In recent years losses on non-performing hotel loans have made many lenders gun-shy. They see hotels as risky and believe assessing the business is complicated. But to sweep away in one broad stroke an entire segment of the real estate market means these lenders are missing out on potentially great opportunities.
A recovery in the lodging industry has made hotels attractive again but with one caveat: you must do your research. Here are the five Key Performance Indicators (KPI) you need to know when evaluating a hotel transaction:
As in any business, the people behind the project are often what determine success or failure. For hotels, bet on the team.
Look for an owner or management team that is all-in. In every aspect of the hotel’s development and operation, they are fully invested, financially, but more important, mentally. They are passionate about the property and care deeply about their customers.
Hands-on owners trump absentee owners every time. They’re the ones who will roll up their sleeves, make beds and scrub toilets when times get tough. But passion only goes so far.
Evaluate the team’s experience level. Have they attended Cornell’s or USC’s hospitality program? Have they been through franchisor training?
First-hand experience counts too, perhaps even more than education. People who’ve grown up in a “hotel family” or have worked in the hospitality industry for years bring real-life expertise to the job; and there’s no substitute for that!
As in any real estate transaction, location is critical. Some of the questions to ask are:
A thorough examination of the location will help you to predict the hotel’s business volume.
Gone are the days when you make judgments about a loan based on gut feel. Data-driven decisions are far more accurate. Fortunately, these days there’s no shortage of data.
Statistics from other hotels in the franchise of the proposed property are an excellent gauge of what to expect. They provide a rule of thumb for items such as net operating income (NOI) and net cash flow (NCF), including operating expenses, payroll, debt service and more.
Most limited service properties operate at 28% to 40% NOI. NOI is a percentage of the Gross Room Revenue and therefore a quick indicator of how efficiently a hotel is run.
Use a cap rate of 8% to 14% to assess the value of a property prior to receiving an appraisal. Most limited- and full-service brands will fall in the 8% to 10% cap range. Knowing the NOI/cap will help you determine the value of the property and LTV upfront.
Hospitality assets usually trade between 3x to 5x of gross room revenue, thus providing another way to value the property. States like California or coastal cities will be at the higher end, typically four to five times the room revenue.
By comparing your projections with existing hotels in the franchise and using the ranges mentioned above as guides, you can estimate whether the hotel makes financial sense.
The choice of franchise has an enormous bearing on a hotel, influencing nearly all aspects of operation. A strong brand greatly increases a hotel’s potential success in the following ways:
Bottom line: A well-established, high-quality, name-brand franchise brings numerous benefits to the table and should positively influence your evaluation of the hotel.
The feasibility of the hotel is one side of the equation; the strength of the borrower’s balance sheet is the other. Here’s what you’ll want to consider:
Tally the Score
After doing your research, rate each of the five key performance indicators on a scale of 1 to 5, with 5 being the strongest. Now add them together.
To ensure strong principal recovery, lend on the asset only if the total score is above 20. If assessed accurately, the five KPIs will have helped you to make a sound decision