessary to limit delivery costs, may not be a good fit with the use patterns and economic order quantity of a particular hotel.
• Food purchase specifications may not be optimized for intended use of the product or what customers are willing to pay for. A hotel may find itself overpaying for quality it does not use and which its customers do not expect.
Reconciling the Differences
The successful hotel owner who has one of the big brand managers directing the operations of his property needs first to understand the manager’s goals and how they differ from those of ownership. He or she then needs to become a healthy skeptic about actions the brand takes and programs it proposes. Next steps include:
• Challenge the status quo. Request managers to prepare mini-P & L’s to prove the profitability, or lack of it, of multiple food and beverage outlets, brunches, holiday dinners and other special promotions.
• Strive to cut through the bureaucratic “maze” by regular and thorough reviews of hotel performance – from revenue and cost variances to market share to sales production and booking pace. Get explanations for, and thoroughly understand the reasons for “positive” variances, as well as negative ones. Push for actions and timetables to solve problems identified and exploit new opportunities surfaced. Do not accept “business as usual” unless it truly is, and you are completely satisfied with your cash flow and investment return. Participate in brand advisory councils, or at least provide input to other “representative” owners who do.
• Study, understand and question the annual operating and capital budgets. Get information about trends from industry experts and other owners and compare to what is happening at your hotel and in the local market. Get very good explanations for differences or request changes to be made.
• Delve into brand programs. Determine what, if anything, they do for your hotel, how success and ROI (return on investment) are measured and how fees are determined and assessed. If people or services are shared, be sure that the arrangements lead to favorable results at a fair cost for your hotel.
• Unless there is an urgent need, try to keep your hotel in at least the second of three waves for system rollout timetables. That way the system put into effect at your property will be more fully tested and modified.
• Go on record with challenges to new hotels of a brand family that are proposed for your market area. Document current and future contribution from the brand’s reservation system and frequent traveler program for follow-up with senior brand executives.
• Get your own hotel web site, or at least a “splash page” if the brand will let you have one. Most brands now oppose this, but many exceptions exist. Have that web site professionally designed and search engine optimized. Recognize that this is not a static process; the site needs to be checked and updated often. If you cannot get your own hotel web site, lobby for and insist that the one developed by the brand be upgraded.
• Demand to see the benefits to your hotel from joining in buying programs. Government regulation has required this to be voluntary and if they are not paying off for you, you may get out.
• Regularly monitor conformance of the manager to the terms of the management agreement and document instances of non-compliance. This may not be more earthshaking than (for example) a brief letter saying that the monthly financial statement that was due on the tenth of the next month was not received until the 14th and that it is expected by the tenth in the future. This puts you on record as not tacitly condoning non-conformance by silence. It also provides the owner with a “gotcha,” which may, with others, become useful when a serious divergence occurs between the interests of the owners and that of the brand managers, and remedies available under the agreement are considered or possible renegotiation of the management agreement seems called for.
Unfortunately, hotel demand is currently weakening in most markets; room rates are under pressure and hotel profits are declining. Reduced leverage and higher cost of debt will reduce the prospect of new brand competition for a time, but will also lessen the value of an existing hotel asset. The disparity between the goals of the brand manager and the hotel owner is likely to widen and stress levels are apt to increase. An owner needs to understand those differences, and take aggressive action to restore or maintain balance and assure that the management company fully understands and remains focused on the owner’s goals. In that way, he will retain the maximum amount of cash flow and investment return possible and preserve more of the asset value.
Wednesday, October 8, 2008
Develop a Strategic Plan
In my June post I wrote about the need for an exit strategy to maximize the return on investment during the period the asset is held. Dramatic changes in availability and cost of financing and economic slowdown brought about by the housing market crisis and the negative affect of an oil price spiral on travel have extended the holding period and postponed exit for most hotel owners who have staying power. Analysts are forecasting RevPAR declines through 2009 and no growth at all in 2010. These conditions make the development of or updating of a strategic plan even more essential. The plan starts with a thorough SWOT analysis, covering the property’s STRENGTHS, WEAKNESSES, OPPORTUNITIES and THREATS.
The Hotel General Manager and Director of Sales could and should provide help with this, but the asset manager’s secret is that their input needs to be taken with many grains of salt and the final plan should reflect an addition of a bit of the owner’s “pepper.” Strengths need to be real, and should represent a clear advantage that a property has compared to its competitors. The ‘Brand X’ reputation, its web presence, its reservation system or its frequent traveler program are not necessarily strengths if there is a well-performing competitor of a comparable brand nearby that is going after the same customer with equally-strong systems and programs. A “tired restaurant,” for which the Brand Manager may have lost enthusiasm or that may have gone unrenovated longer than called for in the management company master guideline, may not be a weakness at all unless it is being compared to a competitor who has a “fresh” restaurant that is doing good business and attracting hotel guests.
Weaknesses need to be property and market specific. Lack of funds for renovation, for example, is only a weakness if competitors are already in better condition, or are on track for upgrading that will provide them with a competitive advantage. New supply is almost always a threat, even if it is not directly competitive. Depending on location and market positioning, the new property may only be a 20% threat or a 50% one. Potential new supply is a threat only when there is confidence the property will get built. There is much fallout between planning for projects and their opening, even in the best of times.
Potential changes in a demand generator are major threats and if a single customer accounts for a substantial percentage (anything over [say] 10%) of the hotel’s total business, the astute strategic planner will assure that the potential loss of that account or substantial curtailment of business from it are automatically included as threats. Companies get taken over; plants and offices close and executives change. The hotel should have a contingency plan in place to react to the loss of a key customer.
Done properly, the analysis needs to consider SWOT’s by market segment; minimally business, leisure and group. Great meeting space has little effect on choice or stay experience by a leisure customer. But inadequate second ballroom or exhibition space could be a major detriment to attracting or serving the group market well. If a market segment is large, the SWOT’s may be further subdivided; they may be different for corporate meetings and SMERFS groups; for tour operators, weekend package customers and FIT’s. Some brands apply point scales to various rating factors to decide if a hotel is pricing its product properly.
Once SWOT’s have been identified, a strategic plan needs to be developed from which action plans can be put into place. How can the strengths be used, or priced to greater advantage? Can the weaknesses be overcome, and does it make economic sense to do so? If not, is it possible to add or create features or service elements to create new strengths that will offset them? The same kind of thinking needs to be applied to opportunities and threats: does it make economic sense to try to exploit them (adding rooms or function space, converting areas to other use, and so forth)? Should actions be planned, or at least contingency plans developed, to deal with expected threats? Perhaps the planned disposition date should be moved up. Maybe the property is not positioned to best advantage and its target markets, its feel, its pricing and perhaps even its brand should be changed.
Under normal conditions, the strategic plan also needs to consider the life cycle of the property in its market. Various terms are available to describe the quadrants, but essentially they may be one of four:
Current conditions within the overall economy have created a climate in which most hotels are now in the “declining” quadrant. The challenge of making a strategic assessment and plan is to determine the position in which a property is likely to be when recovery is under way. Are there actions that can be taken to put it back into the “Emerging” category, or can the hotel at least be expected to get back into the “Growth” mode? The greatest rewards, at least on a percentage basis, are to be had for investments made in the emerging or growth parts of the cycle. If the property is mature, one needs to think about and plan for how soon it could be and what it will take for the asset to slip into decline. Capital expenses need to be examined with greater scrutiny here. If property needs are going to require more than the normal FF&E reserve, the investment yield will be cut. Here again, it may be necessary to revisit the exit strategy.
If the market and the location are expected to remain viable and physical or brand deficiencies can be fixed, it may be possible to put a mature or declining property back into a growth mode. A major renovation, addition to or reconfiguration of facilities, and/or a different brand may lead to new vitality. It is then a question of the investment required to get these done, and whether it is likely to produce the desired investment return. If a property is declining and further deterioration is expected, the strategic planner needs to look at alternative uses for the building. These all depend on location and demand, but perhaps all or part of the hotel can be converted to retail shops or offices. Seniors assisted living housing is another prospect, and more than one fading hotel has been converted to university housing. Two properties I have been to [as a guest] have been converted all or in-part to temporary detention prisons.
The strategic planner should also consider the position of the hotel asset against the dynamics of the market. A tool, known at one time as the “L & H Grid,” may be useful. The grid appears below:
The grid is used to plot the competitive position of a hotel against strength of its market. The position that every hotel owner would like to be in is in the upper left: strong competitive position in a strong and growing market. Conversely, the least desirable place to be is the lower right: weak position in a weak or declining market. Greatest potential opportunity is found in the upper right: an inferior facility in a strong and growing market. The position of the hotel in the grid is the major factor in deciding the strategy. The goal, for an asset that is not already there, is to move to the left in the grid. A hotel that plots in the upper right is the classic repositioning candidate; if the location is good and the rest can be fixed at a cost that makes sense, a new star is born. A property that plots in the lower right is one you do not want to spend a lot of money for, or put much into, but that does not necessarily mean that all is lost or that conversion to a different use is required. If you can buy it at a deep discount and/or put a bit of capital into high-impact renovations, perhaps you can transform the asset into the best facility in the area. Then plan to increase market share, and possibly gain a bit of extra room rate, to provide the desired return.
The strategic plan is not finished until a financial model has been developed that sets forth assumptions in some detail and forecasts annual occupancy and average rate during the planned holding period; the investment and reinvestment expected; a build-up period for the effect of the initiatives to be realized, and a period of stabilization. If the projected rate of return meets or exceeds the desired hurdle rate, the project can move forward. If it does not, the planning assumptions need to be revised until the goal is in sight. Keep in mind a strategic planning guru’s maxim that says: “The best plan is only as strong as its weakest assumption.” It is easy to make an underwriting model look good by increasing the occupancy and/or rate penetration; by shaving marketing, capital replacements or maintenance costs or even increasing the estimated rate of inflation. But do not fool yourself. If these are unlikely to occur, so is the projected rate of return.
One of the “tweaks” I see in strategic plans is to cut the amount of the replacement reserve during the early years of a new project. After all, a big investment has just been made; everything is new, and there will be little need for replacements – right? Unfortunately, it doesn’t work that way in real life. From a cash flow standpoint, the assumption may be fine, as the immediate replacement outgo will be less. But guest occupancy, staff traffic, competition changes, new customer expectations and time tend to create the need to catch up. And when major changes need to be made, they need to conform to current higher-cost building codes. The typical year addition of 4-5% to the reserve is likely to produce a shortfall when major renovations are needed.
The International Society of Hotel Consultants (ISHC) “CapEx 2007” study that was made with the sponsorship and assistance of the Hospitality Asset Managers Association (HAMA) reported CapEx spending was down from the levels in prior studies due to the overhang of the events of September 11, 2001. It still averaged 5.7% of total revenue. Add repairs and maintenance, and the combined cost average ranged from 8.5 to 9.8%. When the hotel transaction market was active, most press releases on major hotel acquisitions included a paragraph about the major renovations that were planned. A buyer will typically try to subtract the cost of “deferred maintenance” from the purchase price.
When the strategic plan is finished, tactical plans need to be developed and executed to realize it. These will include:
• Property positioning:
o Brand
o Service levels
o Pricing and occupancy and ADR penetration goals
o Marketing, sales and public relations strategies
• Renovation and major capital projects by year
• Pre opening or “reopening” activities and budgets
• Eventual sale
An old proverb says: “If you don’t know where you are going, any road will take you there.” Development of a comprehensive, well thought-out strategic plan will provide the best choice of destinations and greatly increase the likelihood that you will get to where you wish to go, and arrive there on or close to schedule and within budget. For the hotel owner, that translates into the best possible return on investment.
The Hotel General Manager and Director of Sales could and should provide help with this, but the asset manager’s secret is that their input needs to be taken with many grains of salt and the final plan should reflect an addition of a bit of the owner’s “pepper.” Strengths need to be real, and should represent a clear advantage that a property has compared to its competitors. The ‘Brand X’ reputation, its web presence, its reservation system or its frequent traveler program are not necessarily strengths if there is a well-performing competitor of a comparable brand nearby that is going after the same customer with equally-strong systems and programs. A “tired restaurant,” for which the Brand Manager may have lost enthusiasm or that may have gone unrenovated longer than called for in the management company master guideline, may not be a weakness at all unless it is being compared to a competitor who has a “fresh” restaurant that is doing good business and attracting hotel guests.
Weaknesses need to be property and market specific. Lack of funds for renovation, for example, is only a weakness if competitors are already in better condition, or are on track for upgrading that will provide them with a competitive advantage. New supply is almost always a threat, even if it is not directly competitive. Depending on location and market positioning, the new property may only be a 20% threat or a 50% one. Potential new supply is a threat only when there is confidence the property will get built. There is much fallout between planning for projects and their opening, even in the best of times.
Potential changes in a demand generator are major threats and if a single customer accounts for a substantial percentage (anything over [say] 10%) of the hotel’s total business, the astute strategic planner will assure that the potential loss of that account or substantial curtailment of business from it are automatically included as threats. Companies get taken over; plants and offices close and executives change. The hotel should have a contingency plan in place to react to the loss of a key customer.
Done properly, the analysis needs to consider SWOT’s by market segment; minimally business, leisure and group. Great meeting space has little effect on choice or stay experience by a leisure customer. But inadequate second ballroom or exhibition space could be a major detriment to attracting or serving the group market well. If a market segment is large, the SWOT’s may be further subdivided; they may be different for corporate meetings and SMERFS groups; for tour operators, weekend package customers and FIT’s. Some brands apply point scales to various rating factors to decide if a hotel is pricing its product properly.
Once SWOT’s have been identified, a strategic plan needs to be developed from which action plans can be put into place. How can the strengths be used, or priced to greater advantage? Can the weaknesses be overcome, and does it make economic sense to do so? If not, is it possible to add or create features or service elements to create new strengths that will offset them? The same kind of thinking needs to be applied to opportunities and threats: does it make economic sense to try to exploit them (adding rooms or function space, converting areas to other use, and so forth)? Should actions be planned, or at least contingency plans developed, to deal with expected threats? Perhaps the planned disposition date should be moved up. Maybe the property is not positioned to best advantage and its target markets, its feel, its pricing and perhaps even its brand should be changed.
Under normal conditions, the strategic plan also needs to consider the life cycle of the property in its market. Various terms are available to describe the quadrants, but essentially they may be one of four:
Current conditions within the overall economy have created a climate in which most hotels are now in the “declining” quadrant. The challenge of making a strategic assessment and plan is to determine the position in which a property is likely to be when recovery is under way. Are there actions that can be taken to put it back into the “Emerging” category, or can the hotel at least be expected to get back into the “Growth” mode? The greatest rewards, at least on a percentage basis, are to be had for investments made in the emerging or growth parts of the cycle. If the property is mature, one needs to think about and plan for how soon it could be and what it will take for the asset to slip into decline. Capital expenses need to be examined with greater scrutiny here. If property needs are going to require more than the normal FF&E reserve, the investment yield will be cut. Here again, it may be necessary to revisit the exit strategy.If the market and the location are expected to remain viable and physical or brand deficiencies can be fixed, it may be possible to put a mature or declining property back into a growth mode. A major renovation, addition to or reconfiguration of facilities, and/or a different brand may lead to new vitality. It is then a question of the investment required to get these done, and whether it is likely to produce the desired investment return. If a property is declining and further deterioration is expected, the strategic planner needs to look at alternative uses for the building. These all depend on location and demand, but perhaps all or part of the hotel can be converted to retail shops or offices. Seniors assisted living housing is another prospect, and more than one fading hotel has been converted to university housing. Two properties I have been to [as a guest] have been converted all or in-part to temporary detention prisons.
The strategic planner should also consider the position of the hotel asset against the dynamics of the market. A tool, known at one time as the “L & H Grid,” may be useful. The grid appears below:
The grid is used to plot the competitive position of a hotel against strength of its market. The position that every hotel owner would like to be in is in the upper left: strong competitive position in a strong and growing market. Conversely, the least desirable place to be is the lower right: weak position in a weak or declining market. Greatest potential opportunity is found in the upper right: an inferior facility in a strong and growing market. The position of the hotel in the grid is the major factor in deciding the strategy. The goal, for an asset that is not already there, is to move to the left in the grid. A hotel that plots in the upper right is the classic repositioning candidate; if the location is good and the rest can be fixed at a cost that makes sense, a new star is born. A property that plots in the lower right is one you do not want to spend a lot of money for, or put much into, but that does not necessarily mean that all is lost or that conversion to a different use is required. If you can buy it at a deep discount and/or put a bit of capital into high-impact renovations, perhaps you can transform the asset into the best facility in the area. Then plan to increase market share, and possibly gain a bit of extra room rate, to provide the desired return.
The strategic plan is not finished until a financial model has been developed that sets forth assumptions in some detail and forecasts annual occupancy and average rate during the planned holding period; the investment and reinvestment expected; a build-up period for the effect of the initiatives to be realized, and a period of stabilization. If the projected rate of return meets or exceeds the desired hurdle rate, the project can move forward. If it does not, the planning assumptions need to be revised until the goal is in sight. Keep in mind a strategic planning guru’s maxim that says: “The best plan is only as strong as its weakest assumption.” It is easy to make an underwriting model look good by increasing the occupancy and/or rate penetration; by shaving marketing, capital replacements or maintenance costs or even increasing the estimated rate of inflation. But do not fool yourself. If these are unlikely to occur, so is the projected rate of return.
One of the “tweaks” I see in strategic plans is to cut the amount of the replacement reserve during the early years of a new project. After all, a big investment has just been made; everything is new, and there will be little need for replacements – right? Unfortunately, it doesn’t work that way in real life. From a cash flow standpoint, the assumption may be fine, as the immediate replacement outgo will be less. But guest occupancy, staff traffic, competition changes, new customer expectations and time tend to create the need to catch up. And when major changes need to be made, they need to conform to current higher-cost building codes. The typical year addition of 4-5% to the reserve is likely to produce a shortfall when major renovations are needed.
The International Society of Hotel Consultants (ISHC) “CapEx 2007” study that was made with the sponsorship and assistance of the Hospitality Asset Managers Association (HAMA) reported CapEx spending was down from the levels in prior studies due to the overhang of the events of September 11, 2001. It still averaged 5.7% of total revenue. Add repairs and maintenance, and the combined cost average ranged from 8.5 to 9.8%. When the hotel transaction market was active, most press releases on major hotel acquisitions included a paragraph about the major renovations that were planned. A buyer will typically try to subtract the cost of “deferred maintenance” from the purchase price.
When the strategic plan is finished, tactical plans need to be developed and executed to realize it. These will include:
• Property positioning:
o Brand
o Service levels
o Pricing and occupancy and ADR penetration goals
o Marketing, sales and public relations strategies
• Renovation and major capital projects by year
• Pre opening or “reopening” activities and budgets
• Eventual sale
An old proverb says: “If you don’t know where you are going, any road will take you there.” Development of a comprehensive, well thought-out strategic plan will provide the best choice of destinations and greatly increase the likelihood that you will get to where you wish to go, and arrive there on or close to schedule and within budget. For the hotel owner, that translates into the best possible return on investment.
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