Hotels, whether standalone or part of a chain, are perceived as attractive investments by a range of investors but what are the key concepts you need to understand hotels as an investment?
In the latest in the Bayfield Training webinar series, Andri Rabetanety, a senior lecturer at Glion Higher Education for MSc in Hospitality, Real Estate and Finance and financial modelling trainer at Bayfield Training, explained the capital market; the key point of difference of hotels from traditional real estate; their business models and their categorisation, allowing those on the webinar a clearer understanding of where to start when they need to consider and value hotel investments.
Hotel capital market
Rabetanety said that according to JLL figures hotel investments totalled $68 billion in 2018, with a number of key transactions during the year made by a range of investors – from private equity investors, to overseas corporate investors and UK institutional investors. “The volume in transactions is mainly driven by a healthy global economy and growing traveller volumes,” he said.
As well as the economy and traveller volumes playing their part it’s also the attractiveness of the yield profile that appeals, he explained, since it outweighs more traditional commercial real estate classes such as office or retail. It is also reflected in the growing funds raised to invest in hotels by closed ended private equity funds, he explained.
The key point of difference
Hotels are income-producing investment properties whose value is devised from the future cash flow they generate – this makes it similar to other real estate assets. However there is a key difference – the fact that they are a combination of two key businesses. That is the operation of the rooms and amenities on one side and the ownership of the physical asset, or walls, on the other.
Rabetanety explained that the dual purpose means that a wider range of factors can impact the market – including its exposure to the service industry and its reliance on the guest experience and tourism flow, as well as an exposure to the real estate market that relies on the dynamics of letting, construction and capital markets.
However it’s the first that is more volatile since hotel revenue is derived from the combination of room occupancy and room rate. “Both are affected by the spending power of consumers, the flow of tourists, the cycle of conferences and the availability of an alternative, whether that’s other hotels or Airbnb rooms,” said Rabetanety.
Assessing performance: 3 KPIs
He explained that the performance of hotel operations is measured using three main performance indicators:
- Occupancy rate: % of rooms sold compared to the rooms available
- Average daily rate: the room revenue divided by the number of rooms sold
- Revenue per available room: room revenue divided by the number of rooms available.
These 3 metrics are combined to forecast the gross operating profit, or GOP. “This will turn into the cash flow which will be the basis of any valuation model,” said Rabetanety.
He explained that it’s also worth noting that financial information for hotels is arranged in accordance with a specific standard or uniform system of accounts (USAT) for the lodging industry.
4 Ownership management structure types
There are four main ownership or management structures for hotels, the latter of which separate the ownership from the operation:
- Private – Privately owned and operated.
- Managed – The operator manages the hotel on behalf of the owner in return for a management fee. Maintenance fees, capex and employer costs are owners expenses rather than operator expenses and profits go to the owner.
- Franchised – An agreement between the franchisor (the hotel chain) and the franchisee (the owner) means that the owner can use the chain’s brand services for marketing, booking etc in exchange for royalty fees.
- Leased – privately owned by a different company than the one who operates the hotel. The owner receives a fixed rent or a combination of fixed rent and a variable rent based on EBITDA or turnover. All maintenance, capex costs, operator expenses employee costs and profit go to the operator.
Hotels as an investment product
In the hotel market the STR Chain Scale is used to define the different variations of categories of hotels, Rabetanety explained. These range from economy to luxury and are usually defined based on the average daily rates ranges of all the hotels in the world.
“In conclusion, hotels are composed of two key elements,” he said. “The operation and the real estate. The operation is the key area to focus on to understand the asset management strategy and to model the hotel assets. The operation links to the industry of service and that sets it apart from traditional real estate.”
However, Rabetanety warned that the distinction was fading. “The real estate industry is integrating back the services, with the trends of coworking or coliving. Those overall trends are also referred to as real estate as a service. So hotels are great assets to understand service based real estate,” he said.