Make Sure The Right Contingency Plans Are In Place

I once met with a hotel owner, not long after taking over management of his group of hotels, to tell him how I planned to reenergize the lackluster and ineffective sales effort I found in place. I told him that I planned to create a new position of Divisional Sales Manager and promote a “sparkplug” I identified at one of the properties. He asked but one question: “What if she gets hit by a truck?” That was my introduction to contingency planning. I had used long-range planning for many years; looking at facility condition, patronage levels, operational trends and market developments to plan when changes should be programmed to an area or an outlet. I had also been involved in succession planning, where a grid was developed to provide theoretical promotions and transfers if a key manager was promoted or left. I was also well-acquainted with emergency or disaster planning. Contingency planning is different.

Most management companies have detailed emergency plans, and well-publicized disasters, from major fires to bomb threats, death or serious injury at the property to power blackouts to earthquakes to hurricanes have put hotel managers to the test. Where they have performed well, and even superbly, it is usually because they were working, like airline pilots do, from a well-prepared plan. These emergency plans provide the framework for development of sound contingency plans. They detail an event that may occur – the “trigger point, “and provide complete action steps to be taken, and by whom. Current economic conditions, along with cuts in airline seat capacity, are leading to 90-day forecasts that show large shortfalls versus budgeted profits for most hotels. Early trigger points have already been reached and most asset managers, and many hotel managers, have already put into effect a part of their contingency plans.

Ideally, contingency plans should be developed during times when business is good. What actions will be taken if volume drops by 10%? By 20%? By 50%? The tragic events of September 11th highlighted the need for such plans – business survival. Precious time (and much money) was lost by those who had not already developed those answers in advance. Sadly, another act of terrorism is possible (many lenders are requiring insurance against this peril), and the effect on hotel business is predictable. Aggressive action is essential to limit losses in NOI. The right contingency plan needs to deal with three major areas at each potential trigger point:

1. What actions can be taken to reduce fixed costs?
2. What operating standards and procedures can be changed to cut variable costs without destroying the loyalty of the regular customer base?
3. What sources of revenue that were earlier overlooked or were thought less desirable can be tapped?

Contingency plans are brutal, of necessity, and for that reason some managers resist developing them. The jobs of assistant department managers seem always to be the first to be cut; it is one of the quickest ways to lower fixed costs. I have seen charts with names and salary amounts at various stages of assumed business decline. The next area to be looked at is standards of service and level of amenities. Cuts here will reduce some of the costs to serve every guest.

The hotel manager must be persuaded to do a “high wire act” to balance the expectations of current customers with what they are paying. These guests may be somewhat different; paying lower rates, than those originally budgeted for. Many times, service levels can be tweaked slightly to cut costs: coverage at the front door and at the bell stand may be a little less, and it may take a little more time for a guest to check in or out. Food and beverage outlet hours of operation may be curtailed to limit staff on duty during periods when there is little customer demand. Those of us who have been through these downturns before have a “laundry list” of best practices garnered from experience. They range from limiting amenities to reducing the amount of bathroom towels to squeezing service contractors and concessionaires to raising/lowering public area temperature set points and cutting slightly the temperature of hot water delivered to guests and the house laundry.

A sound contingency plan will, at some point, revisit areas where the benefit of change was previously considered slight or undesirable. These may include:
· Extra energy conservation measures. If a Green program is not in place, it should be called for
· Outsourcing of departments or services (including valet parking, concierge, laundry, business center, restaurant and coffee shop)
· Closing, temporarily restaurant and lounge outlets and floors of guest rooms
· Leasing or finding different uses for non-revenue producing or low revenue producing areas

The contingency plan should also provide for an updated review of what competitors are charging and for increases in restaurant and banquet menu prices, parking charges, and other guest user fees where warranted to produce revenue not expected when the operating budget was approved.

A good contingency plan will provide actions to be taken if business from a major customer is lost, if a single customer accounts for a large percentage of hotel revenue. Companies go bankrupt, are acquired, move their headquarters and are, themselves subject to the possibility of losing a major part of their business. When occupancy falls, the typical hotel manager strategy is to try to replace profitable business earlier expected with customers who are paying less. This does not necessarily mean rate-cutting, though the industry has a history of succumbing to that course of action and it becomes difficult for a manager who does not wish to cut rates to resist in order to keep market positioning. But the loss of business travelers can sometimes be offset with more government employees, contract business and leisure customers. New packages and special events can be created; preferred corporate programs can be started or made more appealing. Contract business or tour groups can be negotiated.

If group pace falters, because of curtailed attendance or events from corporate and association groups, the lost business can sometimes be replaced with business from more price-sensitive, social, military, etc. organizations; the SMERF’s.

Capital spending should be thoroughly reexamined and potentially curtailed. Since more capital increases the investment base, cuts will preserve part of the rate of return from a reduced NOI. But do not lose sight of the overall investment objectives and exit strategy – see the last post. A period of lower occupancy may provide a window of opportunity to complete renovation or other return on investment projects with the least displacement of revenue. And projects whose ROI rate stays high, after factoring in the changes in business conditions, will quickly pay for themselves and should not be dropped as part of an arbitrary percentage spending reduction.
A hotel owner or his asset manager also need to assure that contingency plans are in place to provide business continuity: How will telephone service be maintained or rerouted to cell phones if regular service goes out? How will current and historical electronic data be backed up and safeguarded? How will staff be communicated with or perhaps housed on property? How will reservations be controlled, check-ins and check-outs tracked and accounts kept without computers? How will records be protected? And on and on.

Insurance is another form of contingency planning. It’s not a secret, and I’m not going to write much about it here. Of course, you do have adequate coverage, and deductibles in line with the risks you can afford to bear -- for property damage – liability – business interruption, theft and specialized policies to cover loss from hurricanes, floods, earthquakes, or the like, if you are in an area that has exposure. Just like the case with your personal home and auto insurance policies, a higher deductible will result in a decrease in premium. It then becomes a question of how likely and how frequently you believe a loss is likely to occur, then weighing the insurance premium savings against your willingness and capability to absorb those losses.

Be sure to shop your policies. Even if your management agreement provides for insurance to be obtained by the manager, you should get quotes to provide the required policies directly from at least one hospitality insurance professional. Sometimes, you will find you can get better coverage for less money. Bring the differences to the attention of your Manager and persuade him to change carriers or negotiate. Keep in mind that insurance premiums tend to follow a cycle, escalating after notable national losses until competition leads to reductions. Do not fail to test the market every time your policies come up for renewal, or you may miss a major opportunity for cost savings.

If complete and well-crafted contingency plans are in place, the hotel manager will be able to deal routinely with these anything-but-routine situations, when and if they do occur. Nobody voluntarily participates in a recession. The right contingency plans, quickly and properly put into effect, will assure that your hotel does not do so to the extent of its “fair share.”

You Need to Have an Exit Strategy

Introduction

If you are the owner of a portfolio of hotels, you are undoubtedly already aware of Hotel Asset Management, and how it can increase the value of your investment; you probably employ or work with one or more professionals in the field. If they are members of HAMA (Hospitality Asset Managers Association) or ISHC (International Society of Hotel Consultants) they already know and use these techniques. In fact, several members have written or contributed to textbooks on the subject; others are reaching college-level courses on it. But, if you own a single hotel asset, or perhaps even a small group of hotels, you may not be taking full advantage of all the strategies and techniques that professional hotel asset management has to offer. This blog is for you. A professional asset manager, I have operated as Burr Company since 2004 to asset manage select hotels and assist owners with acquisition, disposition and value-enhancing strategies. My experience includes asset management of over $900 million of hotels, including Marriott, Hilton, Hyatt, St. Regis, Westin and Embassy Suites. Previously, I was a large hotel General Manager, a multi-unit Vice President, a Franchise Operations Director for one of the brands and a Principal at one of the leading hotel consulting firms. This Blog will set forth asset management “secrets” to help the single-hotel or small hotel group owner get more out of his or her investments.


First Secret: You Need to Have an Exit Strategy

It’s no secret to any hotel owner – or prospective buyer, or for that matter, to an army of brokers, lenders and consultants, that the hotel industry is a challenging place to be right now:
· Our national economy and perhaps much of the worldwide economy is reeling from the effects of the housing crisis, the retrenchment of the financial industry and the big run-up in the cost of oil. Unemployment is rising, inflation is threatening, businesses are cutting back and travel is slowing.
· Money remains available for financing, but interest rates are higher, and the terms and borrower requirements are much less favorable than they were. Lenders are again demanding personal guarantees, lower LTV (loan to value) ratios, amortization of senior debt from day one and greater debt service coverage.
· The cost of non-hotel elements of business travel: air fares, rental cars and business meals are escalating even more rapidly than hotel room rates. In the face of earnings pressure, at best, or declining profits, at worst, companies are cutting back on people, and on their travel and on their meetings.
· Leisure travel is being cut by the reality that more money is needed for necessities so fewer discretionary dollars are available. People are planning fewer vacations, and ones that are shorter and closer to home. Foreign visitors are still creating room demand in gateway cities but many domestic, middle-class customers are trading down in their choice of hotels.
· Hotel profits are under pressure, being squeezed between softening demand, and higher costs of labor, fringe benefits, energy and foodstuffs – to name just a few.
· Hotel cap rates have increased and values have declined. A willing buyer will commit to purchase only at a higher cap rate – a lower multiple of earnings. Frustrated sellers are reluctant to accept those offers because they are so far below what was quoted to them less than two years earlier.

The good times will return! Keep in mind that the hotel business has been and will continue to be cyclical. Though it lags by several months, hotel demand is highly correlated with national GDP. Just remember what happened to hotel business, and to hotel values following the September 11th terrorism events. The steep decline was later followed by far greater increases. Or go back a little further, to the times of the RTC crisis. At that time, lenders viewed a hotel loan about as favorably as cancer. I recall sitting in a bank lending officer’s office, with a hotel owner in the 90’s. The loan was current, and had been kept that way despite the hotel’s poor performance, because the owner, a former director of that bank, had dipped into his deep pockets to meet his obligations. But the term loan was due, and the owner was trying to renew. “No way!” said the loan officer, “we just are not making any hotel loans.” A less substantial owner may have lost the property at that point. Many did at that time. Fortunately, this one had other businesses and other resources. He got a new loan and invested more money to renovate the hotel. When the next up-cycle came, he sold it at a nice profit. Because he had a vision (of better hotel performance and greater value) and an exit strategy (a plan to sell at a target price) he cashed out of his hotel investments a winner.

Take a look at the real estate investment alternatives. Apartments and self-storage facilities appear to be making comebacks but retail is losing its luster, office buildings are mixed and industrial sites are questionable. Every one of those investments involves finding a tenant and signing a term lease. Only in the hotel business, if economic conditions permit, can you raise the rent every day. With the threat of higher inflation looming (and many say it is already here) where would you rather be? The latest forecasts from Hospitality Valuation Services (HVS) predict an average 8% increase in U. S. hotel values per room in 2009, followed by a rise of 17% in 2010 and another 8% in 2011. This follows value declines of 5% in 2007 and (forecast) 4% in 2008. During the “boom” period of 2004-2006, U.S. room value growth ranged from 27% to 21% annually. Indeed, “Timing is everything!”

Unless your name begins with “Sheik,” or perhaps “Warren,” you need to recognize, from the day you build or buy it, that will be out of your hotel investment at some point. Let’s look at some possibilities:

You are out of money [“the well is dry!”]
Either the hotel isn’t doing well or other investments aren’t performing or financing isn’t available. The hotel needs cash and you don’t have it or can’t raise it. This is what the brokers refer to as “a distress sale” and 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.


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:

o Managing the outflow of capital expenses (and maintenance costs) appropriately.
o Structuring financing and lease versus buy decisions for greatest benefit.
o Making short-term decisions on a host of other items, including service contracts, booking agreements, sales & marketing activities.
o 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, 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? If the answers are “No,” and “no,” perhaps it is a good time to recycle the capital and the property should go on the disposition list. A “harvesting strategy” is then put into effect: limit capital replacements and maintenance and, depending on the timetable and current status, either boost the sales budget or cut it back. This is a great asset management discipline that should be applied by any hotel owner on an individual asset basis.

A sound exit strategy, put in place at the time of entry, will greatly increase the likelihood that when you do exit your hotel investment it will be on your terms, to your advantage and that you will have increased your return during the holding period. This is the first in a series of Hotel Asset Management secrets.



Next: Make Sure the Right Contingency Plans Are in Place.