Guest Post: The New Philosophy For Buying A Lodging Property

Guest Post by Howard Mathews of National Hotel Motel Brokers

The market for the purchase of lodging properties is ever changing. Those of us who have been “in the business” for longer than the short term, have seen the market transition from a buyers market where we were inundated with lodging properties of all shapes and sizes for sale; to our current sellers market where buyers cannot find a property to purchase, even if it is a “bad” buy. Over the past three years in the 20 to 150 room category, there has been an abundance of foreclosed properties. But as the average buyer found out, unless you are filthy rich with your own financing and very good banking connections, the typical 75% to 80% SBA financing was almost nonexistent.

During the recent downturn, we found that banks have been burned when financing foreclosed “turn around” properties or newly constructed properties that had not yet established a mature income stream. Another large group that experienced a large number of foreclosures were properties purchased at the top of the market prior to the crash. Their debt service was too high to be covered by their income which had decreased dramatically from their peak years.

Now we are seeing the market turn again and when we review everything on the market today we again see an abundance of lodging properties in default or REOs. But the majority of properties on the market with an existing history of good income are at very high prices compared to the income. Instead of seeing capitalization rates at the 11% to 12% rates lodging properties normally sell at; we are seeing only 6% and 7% cap rates. Those are not good investments for a lodging property. It seems that the typical lodging properties for sale based on a solid income history at an 11% cap rate and a 20% cash on cash return or better are just not there.

The buyers who are not able to pay cash for the purchase of a new property now find that there is almost nothing on the market that makes financial sense. If they attempt to purchase a lodging property at the offered capitalization rates of 6%, the income is not strong enough for the buyer to obtain new financing without a down payment of 30% to 40%. Without the leverage of a 20% downpayment, the new purchase results in a minimal cash on cash return and thus detracts from the attractiveness of an investment in the hospitality industry. This kind of return falls into the lower return category of an investment in an apartment or a commercial building.

So how do buyers purchase a larger property or move to better locations and find something that makes financial sense? To me, the answer is simple: find a property with problems and add value. Sounds easy doesn’t it? While there is a fine art to accomplishing it, the process is straightforward, if you use the tools available today.

Let’s look at the steps, one at a time:

First, quit thinking about four times (or three, or five or six) gross room income as a valuation of lodging properties. “Times gross” doesn’t mean anything in the short or long run and it is not a true indication of value. We have seen good buys at 10 times room gross and bad buys at 2 times room gross. An under performing property in a good location in a strong market could be a good buy. Also, a 100 unit property showing an annual gross room income of $500,000 and a price of $1,000,000 might be a very poor investment. Even a property showing a decent income with a price of four times gross could be a terrible deal, if all the FF&E is leased instead of owned, or if it is at an airport with the airport shuttle costing the property $100,000 per year. Instead, look for properties that have been mismanaged, have no franchise or the wrong one or are in poor condition with bad reviews.

How do you analyze the upside of a prospective purchase? Let’s start with a typical example. When we see an 80 unit motel with a room income of $800,000 listed for $4,400,000 or about 5.5 times room gross, do we just pass it by and look at the next property on the market or do we stop and examine it more? Without a doubt, we stop and look a little further. Does it have a franchise? No. Is it in good condition? No. Are the rooms clean? No. Is the staff well trained and friendly? No. Is the market area strong? Yes. If these are your answers, then we may have found a winner.

In a properly managed hotel with $800,000 room gross revenue for 80 units, the NOI (Net Operating Income) should be above breakeven and might even cover the debt. This income would give us a Revpar (revenue per available room) of about $27. Now we need to know how to improve it and which franchises may be available. Go online to Smith Travel Research, www.smithtravelresearch.com or phone them at 615.824.8664. Request a Trends report and then a customized report. Insert the property zip code into the search window and see what the 50 closest properties are. If we see that a couple of the major franchises are not listed, then one of those may be available. If the flag would fit this property then we see the possibility of an increase in business and we move on to phase two of our investigation.

Second, look at the property condition. If the property condition is average or below, then maybe by improving the property condition, we can put it at the top of the local market instead of the bottom. Go to www.tripadvisor.com and look at the reviews of this property. We recently investigated a property purchase that was similar to the above scenario. We went on tripadvisor.com and saw 36 reviews with about 32 of them claiming this property was one of the worst properties the reporting guests had ever stayed at. Some buyers might look at this Tripadvisor report and write this property off, but let’s look at it in a more positive way. If this property is in poor or below average condition and still showing a Revpar of $27 or an income of about $10,000 per room per year, what kind of income will it have if it is cleaned up, with a franchise and in above average condition? If Tripadvisor only had rave reviews and every guest loved it and the property was showing this current income, there would not be any upside as it would already be taking its share of the market.

So now we have a property performing below the market, in less than average condition with public reviews on the property condition that would drive even the most price conscious guest away and there is a major franchise available that fits this property. If you are the typical buyer who just looks at the existing income you will walk away and look at something else, but if you want a property that may be a very good buy (not just a good buy, but a very good buy) you will investigate further.

Step 3, look at the price per room. If you are buying this property at $50,000 per room and recent comparable sales in the area show the same then we don’t have any room for improvement. But if it shows that the most recent average sale in this market is $90,000 or $100,000 per room then we have the makings of a good deal. We should ask how much it would cost us to build a new property in this area. If we see that this figure would be above $90,000 to $100,000 per room and we can buy this property for about $30,000 per room less, then is it reasonable to assume that we can buy this 80 unit property at about $50,000 or $55,000 per room and improve the property condition to acceptable standards for $10,000 per room ($800,000). We would now be in ownership at $60,000 to $65,000 per room and the average selling price in the area is over $90,000 per room. We have added value of about $25,000 per room or about $2,000,000 (80 rooms at $25,000 per room). If the property condition is such that it can be improved to market standards for a reasonable amount and still have a price per room under the market average, then we may have a winner.

Next, go to the city or county offices where the property is located. Visit the planning department and the building department. Find out what new hotels are planned or under construction in the immediate area. I find these offices are very helpful and offer great information. If there is not a major lodging property coming into the area then go ahead, if three new properties are being planned, then pass on the deal.

All of these steps are relatively free and you haven’t paid any fees yet. If all of the above steps have yielded positive results then you need to start spending a little money. Now, go online and purchase a custom STAR report (www.smithtravelresearch.com). See what the actual income is for the four or five closest reporting properties that are comparable to the subject property when the improvements are complete and it has a national franchise. If we see that the STAR report shows the ADR of these competitive properties is somewhere around $46 to $50 giving us an annual income of over $1,400,000 on this 80 unit property. Quite possibly the future value would be about $7,000,000 with our total cost at about $5,000,000. Now we have a “very good buy”.

How do we order the STAR report? Go back to the Smith Travel website and again go to the customize report and insert the property zip code. As you look at the reporting information for the properties near your prospective property, you see that they have each property categorized as to their market tier ranging from economy to upper upscale. You will now be creating what STAR calls our “competitive set”, a list of properties that are direct competitors. You must have a minimum of four properties. One franchise or one property cannot be over 35% of the properties chosen for your competitive set so the information can not be dominated by any one property or group. Study these properties carefully, pick properties that are similar in size, location and market tier to your subject property. It doesn’t do you much good to buy an economy property and compare it to a luxury property. It will take two to three days to receive the report by email.

Once you have finished the preliminary steps, the STAR report is probably the most important tool in making your judgment for the purchase. This $400 report will tell you what the average occupancy, ADR and Revpar is for the properties you choose as your “competitive set” on a monthly basis for the past four years. To analyze a hotel purchase, this is the best money you will ever spend. If the report shows the income for the competitive set is substantially above what your property is showing and you can see that with some reasonable building improvements, a franchise and a marketing program you could bring your property income up to what the competitive set is showing, then you are ready to proceed with your purchase.

There may be other factors to consider, but the process for shopping for a property in a slow or depressed economy is much different than during robust period. In the boom times, you can rely on the rising tide to lift you. Not so, when the economy is flat Consider how you can add value to the property through facility improvements, marketing or repositioning. That is where you make your money.

Howard Mathews of National Hotel Motel Brokers can be reached at 925.634.2299 or howard@nhmb.com. Visit www.nhmb.com for more information.

A respected industry professional, Howard had developed relationships with brokers and industry leaders throughout the western United States. His extensive network of contacts has expanded the exposure in the market place that he can offer his clients. Adding Howard’s marketing expertise to his operations background and finance knowledge has created a winning combination for National Hotel Motel Brokers, establishing it as the premier lodging brokerage in California.

In addition, Howard has been involved in over 15 SBA work outs where lenders and owners have asked him to not only sell the property in default at an equitable value, but afterwards assist the owners and lenders in completing a successful agreement for release of that owners personal guarantee at literally cents on the dollar.

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About Heather Turner

Innkeeping Tip and Tricks: Please check out some marketing ideas for Inns and B&Bs, Blogging ideas, Facebook Tips and Social Media Tutorials http://chefforfeng.wordpress.com/marketing-for-lodging-resources/
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