May 13 2012
Why Hotel Financing Is Different Than Other Commercial Real Estate Loans
The term real estate represents livable or leasable buildings, like homes and offices, or land. Hotels fit the initial definition, but they are not merely another part of real estate. Hotels are also complex functioning organizations. Investors normally do not realize this and overlook the challenges within these buildings.
Commercial real estate investors who know how a hotel’s operations come into play when analyzing value may best help themselves when in search of hotel loan.
In all cases, the operating business plays an important role in how hotels are appraised. A hotel’s day-to-day operations is complex, so it’s important to have the proper operational data to assess a hotel’s value.
There are many types of hotels: limited-service, select-service, full-service, convention, resort and extended-stay hotels. These categories also provide various quality levels, such as a one-to-six rating, using stars or diamonds. There are also brands – of which there are over than 50 – that match up to the type of hotel.
The different combinations of the aforementioned classes and quality levels produce an image of what the asset is like and what it’s worth. The brand name tells a story in regards to a hotel and sets an image of how the hotel will perform. Nevertheless this alone does not set the hotel property’s value – again, the hotel’s operations verify its value.
Unlike retail centers and many other property types, hotel fees change daily. Large, full-service hotels show this particular pricing volatility more regularly than smaller, limited-service hotels. There also are daily fluctuations in room occupancy and a number of additional revenue streams, including food and beverage, rental space, golf, spa, parking, resort fee,telephone revenue, and others.
This results in operational expenses being higher for hotels than for other property classes. The smallest hospitality buildings have eight to 10 employees, and full-service properties require typically one employee per room.
With all these challenges, why would anyone invest in a hotel? One reason is that, with specialized management and a solid brand, and infused by the proper investment capital to enhance the property’s visual appeal and condition, a hotel’s worth can multiply significantly and return an investment many times over.
Commonly, this is because the operating business results in value. For instance, a 400-room hotel that operates at Sixty percent occupancy with average room rate of $150 generates an annual room income of $13,140,000. Other earnings sources, like food and beverage, will bring the total revenue to $15 million. If the net operating income (NOI) is 20%, than the hotel’s profit is $3 million. If the market cap rate is Ten percent, the property has a potential sale value of $30 million.
Let’s say management takes over when the property is bought, a new brand is introduced and the hotel is renovated. Concurrently, market conditions boost and the cap rate tightens. The property now generates 65 % occupancy and a $200 per room rate. The new annualized room earnings is $18,980,000, and the total income is $21,000,000. With new supervision, the real estate generates an NOI profit of 25 %, and the new NOI is $5,250,000. A better economy signifies a lower cap rate of 9 %, and the asset is now worth $58 million. The rise in value, over a 2-year hold, is about 100 percent.
This example displays how the operating business’s management can alter the property’s value. In today’s market, some hospitality investments can be acquired at a great discount, representing an great possibility for buyers. And of course why some lenders are continuing to do hotel financing for the right property and operating manager.
