Hotel Motel

Hotel and Motel Investment

After 9/11, the tourism and travel industry took a major financial hit. However, this rapid decline positioned certain sectors, including lodging, for a spectacular comeback. And while the double digit growth experienced during the recovery may not be sustainable forever, the long-term outlook for hotel/motel investment opportunities remains strong.

Business travel continues to boom as the baby boomer generation continues to enter into retirement, leisure travelers will provide full service resorts and tourist cities such as New York and San Francisco a steady pipeline of business.

Additionally, with interest rates remaining low in recent years, the relatively higher return rates in hotel real estate have attracted an increasing amount of new debt and equity capital into this market. The result has been solid growth in property value as the supply of buyers and investment capital remains strong.

Investing in hotel/motel properties requires that you know your niche, or at a minimum have a vision for creating that niche. Finding this niche and matching it with the appropriate property is critical. A three to four star hotel with a restaurant, bar and gift shop, located along I-80 in Iowa might attract enough business to keep the doors open, but the same property located in Las Vegas will likely struggle against the larger more upscale resorts catering to the affluent gambler. Knowing your target market and matching your services to the cliental is a crtical key to success in the lodging industry.

Perhaps as important as finding your niche is determining valuation and verifying that you are investing your hard-earned dollars in a property that can generate an appropriate return for the risk. There are a variety of methodologies for calculating the value of a commercial property. Appraisers will often use a combination of replacement cost and comparable sales analysis to determine a value. While this may be useful to some degree, perhaps for determining a list price for sellers, buyers are encouraged to analyze their properties from an income perspective -- specifically by calculating the net operating income (or NOI) by subtracting expenses and the cost of vacancy (excluding interest, amortization and depreciation), and dividing it by the market capitalization rate.

Cap rates vary from market to market and by type of property. Generally speaking an investor prefers a higher cap rate, meaning that they’ve paid less for a property with a given income than they would for a property with similar income but a lower cap rate. Cap rates are also a function of risk. Like most investments, the higher the risk, the higher the return, and cap rates are no exception. Top quality, full-service hotels in good markets have cap rates in the 7 to 8 percent range while middle tier properties hover around 10 percent. Older, limited-service hotels have cap rates over 10 percent.

Many commercial investors use a grading system to assist them with their research. For example, with office space, properties are divided into Classes, A, B, and C. When investing in hotels, there are similar tier systems used to identify the different levels of investment in terms of return and risk. There are generally considered to be around four categories or tiers of property. Essentially, newer, quality hotels located in popular resort areas or major metropolitan areas will fall into the first tier. These are usually 4 to 5 star hotels in terms of service or amenities, but a newer 3 star with great location and no immediate need for renovation might fall into this category as well.

Second tier properties are mid-market hotels in a good location. They are relatively new (less than 10 to15 years) and will require little to moderate renovation in the near future. These are the ultimate “middle-class” operations, offering just enough amenities at a reasonable price to capture a majority of the market.

Tier 3 and Tier 4 properties are older buildings, usually with exterior room entrances and limited or no amenities. These are some of the most challenging investments, but their returns can be terrific. In fact, in recent years, the strongest growth has been in the limited-service hotel market with an average of 11 percent annual revenue growth and close to 18 percent in operating profits.

Investing in a hotel or motel is certainly not a one-size-fits-all venture. From roadside motels along rural interstates to beachfront resorts, the variables are innumerable.

However, the one common thread that exists across all levels of such an investment, regardless of amenities, is that revenue and profits are driven primarily by guest room revenue -- the one exception are casinos, who often give away rooms so that their guests will spend money gambling. Focus on providing the guest with a pleasant night’s stay for an appropriate price, and you’ll find your job a whole lot easier. While restaurants, bars and banquet halls can add gravy to your margin, a lodging facility will ultimately fail if the guests are not satisfied with their room. Industry experts do acknowledge however, that alternative revenue sources offer more consistent and predictable income. Many hotel owners have developed these additional cash flow amenities to smooth the often volatile room rental market.

Financing a hotel or motel is like financing any other commercial property. Lenders will take the usual things into consideration such as operating costs and income, as well as the overall condition of the property. Underwriters will also consider expected future growth and the overall risk of the investment (think back to market cap rates). Expect a lender to loan a maximum of 70 percent of the sales price, so you’ll need the other 30 percent either from a down payment or through owner-financing.

With almost any commercial real estate venture, an investor needs to identify how involved they’d like to be in the management of the property, and in the case with hotels, the daily operations of the business. There are a myriad of different management structures you can establish, and the larger the operation, the more complex these decisions will become. Room cleaning and laundry, building and grounds maintenance, restaurant operations, etc. are all on the table when it comes to who and how those operations will be managed.

There are also opportunities to convert small to mid-size private operations to more well-known franchises such as Hampton Inns or Best Western – thereby reaping the rewards of its corporate support, training and national advertising campaigns.