5 Important Considerations For The First-Time Hotel Buyer
Brave enough to buy a hotel during a pandemic?
The shocking decrease in demand created by Covid-19 crippled balance sheets and sidelined many of the traditional hotel buyers such as hotel REITs, current owners, and Private Equity groups. As liquidity pressure mounts on current owners, quality hotel opportunities are certainly going to come on the market (or off-market) at deep discounts, but the window of opportunity is likely to be brief.
The outsized opportunities will be in the segments and markets that are currently the hardest hit. Those markets are core urban and gateway cities that rely on conventions, large events, and international travel. Risk is lurking, but there will be outsized returns for smart buyers.
Welcome to New Investors.
Below is a quick snapshot of key considerations you will want to bear in mind as you evaluate your hotel opportunities:
- Location- The hotel business is a street corner business with location relative to demand drivers and amenities as the most important considerations. Looking past Covid-19 implications, you want to be as close to the demand epicenter as possible. Small differences, even a few blocks, can make a difference in occupancy and/or room rates and, by extension, profit.
- Brand (or not)- If the hotel you consider buying is not brand affiliated (e.g., Marriott, Hyatt, Hilton, IHG), then you have multiple options, including conversion to a brand affiliated hotel. If the hotel is brand affiliated, you’ll want to understand the remaining time left on the licensing agreement. Most franchise agreements convert to the new owner and have heavy penalties for breaking an existing licensing agreement. They may, however, allow you to upgrade within their brand family if it works for them.
- Management company- Hotels have high operating leverage, and the hotel vertical is different from other real estate classes in that the lease is 24 hours and can be repriced daily. Given this dynamic, your selection of the hotel management company to manage the hotel post-purchase will have the greatest impact on your net operating income. More specifically, the selection of key players (General Managers, Revenue Leader) will be the key factor in operational performance. Get this right and have the best shot at maximizing asset value.
- Cost basis- This term refers to the “all-in” amount you will pay for the hotel, including your internal costs related to the transaction. If you significantly overpay for the property, the management company cannot manage your way out. Spend the front-end time to run multiple scenarios and “stress” your proforma and be realistic in underwriting your loss from purchase to recovery. Two mistakes I see most often: 1) Too much optimism in room rates. 2) Underestimating CapEx expenses.
- Real estate taxes- In some markets, particularly core urban areas, real estate taxes have skyrocketed in recent years, and municipalities scramble to cover budget gaps with school systems and other needs. This will only get worse with municipal tax revenue declines created by COVID-19. I strongly recommend using a quality real estate tax consultant with detailed knowledge of the local area.
Buy low, sell high as the saying goes. There is no industry hit harder than hospitality right now. As a result, net operating income in core urban and gateway cities are heavily depressed, and defaults and mortgage delinquencies are 50% higher than during the Great Recession. If you believe travel will return, then those with access to capital have a brief opportunity to buy quality hotel asset(s) at the bottom of the cycle. The key is to buy the right hotel products at the right price.