Classical Hotel-Evaluation-Method is being put to the test

Formerly seen as a proven method for a quick estimation whether a hotel will pay off or not, the “ rule of thumb” is nowadays no longer applicable.

Until a few years ago, the “rule of thumb” was considered as a good foundation, to calculate the feasibility of a hotel as it were “on a beer mat”. According to this rule, a hotel with an average room rate of 80 Euros should not create development expenses of more than 80.000 Euros per room. Development respectively investment costs are all expenses which arise up to the completion of the hotel project including the premises. Meanwhile, this rule can only be applied in some cases, since the majority of hotels have evolved over the years and have expanded their portfolios simultaneously. Moreover, additional facilities such as large and well-equipped conference rooms and wellness areas have boosted investment costs and make a calculation of the profitability according to the “1000 € rule of thumb” nearly impossible. These days, this rule can merely be applied to properties like bed and breakfast establishments as well as apartment-hotels, which once accounted for the majority of businesses and restricted themselves to a minimal range of services, namely the letting of hotel rooms without an additional source of revenue.

The hotel development and consulting business, FEURING, came to the conclusion that the application of the “1000 € rule” is complicated as a result of the increasing diversification in hotel supply as well as the rising quality standards of particular hotel products. This is illustrated very plausibly by current projects such as the InterCity Hotel Mainz, the InterContinental Davos or the Hyatt Regency Düsseldorf. Exceedances of up to 45% with regard to the rule of thumb are here more than common. For these and numerous other new projects, the investment expenses are incomparably higher than in the past.

Are hotel investments less profitable nowadays?

Does this mean that hotel investments are less profitable than in former times, when the rule of thumb was still applicable to the majority of hotel projects? No real general answer can be given to this question, since the “rule of thumb” completely neglects the occupancy rate of a hotel property. Ultimately, a hotel with acquisition costs of 90.000 € per room could be more profitable than a project with costs amounting to 80.000 €, given that the more expensive hotel is able to clearly increase its occupancy. It is therefore impossible to give a realistic forecast about the returns by means of the rule of thumb. If, however, we assume a good occupancy rate for a hotel, which used to successfully apply the rule of thumb, and compare this property to a similar hotel nowadays, which is unable to utilize the “1000 € rule”, today’s hotel would need to:

• achieve a much higher occupancy rate than a hotel 30 years ago,
• generate extra revenue by additional facilities, which was earned by the corresponding rooms of the hotel 30 years ago and
• accomplish an overall increase in efficiency to attain the same profitability.

International marketing systems such as hotel chains and worldwide connected reservation systems have contributed to an improved occupancy rate. Moreover, resort hotels in particular attain higher rates by no longer closing their properties for weeks or even months at a time, but instead extending their season by offering wellness and conference facilities for example. Nevertheless, this additional revenue certainly produces a lower profit margin than the revenue created by overnight stays and can therefore compensate only a small part of the losses. An increase in efficiency of the hotel properties over the course of the last 30 years can unfortunately not be statistically proven, but on the basis of the technological progress alone, it can be assumed that the efficiency within the entire hotel market has increased substantially.

It seems probable that during the last 30 years the biggest jump on the efficiency ladder was made when modern computer software and the internet were implemented and replaced part of the workforce. By introducing the computer as a tool, simplifying hotel reservations through the internet, international reservation systems and global hotel corporations as well as by the steadily increasing interest in national and international journeys, a boost in efficiency and occupancy over the last ten years can be recognized as well as explained. Another aspect furthermore considers the hotel’s increase in size as well as room capacities based on a strong consolidation progress, which also leads to a long-term boost in efficiency.

Profitability today – How can it be calculated?

Nowadays, the “rule of thumb” in its original form, which evaluates the profitability of a hotel, is no longer applicable, due to new incorporated attributes, such as investment expenses, higher occupancy rates and an increase in efficiency. An approach for a convincing result close to reality could be achieved by a formula adjustment, which considers the total sales per sold room. This would at least take the additional revenue generators into account as well as the fact, that the hotel’s entire revenue is no longer only generated by the rooms. On the other hand, this also does not include increases in efficiency and higher occupancy rates. The consequence of this is that common international evaluation methods of the current investment theories, such as the net present value or the internal rate of return method, have to be applied instead. Nevertheless, a profound and product-specific market and location analysis remains the basis for the target-oriented employment of these methods.

Sandra Rainer-Pöselt is the Director of Advisory Services at FEURING ([email protected])

About Feuring – Visionary Hotel Development | Feuring was founded in Mainz in 1959. Feuring accompanies its customers right from the idea, the market analysis and the concept over the procurement of a suitable operator and the arrangement of appropriate contracts, setting up a steering committee for the project and fitting and furnishing the hotel up to its turn-key handover and the subsequent investment control. Up till now, Feuring has supported investors and hotel chains in the successful development of more than 400 first class and luxury hotels at home and abroad. The financial volume of current projects amounts to around one billion Euros.