Hospitality entrepreneurs usually enter a dilemma when it is time to expand their portfolio of assets, particularly hotels. They are confused whether to invest in a newly constructed hotel or to invest into the renovation of an existing one; investments should be made after measuring the pros and cons of each situation. Sometimes looking at the bigger picture is more relevant than the current performance of an existing asset, so it’s better to evaluate each option thoroughly.
There are two types of investments available for hotel entrepreneurs; either investing in an existing hotel or laying down the groundwork for a newly constructed one. Your choice should ultimately depend on the cost basis, time, quality, and potential disposition value of each deal.
Whenever you decide to undertake the renovation of an existing hotel, two things are always considered; the cost basis of your acquisition and the cost benefit of changing flags, or renovating the property into a different brand. This is especially true if the hotel is located in an extremely busy market, center-city location, or in market where vacant land is scarce.
How will you benefit from investing and renovating an existing hotel over constructing a new one? Here are the reasons:
-If you purchase an existing hotel with operating history, you’ll have a very accurate look of what’s going on today, or what the return on your investment currently looks like.
-Due to the rising costs of construction and scarcity of land in reputable markets, the feasibility of building a new hotel is harder said than done.
-Assuming the property is cash flow positive, you can recognize income 12-24 months sooner compared to new construction hotel investments.
-When buying an existing hotel, you can safely skip the entitlement, design, and development process.
-Sometimes acquisition cost can be significantly below new construction replacement cost.
-Existing hotels often have financing that you can assume. It’s convenient not having to go searching or negotiating for a loan when you can readily assume a good loan.
As far as the risks are concerned, you will have to think about the following:
-Many older hotel buildings do not have adequate electrical, plumbing, or mechanical functions to keep up with the demand of today’s corporate traveler. You’ll end up spending just as much money replacing these systems as you would installing brand new ones.
-The price of acquisition with the cost of renovation must not be greater than the cost of constructing a new hotel.
-You might have less branding options as opposed to building a new hotel.
-Selling renovated or repositioned hotels will most likely sell for a drastically smaller premium than newly constructed assets.
-Your maintenance costs will never be as low as new construction hotels.
New Construction Hotel
Investing in a new development project can also be a risky but rewarding investment. It’s important to invest in reliable markets and cater to the business traveler.
New development & new construction investments have the following benefits:
-The guest experience and floorplans of today’s hotel prototypes are more efficient and modern than older hotels. Guest are satisfied and leave great travel reviews. Everything is new!
-New construction hotels typically become market leaders with rate and occupancy because business travelers don’t mind spending more money to stay in newer hotels.
-Operating profits are very lean because the property manager isn’t always spending money on maintenance and repairs.
-Disposition is often very rewarding. REITS and institutional buyers demand the best performing assets and often pay the highest value to new or newer hotels.
However, new construction and new development hotels have their own risks:
-The development process often takes 6-18 months of hard work with engineers, attorneys, architects, and City Officials with another 16-24 months of physical construction.
-No income during the development and construction process.
-Building codes and zoning laws are different everywhere and subject to government review
-Construction financing is generally tighter and more expensive than existing hotel acquisition loans. There are plenty of lenders for existing hotels, not so much for new-construction loans.
Both options come with their own set of pros and cons. Whatever investment you end up making, you should take into account whether you’re making these investments to supplement your cash flow or to maximize your long term gain. Both of these objectives can be rewarding, but take a look at the bigger picture which can often be found in a metric called “equity multiples”.
equityroots.com is website owned and operated by Equityroots, Inc., a Delaware Corporation and real-estate developer specializing in select service and full service hotel development. Equityroots found value in partnering with Intercontinental Hotel Group (IHG), recently licensing two of their most iconic brands, Holiday Inn and Holiday Inn Express in a dynamic dual brand design. The development was able to identify Class-A vacant site in a market with barriers to entry, it was an easy decision to pursue new development given the circumstances. New development projects and investments often require a higher degree of patience compared to existing hotel acquisitions, but the added layer of patience is often rewarded during the exit strategy.
For more information on hotel investments, visit us at www.equityroots.com or sign up for our monthly newsletter at the bottom of our homepage.