Buying Smart in a Tough Economy

Even in today’s challenging economic climate, certain market segments are still active for hospitality real estate transactions and certain properties continue to sell as they would in any market, good or bad. However, understanding and accurately assessing hotel market values in the current hospitality market is a difficult task, even for the most experienced professionals. Many appraisers, lenders, owners, and buyers are calling upon experienced brokers in this regard. Considering the following steps may help all commercial real estate professionals make educated decisions that result in profitable transactions, even in today’s climate.

1. Be Aware of the Current Market and Act Accordingly.

Today’s tight financing is having a huge impact on hotel buyers. Based on recent transactions and market trends, more buyers are showing concern for clearly stated exit strategies and looking for markets with high barriers to entry. Educated buyers also are factoring new development and ongoing capital improvement programs into a property’s proposed value.

2. Identify and Capitalize on Areas of Opportunity.
An important factor in many markets is the aging of area hotels For example, in New England the two-story interior corridor hotels of the 1970s and early 1980s are facing functional obsolescence. They often require extensive maintenance and high operating costs. But many of these properties have the best locations and are well-suited for redevelopment. In fact these properties may occupy locations where the value of the site is greater than the value of the hotel based on the generated revenue. Analyzing potential new uses and redeveloping the property may be a terrific exit strategy. For example, new retail shops, restaurant pad sites, or big-box stores could create much higher value.

3. Know the Key Factors Affecting Sales Price and Transaction Structure.

Knowledgeable buyers must consider the cost of the property’s product improvement plan and how that plan affects hotel value. PIP costs have an effect on pricing in this market, and sellers likely will see a dollar-for-dollar reduction in a buyer’s offering price after capitalizing the net operating income for the price of the PIP. Buyers should not assume that just because they plan a property refresh that revenues will increase; in fact, it is more likely that the refresh will be necessary just to maintain the same revenues.

Allocation of sales price is another important aspect of structuring a transaction. An experienced broker should suggest allocations in order to reduce or increase the following: land and building; furniture, fixtures, and assets; and goodwill. Proper price allocation can create favorable tax treatment for both sides of the transaction.

Many appraisers, buyers, and lenders often are misled when the value of a property is assumed to be calculated based on state tax stamps paid on that property when the deed is recorded, when in fact the actual sales price may be much higher due to the allocations of personal property and goodwill. This is applicable throughout the Northeast.

4. Make Smart Choices for the Future Based on Knowledge of the Past.
Consolidation in the hospitality real estate industry since the early 1990s has allowed for fewer foreclosures in this downturn, since more owners have concentrated on maintaining capital reserves and expense control. Today, without any indication as to when room demand will increase, hotel owners should continue to focus on developing programs to keep operating costs as low as possible while still providing a hospitality experience that exceeds customer expectations.

Many hospitality experts believe that resort hotels hit bottom between May and July of 2009, based on slowing of revenue and the decline of values. Urban hotels, business and corporate hotels should start to see the end of their revenue decline by late spring 2010, that is if they haven’t already. Hotel revenues have been down, along with cash flow and net operating income. So the big question for hotel owners, buyers, and sellers is: Will prices continue to drop?

It is reasonable to predict that revenues in 2010 will be, at the very least, the same as 2009, and that the worst of the revenue decline is over. Therefore, it also is safe to assume that cap rates will be geared toward the cost of funds and the required yield on equity. In this market, yields may range from 15 percent to 20 percent or more. If this is the case, cap rates will likely range from 10 percent to 11 percent on 2009 numbers, with the chance that they may be slightly lower if there is a shift toward increasing revenues. A buyer who expects a 20 percent return on equity -- a return that has historically been more in line with hotel operators based on risk -- and who will be looking at a 6 percent interest rate, will require a cap rate of 11.4 percent, which is much higher than the cap rates of the past few years.

The Wrap Up
Understanding hotel market values in the current real estate market is challenging, but not impossible. Once the current market has been carefully assessed, buyers should seek out properties that have redevelopment opportunities that make sense in today’s economic climate. Finally, new and existing hotel owners are advised to stay abreast of current and future trends, and learn from past experiences of participants in the hospitality real estate industry to ensure the greatest success of their investment.

Earle Wason, CCIM

Earle B. Wason, CCIM, is president and owner of Wason Associates Hospitality Real Estate Brokerage Group in Portsmouth, N.H. Contact him at (603) 539-5545 or at earle@earlewason.com. For additional information go to www.hospitalityrealestate.com.