It’s critical to understand and evaluate the customer, value versus cost, and strategy and capitalization.
Within real estate, hotels are the one asset class that is
an actual operating business more so than a real estate asset, whereby
incremental increases in revenues directly impacting net operating income (NOI)
have a compounding effect on valuation. Because the hospitality business
is measured day-by-day as a transient business, the industry is thus more
susceptible and well-acquainted with the impacts of economic downturns, crises,
and changing consumer trends.
Due to the recent recovery in hospitality coming out of
COVID-19 – with many hotels returning to or exceeding 2019 performance levels –
many properties that postponed property improvement plans (PIPs) and
large-scale renovations are now pursuing those upgrades, whether voluntarily to
remain at the top of their competitive set, or involuntarily due to the
requirements of their flag.
Unfortunately, for many existing owners, this comes at a
time where the capital markets are dislocated with the cost of new capital
averaging 200-400 bps higher than in-place legacy financing. This has led
to forced sales by some owners, a trend which is expected to expand in 2024
amidst looming maturities. The resulting distress has created opportunities to
acquire great assets at an opportunistic price point, and to implement the
necessary or desired PIP programs and renovations.
While these property improvement programs are very
well defined with costs and schedules generally known within a standard
deviation, many owners or purchasers are evaluating larger-scale renovations
and repositioning of hotel assets for a variety of reasons such as changes in
market demand/dynamics and flag changes.
When evaluating a large-scale renovation, it’s critical to
understand and evaluate these three key areas and questions:
Customer:
* Who is the customer that you are catering to
and what drivers are there presently directing them to other properties in your
geography, and does your renovation plan match said demand drivers?
* Is the renovation necessary to retain or
enhance continued relevance in the marketplace?
* What comp set are you marking your asset
against and is this aspirational or attainable?
* Will your existing customer demographic pay a
premium to stay at the renovated property, or are you catering to an entirely
different customer cohort?
Value
versus Cost:
Value:
* What incremental value in ADR and occupancy can
result from the renovation?
* Does this value creation result in a meaningful
ROI (on both dollars and time allocation) on the cost of the renovation, inclusive
of downtime/lost revenues, carry costs incurred during the renovation, and
ramping back up post-completion?
Cost:
* Renovation: What will the cost be to implement and what sensitivity analysis looks
like if schedule takes longer and costs more (large-scale renovations often are
far more complex than ground up construction and lead to unforeseen additional
costs and basis creep)?
* Operations:
Can the renovation be completed while maintaining operations, service
levels, and guest experience? Or is full
closure required?
* Financing:
What incremental capital and friction costs will be incurred on the interim
financing?
Strategy
and Capitalization:
* Do present market conditions support the
viability and financeability of the renovation?
* What is your investment strategy for the
property, and does the extent of the renovation match your investment horizon?
Stabilize and sell into a better and normalized
market; or
Refinance at stabilization and hold long-term.
* Is your capital stack calibrated with your
investment strategy and horizon?
Contributed by Greg
Freedman and Daniel Lebensohn, BH3, a vertically integrated real estate
investor, operator and developer, Fort Lauderdale, Florida
The views and opinions expressed in this column do not necessarily reflect the opinions of Hotel Investment Today or Northstar Travel Group and its affiliated companies.