Re: Are small hotels a good investment? - Posted by ray@lcorn
Posted by ray@lcorn on August 06, 2005 at 11:25:22:
Mike,
Bill’s points are dead on, and from an owner of a very similar property.
I’ve been in the hotel business since 1990. We currently own an 80 room franchised property and the monthly operating statement is three pages long. The income portion is seven lines, and the expenses are 75 lines.
Here’s the line item expense categories:
Advertising
Website Hosting
Advertising - Other
Total Advertising
Automobile Expense
Van Maintenance Expense
Van Gas Expense
Van Maintenance Expense - Other
Total Van Maintenance Expense
Total Automobile Expense
Cash Over / Short
Cleaning Supplies
Continental Breakfast
Dues and Subscriptions
Employee Recognition
Equipment Rental
Lease Expense - Computers
Total Equipment Rental
Franchise Fees
Guest Supplies
Insurance
Health Insurance
Liability Insurance
Total Insurance
Interest Expense
Loan Interest
Mortgage
Total Interest Expense
Laundry Supplies
Laundry Valet
Linen
Maintenance & Repairs
Equipment Repairs
Other Maintenance & Repairs
Total Maintenance & Repairs
Marketing Fees
Office Supplies
Outside Services
Snow Removal
Total Outside Services
Payroll Expenses
Bonus
Front Desk Payroll Expense
Housekeeping Payroll Expense
Maintenance Payroll Expense
Management Staff Payroll Expens
Manager Payroll Expense
Payroll Expenses - Other
Total Payroll Expenses
Postage and Delivery
Printing and Reproduction
Promotional Expense
Reservation Fees
TA Commissions
Taxes
Real Estate
Total Taxes
Telephone
Long Distance
Paging Expense
Telephone Line Fees
Telephone - Other
Total Telephone
Travel & Ent
Travel
Total Travel & Ent
Uniforms
Utilities
Cable
Electric
Exterminating
Gas
Trash
Water & Sewer
Total Utilities
Total Expense
Granted, this is a much more sophisticated operation than the deal you’re looking at. But the point is, a hotel is an operating business and you must value it as such.
The rule of thumb for hotel valuation is around 3 to 3.5 x gross. Some go for less, some for more, but over the years that number has become the benchmark. This deal is priced at 7.8 times gross, so unless the dirt has exceptional value for redevelopment, the deal is way overpriced. (3.5 x 160,000 = 560,000)
Average caps for small, owner-managed properties range 11%-14%. A well-run limited service property (i.e. no restaurant) will have an NOI of about 50%-55% of gross. That assumes paid management, which 27 rooms will probably not support.
Personally, I wouldn’t buy a hotel that could not support absentee management, and be franchised. I don’t want to spend my time renting rooms and babysitting employees, and a good franchise can produce 15%-25% of gross revenue that would not otherwise be available. The minimum size for a franchised property is around 50-60 rooms, and even then you’re on the borderline of whether the franchise makes sense.
And yes, you can depreciate the property, but I would remind you that before you can use depreciation to shelter income, there must be income to shelter.
All that said, I am not negative on owning hotels. Quite the contrary, as I think an operating business is an excellent adjunct to investment real estate. RE properties generally produce even cash flows, and can provide an excellent platform to support the cyclical cash flows of most businesses. Conversely, the business produces excess cash at its cycle peak that can be used to acquire more real estate. The trick is to find the right business, at the right price, that matches your talents and capacity.
ray