The Hotel Investment End Game: Exit Strategy

2 min read

Exit Strategy - Hotel Investments

 

Often times, when we talk about hotel development and investments, we imagine dynamic beginnings. Plans and blueprints are drawn up for new construction hotels, and investors seek promising returns on their initial investments as the hotel begins its operation. Yet, in order to be a strategic investor or owner of a hotel, it’s important to think about the end game for your investment. Being able to keep the long-term goal for your hotel investments can ensure that you do not mismanage your hotel years down the road. Poor planning at the outset might be hidden by a strong start to your hotel or investment’s life, as your investment ages, that poor planning can really cause some serious liabilities for you later.

As with many considerations with hotel investments, there are a number of key factors you should consider before even starting an investment project in an existing or new construction hotel. Unlike bonds or stocks, your hotel investment is a physical “brick and mortar” investment. Over time, there will be expected wear and tear on your hotel, and your hotel will need to go under renovation or redesigns in order to stay competitive with newer construction hotels and changing trends in customer preferences. Investors can have different strategies – where one investor may intend to continue to invest in a specific hotel for a long period of time, other investors may view the same hotel as a short-term investment. Regardless, it is smart to think ahead to your exit strategy, or how you plan to exit your investment in a specific hotel.

Hold time

The holding period for an investor is the length of time that investor holds an investment. In other words, this is the time period between the time the investment is purchased or developed, and later sold. The hold time varies greatly based on the hotel. Existing construction hotels tend to have shorter hold periods, whereas owners who newly develop a hotel tend to have longer hold periods, especially when considering the front-loaded costs to develop the hotel in the first place. This hold time also depends on the investment strategy. Investors that are looking to generate a quick source of cash-flow typically have shorter holding periods, but investors that want a larger and more cumulative return adjusted for inflation may seek to hold onto (and continue to renovate and update) their hotels for longer.

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Sometimes hotel companies sell their hotels in timely fashion before a property improvement plan (PIP) is identified by the Brand.  In a nutshell, a PIP outlines a list of improvements, modification, and general upkeep and maintenance of a hotel in upcoming years.  Hoteliers sometimes elect to sell a hotel before its PIP because they want to avoid the inconvenience and expenses associated with renovating the hotel.  Sometimes hotel companies choose to exit or sell their hotel when their license agreement with any given Brand is coming to an end.  Other hotel companies like to develop newly constructed hotels, stabilize their performance, and then sell the property for a big premium to institutional grade investors.  An exit strategy has to be realistic with the condition and age of the property.

One must be conscious of the timeline that he or she is investing in.  The goal is to time your exit strategy in strong or peak markets, while down markets and recessions are typically more advantageous to buyers.  Being conscious of the general economy and timing your exit is an important part of the process.  One must be cognizant of credit markets, to know whether a sale can occur and get financed (unless your buyer doesn’t need financing contingencies).  Hotel investments and markets are cyclical, so there is a good and bad time to exit and therefore the disposition price is largely reflective of this cycle.  

Common strategies for hotel investors are:

  • Long term holds, aka core holdings
  • Opportunistic value-add and disposition
  • Fix and Flip

On another topic, what to do after exiting?

See our blog on 1031 exchanges to learn how hotel investors are deferring their long term capital gain tax liabilities by electing to use Internal Revenue Code, Section 1031.

 

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Should I Invest in a New Hotel or an Existing Hotel?

5 min read

Should I Invest in a New Hotel or an Existing Hotel?

Do I invest in a brand new hotel, or in an existing hotel? Real estate investors often find this decision difficult when first expanding their investment portfolio to include hotel assets. When deciding between hotel investment opportunities, knowing the distinctions between new and old hotel assets can serve you well. Combine that knowledge with information about the cost basis, time, quality, and potential disposition value of each deal, and you have the foundational tools you need to make smart investment decisions.

For starters – there are two types of investments available for hotel investors. Hotel investors can choose to invest in a new construction project. This is where a hotel developer takes the time to design and build a brand new hotel. On the flip side, hotel investors can choose to invest in an existing hotel, usually in the form of a renovation project. Renovations could include structural upgrades to a building, but may also involve a change of a hotel’s brand name. For example, a developer might want to take a pre-existing Country Inn & Suites and convert it to a Staybridge Suites.

The benefits of new construction hotels might seem apparent to many first time investors. After all, the hotel asset that you invest in will be brand new, often coming with the newest amenities. However, existing hotel renovation projects also have their fair share of benefits.


New Construction Hotel Investments

New Construction Hotel Investments

Investing in a new development project can be a risky but rewarding investment. It is truly a unique experience, being able to invest in a project that you can see from its designing stages, to the groundbreaking, and to the final construction phases.

Advantages to New Construction Investments

New construction developments have numerous benefits, including:

  1. Modern Design: Everything is new! The guest experience and floorplans of today’s hotel prototypes are more efficient and modern than older hotels. Guests are satisfied and leave great travel reviews, encouraging additional business.
  2. Market Leaders: New construction hotels typically beat out the older competition in the area. These new assets often become market leaders in rate and occupancy in large part because business travelers don’t mind spending more money to stay in newer hotels.
  3. Lean Operating Margins: Operating margins in new hotels tend to be leaner than their older counterparts because the newer hotel is less susceptible to extensive maintenance and repairs.
  4. Higher Disposition: When selling a newer hotel after owning it for a few years, it is common to see offers that are higher than those that would be made for old hotels. REITS and institutional buyers demand the best performing assets and often pay the highest value to new or newer hotels.

Disadvantages to New Construction Investments

However, savvy real estate investors know that depending on the individual deal, new does not always mean better. New construction hotels have their own share of risks:

  1. Longer Process: The development process often takes 6-18 months of hard work with engineers, attorneys, and architects. Only after the development undergoes several rounds of approval does the project move forward to construction, which often takes another 16-24 months of time.
  2. Income Delay: New hotel assets are not taking in any income during that development and construction process.
  3. Building Codes & Zoning Laws: Government review can have a huge hand in restricting the hotel design. Different local governments vary greatly in what is allowed or not allowed in construction. With a brand new hotel, it can add on additional work and approval rounds with city officials, all which can lengthen the amount of time until opening day for that hotel.
  4. Difficult Construction Financing: Construction financing is generally more scarce expensive than existing hotel acquisition loans. There are plenty of lenders for existing hotels, but not as many for new-construction loans.

Existing Hotel Investments

Existing Hotel Investments

When real estate investors decide to invest in the renovation of an existing hotel, they must compare the cost basis of acquiring the hotel to the cost benefit of changing flags or renovating the property into a different brand. In other words, how does the price of investing in the hotel compare with the potential return of the renovated property? This comparison is especially important if the existing hotel is located in an extremely busy market, center-city location, or in a market where vacant land is scarce.

Advantages to Existing Investments

Existing hotel investments offer many benefits that are distinct from new hotel assets, including:

  1. Clear Performance History: Investing in or purchasing an existing hotel with an operating history provides an accurate look at how the hotel is performing right now. This can give you a clear picture of what the return on your investment currently looks like before renovation.
  2. Reduced Development Costs: Due to rising costs of construction and scarcity of land in strong markets, the building a new hotel is easier said than done. With an existing hotel asset, you do not have to shell out for materials to build an entirely new building.
  3. Faster Income: Assuming that the hotel asset is cash flow positive, investors can recognize income 12-24 months sooner compared to new construction hotel investments. Again, hotel investors benefit from a shorter waiting period before the hotel operates.
  4. Shorter Development Period: Pre-existing hotel assets have already undergone the entitlement, design, and development process from its initial construction, so developers and investors can save valuable time.
  5. Assuming Financing: The acquisition cost for an existing hotel can be significantly below new construction replacement cost. Additionally, existing hotels often have financing that you can assume from the previous owner. It’s convenient not having to go searching or negotiating for a loan when you can readily assume a quality loan.

Disadvantages to Existing Investments

With older hotel buildings (and for real estate assets in general), maintenance and other disadvantages can lower the value of your investment. Investors must be careful to make sure that the price of acquiring a pre-existing hotel does not outweigh the cost of simply constructing a new hotel. Other downsides to existing hotel assets include:

  1. Outdated Infrastructure: Many older hotel buildings lack adequate electrical, plumbing, or mechanical systems to keep up with the demand of today’s travelers. Investors can often spend just as much money replacing these systems as they would installing brand new ones.
  2. Limited Branding Options: Older hotels may be limited on branding options, as some brands (particularly high performing ones) may have additional restrictions on which buildings they are willing to allow their branding on.
  3. Lower Disposition Value: Renovated or repositioned hotels will most likely sell for a substantially lower premium than newly constructed assets.
  4. Higher Maintenance Costs: Older, existing hotel assets will cost more to maintain than new construction hotels.

 

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Conclusion

Both new and existing hotel assets come with their own set of pros and cons, and investors should take into account their financial goals when considering investment decisions. If investors seek to supplement their short-term cash flow, then the types of investments that work best for them will be different than if those investors were seeking to maximize their long-term gain. Beyond looking at the type of hotel investment, looking at other variables including “equity multiples” can provide valuable information.

Equityroots recently found value in partnering with Intercontinental Hotel Group (IHG), 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.

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.  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.

Sources

“Hotel Investment: How to Finance the New Supply.” Hotel Online. Apr 11, 2014.

Jones, Michael. “What Does it Take to Start a Hotel?”  Forbes. Feb 23, 2013.

LaSalle, Jones. “5 Forces Driving Hotel Investment.” Building Design and Construction. Feb 5, 2013.

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