The biggest challenge in becoming a hotel owner is finding the right deal. You are looking for a project that has a strong market, excellent financial potential, fits within your financial capabilities and, importantly, appeals to you. Your criteria and opportunities are unique to you.
Recognize that it’s more convenient to own a hotel located 6 miles from your house than 300 miles away. It’s easier to raise equity for a small project than a large one. Acquisitions are simpler than ground up development, particularly for first-time owners. Whether you are excited about a boutique hotel, an extended-stay hotel or a particular brand, part of the process of becoming an owner is studying potential projects until you find something that connects for you. It takes flexibility. You may ultimately choose a project that is very different than your first idea. That’s good because it means you moved through a learning curve.
Your role
You can own hotels as the lead, as a partner, and as an investor. Your role will emerge as you explore potential projects and ultimately pursue your venture. It is not uncommon for people to start in one role and shift to another, depending on project needs.
- As project lead, you are the driver. You may carry the title General Partner or GP. You consider input from others, but ultimately you chose the project, make the design decisions, lead the financing, and oversee operations. You have equity in the deal, but typically your share of equity is less than the limited partners collectively. This relationship makes it possible for people with less capital but more expertise or “sweat equity” to lead projects. The project lead has the most upside opportunity and also carries the most risk. The general partner typically guarantees the mortgage, to the extent that guarantees are required. For a franchised hotel, the general partner also typically guarantees performance and payment of fees.
- As an associate or minority partner, you are involved in bringing the project to life and can have responsibility for many aspects of the venture or you may focus on one contribution. As a minority partner, you may or may not be asked to participate in guarantees, depending on the structure of the company.
- As an investor, you may be a silent partner – money only – or you may take a more active role in advising the project lead and moving the project forward. Limited Partners or LPs collectively put up most of the equity. However, their role and their liability is otherwise restricted.
Hotels deals vary in size and scope from under a million dollars for a small inn to hundreds of millions for convention and resort hotels. Your hotel deal involves two kinds of assets. Unlike some other kinds of investments, as an owner, you have some control over the value of the hotel:
- The real estate asset – Land and building are the underlying assets to a hotel; as an owner or investor, you want your land and building to appreciate over time. How much they do or do not appreciate depends on a host of factors including whether or not you bought at a good price and how you take care of the physical asset. As the owner, you can’t control everything about your hotel’s value, but you can have a significant impact and you can increase your odds of appreciation by smart choices in purchasing the hotel and smart capital improvement decisions.
- The operating business asset – Cash flow – profits from the operation are part of the on-going benefit of the investment to you and your investors. Also, operating profits translate into the value of the asset because hotels are worth the present value of their future operating income (add the present value of each year’s projected income, plus the estimated present value of selling the hotel in the future, and you have a value estimate). The economy, local market, the way you maintain the hotel’s appeal, brand, your management and your marketing drive income. As the owner you can’t control all these variables, but you can influence appreciation by the management and marketing decisions you make. As an owner, you don’t have to manage your hotel. Many owners contract with a management company that brings specific expertise and resources to operating your hotel on your behalf.
Real estate may contribute most value in some deals while operating profits may be the major contributor in others. As you assess each investment, you will consider the opportunity and risk associated with both components – real estate and operating profit.
There are four underlying hotel investment strategies and you may consider several on the way to pursuing your hotel investment:
- Yield investment: Buy a cash flowing hotel that is in good shape and producing revenue and profits
- Value-add investment: Buy a hotel that needs work and gain the upside in real estate value from renovating, upgrading, and better positioning the hotel in the market, as well as the upside in operating profit
- Development: Build a hotel from ground up including buying a site, selecting the brand and having the property designed and built
- Restricted investment: Invest in REIT stock or one of these three strategies with someone else who is buying, renovating or building
Identifying your opportunity is an exploration like any major purchase. Like buying a new house, you decide what you want in a location and find areas that meet your criteria. Then you look at individual properties until you find choices that have most of the features you want. You may plan a renovation or addition to adapt a property that needs work. You negotiate, may move to an alternate deal, and ultimately make your purchase. Although the process is similar, there are many more houses on the market than hotels, so finding interesting opportunities can take a while.
Many people have a “dream project” when they start in the hotel industry. Your dream may be a spectacular boutique hotel with a rooftop lounge in a hot urban center; it may be a beach resort. Your dream hotel may not be your first hotel. The first market you invest in may be a bit more mundane and affordable and possibly simpler to operate. Whatever the project, it will be exciting and handled properly it should build your wealth. There is a glossary from STR in “Knowledge” that includes hotel types and chain scales to familiarize you with categories of hotels.
Setting up for success as a hotel owner is a process. Creating your company, from naming to legal filing to business planning establishes your intention to own a hotel. As you talk to consultants, hoteliers and others in the business, your development team will evolve. Being a future owner or project lead involves work, but much of your job is coordinating and activating the experienced knowledgeable specialists who work with you to bring your hotel to fruition. This includes the brokers, architects, designers and contractors whose expertise is crucial for the physical hotel as well as the brand representatives, hotel managers and consultants who keeps you on track for a hotel with a high probability of success. Consultants will take you through due diligence on the market, financial performance, valuation, technical and legal aspects of the project. As you get closer to opening, the team expands with the brand representative and professional hotel management. You will have help through the process.
Value Creation
The goal of owners is to create value through their hotel projects. You want a hotel that is worth more when you sell it than you have invested in it. This builds your personal wealth. Your hotel plan will take the project from inception through profit from operation and then disposition (revert the asset) when you anticipate profit on sale. Value includes both the profit from operations and the profit on sale.
Owners create value with a combination of five strategies.
- Developing or buying and redeveloping hotels when the market value of the hotel upon completion is greater than the actual cost
- Delivering better than average net operating income through superior operations, better marketing or more efficient expense management
- Accessing lower cost capital through favorable timing, desirable presentation as a borrower (a strong balance sheet), corporate structure or relationships
- Excellent project planning including avoiding bad deals and recognizing good deals, successful project and construction management, and strategic and well-timed exit (sale of the hotel)
- Embracing risk systematically or using leverage well
