Conquering the Credit Crunch | By Brian Bisema | HVS

Declining Hotel Property Values

The biggest impacts of the economic crisis relative to the hotel industry are the frozen credit markets and higher capital costs. Capital costs have risen. Debt is virtually unavailable from traditional lending sources. Conduit financing, previously the principal source of debt capital, has all but disappeared. Insurance companies, private lenders, banks, and pension funds, whose more stringent lending criteria kept them out of much of the recent lending activity, have re-emerged as sources of mortgage debt. On average, the effect translates to a 10 to 20 percent decrease in hotel value from the peak levels recorded prior to mid-year 2007. These market conditions have negatively affected both the number of transactions and asset pricing in 2008 and are expected to endure well into 2009.

The table below illustrates the dynamics of hotel values in markets across the nation, with most showing a decline in 2008.

Estimated Per-Room Property Values For Select Markets (2001-2008)

Strategies for Hoteliers in a Down Market

"When we do come out of this downturn . . . the travel industry [will be] back with a vengeance." – Steve Rushmore, President and Founder, HVS

The economic minefield lies before us, but developers can take careful steps to buffer the negative impacts. Here are some recommendations to consider in reaping the most from your investment.

• Commission a market and/or feasibility study for your hotel project(s). Planning, architectural design, and the acquisition of mandated permits for a new hotel can take months or years to complete. Economists suggest the credit markets and overall economy will begin to recover by mid-year 2009³. Due diligence now will put you ahead of the curve, and lenders will be more eager to engage projects for which a professional market or feasibility study has been conducted. HVS reports provide exceptional detail and analysis that lenders look for when deciding which projects to finance and how appealing the terms of that financing will be.
  
  
• Shift from Wall Street to Main Street. Don’t feel that financing options are limited to Wall Street institutions—local and regional lending still exists. Most community banks were not heavily entrenched in the sub-prime fiasco and thus remain more viable sources of capital, though leverage has been cut back. Banks are shifting back to the basics in terms of loan criteria, focusing on a borrower’s flexibility, additional collateral, liquidity, as well as relationship lending. Similar to the big banks, local lenders place great emphasis on a qualified market or feasibility study in determining which projects will receive financing.
  
  
• Capitalize on municipal incentives such as tax-abatement zones. Some communities offer developers tax advantages to encourage neighborhood revitalization. Look for such benefits when conducting your initial due diligence. The State of New York, for instance, offers partial exemption of real estate taxes through its Industrial and Commercial Incentive Program (ICIP). The program provides tax abatements for varying periods of up to 25 years for eligible industrial or commercial buildings that are constructed, modernized, rehabilitated, expanded, or otherwise physically improved. Municipal incentives are simple ways to greatly reduce future tax burden, allowing for more profitable projects.
  
  
• Recycle buildings. Converting existing structures to lodging facilities is among the latest trends in the hotel industry, as a drive around Boston will show. Notable conversions in the city include: the Hilton in the Financial District, formerly an office building; the historic Langham Hotel, which served as a Federal Reserve Building; the Marriott Long Wharf, once a warehouse; the Jurys Hotel, the former headquarters of the Boston Police; and the latest installment, The Liberty Hotel, which was formerly the Charles Street Jail. The Liberty Hotel’s conversion, as with most adaptive-reuse developments, benefits two parties: the community gains a property-tax generating, reinvigorated building, while the developer reaps tax credits at the federal and state levels.⁴4
  
  
• Mix things up. Another increasingly popular trend in the lodging industry is pairing a hotel with a residential, retail, and/or office component. Many unfeasible hotel-only projects gain the "green-light" by extending their scope to encompass a mixed-use development. Mixed-use projects are typically undertaken as joint ventures. Shared overhead expenses, reduced (per-allocated) development costs, and operational efficiency are just a few of the incentives. From a consumer’s perspective, a hotel within walking distance to entertainment, retail, and/or dining venues is more appealing than one where such amenities are only in reach by car.
  
  
• Become a LEED-er. Developed by the United States Green Building Council (USGBC), the Leadership in Energy and Environmental Design (LEED) certification is the national benchmark for high-performance green buildings. The program addresses all building types and emphasizes state-of-the-art strategies for sustainable site development, water savings, energy efficiency, materials and resources selection, and indoor environmental quality.⁵ Installing motion sensor lights in public areas, replacing windows with energy-efficient models, and utilizing Compact Fluorescent Lighting (CFL) are just a few low-cost ways to make a property more energy efficient and advance closer to a LEED certification. These practices positively affect not only the environment but the bottom line by reducing operating costs, increasing operating efficiency, and positively impacting a property’s image among environmentally conscious travelers.
  
  
• Prepare an ad valorem (tax) appraisal. An up-to-date tax appraisal guided by a hotel professional ensures that your hotel’s value assessment reflects the conditions of today’s market. At the peak of the real estate bubble, hotels transacted at record levels. Upon its burst in late-2007 and continuing into the present, hotel sales have declined dramatically. Given such drastic economic swings, deriving market-appropriate capitalization rates (obtained by dividing a hotel’s net income by the sales prices of comparable transactions) prove challenging for local tax assessors. Assessors can therefore have difficulty in selecting appropriate capitalization rates to use in their valuation models. These rates can also overlook a hotel’s limited growth of potential revenue in a down market. As a result, failure to use an appropriate capitalization rate can result in an inflation of assessment levels and ultimately lead to a higher tax burden for the owner. Firms that specialize in hotel valuation utilize intricate methods such as the Simultaneous Valuation Formula, an advanced “band-of-investment” analysis, when reconciling to an estimated market value. HVS can prepare ad valorem tax appraisals to determine whether your property is being overvalued by the local assessor. Once accepted by the local jurisdiction, ad valorem appraisals can save thousands of dollars in property taxes.
  
  
• Get creative with marketing efforts. Unique marketing strategies can lead to successful, effective public relations and word of mouth. The Colonnade Hotel in Boston is taking a creative spin on the economic situation by offering a "Bulls & Bears" package based on the 4:30 p.m. Dow Jones Industrial Average’s closing bell. If the market finishes down for the day, guests are rewarded with a 20% discount off the day's lowest room rate; if the market is up, 10% will be deducted. Christopher Lynn, Director of Sales and Marketing at the hotel, remarked that the program has been “wildly successful” and emphasized how important it is “to develop packages and promotions that are creative and to employ them quickly,” especially in a down market.
  
  
• Embrace LEED initiatives. It’s never too late for up-and-running hotels to adopt LEED standards. A recent study conducted by the American Hotel & Lodging Association revealed that one in five hotels will incorporate LEED standards in 2009. Before switching over to green initiatives, find out what incentives your local government may provide. Utilities rebates for installation costs and retrofitting changes are offered by many municipalities with energy-conservation programs, thus helping to reduce the initial cost of the switchover. On average, green buildings are estimated to save approximately 40% in water use, 30% in energy use and greenhouse gas emissions, and 50 to 75% of construction and demolition waste going to landfills.
  
  
• Hold on to your asset(s) for the next two to three years. Now is not the best time to sell your property or portfolio. Steve Rushmore recently noted that “overall, the decline in hotel values is expected to reach its lowest point in 2008.” Rushmore adds that “continuing its sluggish pace from the latter half of 2007, hotel sales activity is expected to remain slow through early 2009. Therefore, if it is not necessary to sell, hotel owners should ideally hold on to their assets for the next two to three years.”
  
  
• Get Back to Basics – Service 101. It should come as no surprise that success in the hospitality industry depends on good service. Whether it’s to a budget inn or a five-star resort, patrons will be more likely to return if they feel they’ve been treated by helpful, knowledgeable, expeditious hotel staff. Hotel owners and managers set the tone and agenda for how their properties operate, and it is more important than ever to send an upbeat vibe to your staff. Sometimes this begins with evaluating the attitudes, skills, and goals of your employees. 20/20 Skills, the only HR assessment and advisory firm dedicated to the service industry, provides a heavily researched and field-tested system for human capital management. The firm has a track record of identifying peak performers, mitigating weaknesses, and nurturing talent to buttress a hotel’s bottom line. Cultivate a strong team during these unstable times. Your guests will thank you with their trust and their travel dollars.

By employing some of these suggestions between now and the inevitable economic upturn, hotel developers can better position themselves to capitalize on a revitalized market. The Four Horseman of the economic apocalypse may be on the stampede, but HVS can help see you safely through. Please visit us at www.hvs.com/Services/Consulting/Boston to learn more.

1. www.doctorhousingbubble.com
2. www.dev.nber.org/dec2008.html
3. http://money.cnn.com
4. www.buildings.com/articles/detail.aspx?contentID=6569
5. www.usgbc.org/DisplayPage.aspx?CMSPageID=124

About HVS: Established in 1980, HVS experts literally “wrote the book” on how to value hotels, shared ownership products, restaurants, and more. Hotel owners, operators, lenders, banks, and management companies all turn to HVS as the respected authority on hospitality. We possess detailed knowledge and experience in the markets where we have a presence, and in the regions in between. Whatever the real estate or consulting need, HVS associates possess experience in a wide range of hospitality and operational disciplines. Our entrepreneurial mindset and company-wide philosophy allow us to think as if we were owners and operators ourselves. We know this approach best suits our clients’ needs. Click here for more...