Re: Hotel Development Exit Strategies - Posted by ray@lcorn
Posted by ray@lcorn on June 13, 2009 at 13:26:25:
Richard,
Thanks for the well-wishes… it’s good to be back.
I’m working on two hotel projects right now so your questions are timely.
Last one first? ?what else should I be asking you right now that I’m not??
Answer: Why in the he** are you thinking about building a hotel? 
First comment I have to make is that hotels are not just a real estate deal. They are a business with a large real estate component in their value, but first and most important is the business aspect. Existing hotels are highly vulnerable to competition, economic trends, fuel and energy costs, labor markets, and geographic, cyclical and seasonal revenue trends. These factors and more make the application of normal real estate valuation and projection methodologies irrelevant.
A new hotel is even more difficult because it combines the worst risks of real estate development with the worst of business start-up risks… long lead time for planning and approvals, large capital investment just to get to the ?go? point, long construction time with carry-costs that in addition to interest expense typical in RE development, includes bringing management and staff on board pre-opening, along with marketing, advertising and start-up inventories. Hotels typically require significant ramp-up time to attain positive cash flow. And as you might imagine, they are tough to get financed in normal times, and these ain?t normal times by a long shot.
Now can you see why I asked the question above? It?s not just kidding. If your project is a large one and the hotel is just one piece of it I would first advise that you concentrate your efforts on marketing the site to a hotel developer. There are lots of them around, some even solvent! (joking, kinda!)
Next question: ?Where do I go to learn flags’ requirements for room size, amenities, facilities, layout, etc.? How early on in the process do the flags like to be involved? How early on do they commit? And to what extent do they commit??
In dealing with the ?flags?, first realize that the franchise companies are in the business of selling franchises, not running hotels. They?ll take your application fee at almost any point in the process unless there is a competing project in the market. Many have likened their business model to the world’s oldest profession, if you get my drift.
You can get their building and site specs and developer financial requirements through the franchise sales staff, whose contact info will usually be on a separate part of the chain?s website. They will want to talk to you directly, get a sense of your background and some details about the site location. Then they will mail you a lot of stuff, pretty pictures, lots of slick promo pieces and architects? renderings, and lots and lots of forms. Get used to it, there will be more.
If they think the deal has potential, or need to make a sale that week, they may send a rep out to meet you and hand-deliver the stuff. If you?re serious, talk to several companies at once. Saves time, and you find out real quick it is a competitive business. A good site can set up a great competition between flags.
As to when, now is good. You won?t get a deal financed at all without a franchise, so that?s the first decision that has to be made. Once you pay the application fee you?ll be committed to that flag for that specific site. They aren?t committed until they approve the application, and few will grant any market protection for the brand unless you know how to negotiate for it. Their extent of commitment is spelled out in the franchise disclosure docs, which details any time triggers on construction, etc. Once the site, developer, application and franchise are approved you will have a window of time to get it built, usually about two years, or the deal is voided. No, you don?t get your fees back if it blows up.
?What types of arrangements exist with flags for management? For example, I’ve seen 50% of first-year’s gross revenue with 3.5% annual bumps. Is that typical??
Few of the franchise companies manage properties except for the large hotels you see in cities. Marriott, Hilton and Starwood have management operations, but the rest are focused on franchise sales. If you are a first-time owner then you will need a mgmt company to get financed. There are a lot to choose from, but like everything else, it?s hard to find a great one.
As for fees, I assume that your 50% number above is a typo? 5%-7% is more like a normal mgmt fee. But realize that is after the hotel pays all salaries, expenses, benefits, etc. for the management company?s personnel from the hotel revenues. Annual bumps are not typical. Contracts are based on performance and can be subject to annual renewal, or multi-year, and include termination upon sale.
First question last; ?What are possible exit strategies for hotels? In particular, what range of “hold” strategies are there??
Rather than “hold strategy” it?s more like, get it open and Hang On? ?hold? means its making the payment. That first year is a roller-coaster depending on the local season and your opening date in relation to that. Once the operation is stabilized you only have to worry about things like who is going to build another hotel across the street or across town that cuts off your traffic or steals your res system bookings because its the same brand. If you keep it for the long term (and for all my cutting comments it is a great business, I?ve been in it 20 years) it is all about the people. Service is the game and excellence is what wins.
Margins are still decent, although the industry is seeing pullback right now along with the rest of the economy. Limited service NOI?s will run around 40%, full-service about 25%-30%, budget class, owner-operated run the highest margins, around 50%.
Exit strategies are the usual? sell, exchange, refi. There is a great resale market for hotels, very organized and efficient (moreso than other ComRE types). Good performers will bring valuations in the high single-digit caps, say 9% to 11%, but they figure them a bit differently than we do. (the old standby industry rule-of-thumb of 3 to 3.5 x gross is still in use, but only on a preliminary basis) The typical optimum hold time is about 5 to 7 years, but by then most one-unit owners get addicted to the cash flow and don?t want the hassle of trying to build another one and they wind up keeping it. Others build them to sell immediately, plow the profits into the next deal. Also, foreclosures seem to be pretty steady, meaning it hasn?t gotten any easier.
Now, are you still sure you want to do this?
ray