The 5 Key Performance Indicators You Must Check Before Financing a Hotel

This is part of an ongoing series on hospitality financing by Sundip Patel, CEO, AVANA Capital.

• Part 1 — The 5 Key Performance Indicators You Must Check Before Financing a Hotel
• Part 2 — 7 Proven Ways to Minimize Your Risk on Hotel Construction Loans
• Part 3 — A “North Star” for Hoteliers
• Part 4 — 5 Ways Tax Reform Will Boost the Hotel Industry
• Part 5 — 7 Reasons Why Hotel Developers are Attracted to Modular Construction
• Part 6 — If You Can’t Beat ‘Em, Join ‘Em: How Hotels are Integrating with Airbnb

  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:

1. 1. Management Team

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!

1. 1. Location

As in any real estate transaction, location is critical. Some of the questions to ask are:

1. 1. • Visibility – Is the hotel site visible from the highway?

 

1. 1. • Proximity – How close is it to the airport, a university, businesses, medical facilities or tourist attractions that draw overnight guests?

 

1. 1. • Accessibility – Is the hotel easy to find and easy to get to?

 

1. 1. • Competition – Does demand exceed supply or is the market saturated?

 

1. 1. • Guest Profile – Is the hotel likely to attract business people, groups or leisure visitors?

 

1. 1. • Demographics – Is the area drawing young people vs. retired people?

 

1. 1. • Area Demand – Is the population growing, stagnant or shrinking?

A thorough examination of the location will help you to predict the hotel’s business volume.

1. 1. Operational Statistics

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.

1. 1. Brand

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:

1. 1. • Marketing— Major franchisors – such as Hilton, Marriott and IHG – invest millions of dollars in advertising every year to build brand awareness, define their identity and increase customer loyalty. That investment has a direct, positive impact on revenue for the franchisee.

 

1. 1. • Guests — Brand dictates what type of guests the hotel will attract: budget, business, leisure, extended-stay, families, guests traveling with dogs or any other unique market segment. Consider whether the targeted sector is lucrative and has growth potential.

 

1. 1. • Amenities and Services – The brand specifies what amenities and services the hotel must offer, which can affect construction and operating costs.

 

1. 1. • Training – Franchisors provide training to their hotel owners, guiding them in their day-to-day operations and setting quality standards that result in higher levels of customer satisfaction.

 

1. 1. • Occupancy– Franchisors provide services that drive occupancy, such as reservations systems, online marketing and loyalty programs.

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.

1. 1. Balance Sheet

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:

1. 1. • Post-closing Liquidity – Is the borrower putting 100% of his (or her) resources into the property? If so, he has nothing to cover any unexpected expenses or cash flow issues, especially in the first few months of operation. Hotel owners should have at least 5% loan balance in cash after closing.

 

1. 1. • Global Cash Flow – Is the borrower dependent on a salary from the hotel or are his living expenses covered in some other way? Does he have other assets from which to draw cash if the new property gets into trouble?

 

1. • Personal Financial Management – Is the borrower living within his means? Does he have any surplus cash flow? How much debt is he carrying? How the borrower manages his own finances will tell you a great deal about how he’s likely to manage your investment in his business.

  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