Build, Buy, Hold or Sell? Late-Cycle Owner Strategies

This year, some analysts talk about how the cycle is "getting long in the tooth" since we have been expanding for over 90 months. Since the tourism industry is resilient and still growing, success is very possible for another several years. Further, 2018 will be very prosperous with tax reform, strong consumer confidence, a durable job market and a robust global economy.

If you're considering whether to buy or hold a hotel today, the quality of your team is paramount. One operator cannot optimize revenues and expenses, make sales calls and handle the financial end of the business. Substantial due diligence is required to ensure the hotel has the right management, brand, renovation and business plan/budget. Hospitality might be an art, but it surely has become a science with revenue management, distribution-channel management, social media marketing, website development and much more. If building or renovating, an architect, designer, contractor, lawyer, brand, management company, engineers and lender are required as well as a great operating team.

In buying, I prefer a compelling story—a need for renovation, brand change or management change can get the numbers up. Changing all three can be a home run if you know what you are doing. A strong market and a healthy market mix with a strong base of business will ensure operating leverage. Operating leverage is created when fixed costs have been met and additional revenues "flow through" to the net income line.

There are five key areas that can provide the framework for success: location, product, management, marketing and financial structure. Location has everything to do with the submarket in which the asset competes. An area that has strong barriers to entry—government regulations, cost of land or other barriers—is a safer bet than an area where there is no limit to the amount of new supply coming in. Moreover, location refers to the market demand generators. A strong market should include multiple types of demand generators such as corporate, leisure and group that provide for the aforementioned operating leverage.

The second strategy for success is the product, which might include choosing the right brand. Marriott International, Hilton and InterContinental Hotels Group are three of the main hotel franchising companies. The "verticality" of brands—i.e. Marriott's 30 brands, Hilton's 15 brands—makes the market very complex. Additional critical points to review include system reservation performance, impact policy, recommendations from other franchisees, support for the property and growth of the brand.

Today, millennial travelers are helping us throw out some of the tried-and-true strategies of the past decade. Product quality is paramount to profitable operations, and independent, boutique hotels are enjoying a period of significant success. This, along with brands desiring to expand, has led to a plethora of new "soft brands."

The third and fourth strategies, marketing and management, can be the difference between being able to pay the lender or not. Some firms are good at marketing and driving top-line revenue. Others are good at management and controlling expenses. Some charge back their corporate overhead, others charge only for direct property expenditures. It is hard to find that balance of good marketing and management, but it is very important. Interview a few firms and choose one that suits you best.

Lastly, it is virtually impossible to succeed without the proper financial structure in place. Today, first-mortgage money is typically low-leverage, averaging just 65% of acquisition cost, and less if it is new development. This might generate a need for a second mortgage or mezzanine loan; since this money is higher-risk, there is a premium attached to the rate. A structure today may be 65% first-mortgage debt at say 5.5% interest, 15% mezzanine debt at say 10% interest plus 20% borrower equity.

A return-on-investment analysis will determine if the project will succeed. This is the single most important element in the decision to purchase or build. Many institutional funds and real estate investment trusts have invested in full-service hotels or in the urban, focused-service/upscale lodging sector. This leaves an opening for the entrepreneur today to look at turn-around opportunities or smaller, focused-service hotels, perhaps in secondary markets.

There are some key tenets for success that are clearly required, including persistence, hard work and honesty. Avoid mediocrity, move quickly with reversible decisions and slowly with non-reversible decisions, seek out committed people, review accountability for everything and do not be a spectator—get in the game!

So, if after reading this you feel like today requires too much work, sell—you should get a good price! Now all that is needed is the goal and a set of action steps to achieve the goal. If the entrepreneurial spirit lifts you, go for it! Have a great 2018!

This article was first published in Hotel News Now and is reprinted with the permission of the author.