If you are thinking about buying a Hotel: this Guide is for you!
Not only distressed hotel properties are seen as “good buys”, but an appropriate selection of hotels for an investor also has to meet their needs, a correct market price, and has to be profitable in the long term. Prices per room involve several variants, to choose an adequate investment one has to consider all of them.
Meeting the buyer’s requirements
Hotel investors vary on their profile, some are more driven to generate an income, others to benefit from capital growth. The majority of them are investing in hotels to ensure capital security and many operators tend to have hotels in different locations to diversify their offer to customers.
The remaining criteria for a ‘good buy’ are ‘reasonably priced’. This is often construed to mean cheap, or good value. However, the real meaning is that the risk/reward relationship is favorable to the buyer, meaning that the rewards outweigh the risk.
To understand the dynamics of this equation, it is important to first identify the potential risks and then ensure that the yield adopted adequately reflects the risk associated with the purchase.
Yield selection for investments
Determining the correct yield with which to value a property investment is fundamental in assessing the value. As such, each investment needs to be assessed on an individual basis, drawing from the most similar types.
Depending on the investor is more likely that they look for a lease than a management contract. Management contracts in unproven markets tend to attract softer yields than in traditionally strong markets with strong underlying property values. The tenant will have a major impact on the yield that will be applied to an investment.
The financial standing of a company is often reviewed through various rating agencies, they provide risk assessments, which the investment market uses when assessing how desirable a tenant is likely to be.
Other factors like the quality of the operator, their suitability for the operation of the particular unit, their track record, and the market perception of the operator will also have an impact on the market yield for such an investment.
Vacant possession properties
It is likely that the market will consider many factors when deciding what multiple of earnings to pay. Everything that could have an impact on the profitability of the hotel and/or future growth in the capital value is likely to have an impact on the appropriate yield.
The so-known expression: location, location, location is more important than ever for hotels, as well as the type of property, the quality, and the condition of the property. In regions where the hotel market is particularly booming, then the number of new entrants to the market trying to gain a foothold will increase competition.
External factors in favor of a certain location, a new airport, and local infrastructure investments drive an underlying growth in the value of the property. When there are opportunities to improve the trading of the property through redevelopment, extensions, or repositioning the property in the marketplace, then profitable investments are likely to take place.
The historic trading profile of the property is crucial for the analysis. In many cases, the more stable the trading history, the more accurate the yield adopted, as well as the availability of funding, and the provision of debt can secure the deal.
On the other hand, if a substantial proportion of revenue comes from a less secure income stream (for example, F&B or short-term sublettings, rather than from rooms) the value of the property might be undervalued. The risk will increase also if the business relies on one company’s bookings for example.
The Flexibility of the operator to adapt to changes in the market and the brand-ability to position itself in a particular event such as COVID-19 post-lockdown could lead to more competition for the property.
Operational due diligence
A potential purchaser or valuer needs to review the property to see how it is operating. A hotel needs to meet the constantly changing environment of its potential customer base to be profitable.
It’s important that the due diligence reviews the operational suitability of the property for its given market. If a property is no longer suited to its historical market, reinventing the business model might be an alternative, without the need for extensive capital expenditure.
If the market requirement has changed, then the achievable trading profits may be impacted. lt is important to review each part of the business that makes up the overall property. A hotel needs to meet the specific requirements of the market it is trying to appeal to, allowing it to compete with current, and proposed future, supply if it is to stay relevant and successful.
From an owner’s perspective, the hotel usually needs the ability to deliver bottom-line returns, while from an operator’s perspective, it may also need to meet brand standards, to help build brand recognition for the operator and ultimately enhance the brand value.
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