Operational Budgeting for Hotel Openings: Getting Stabilization Right

Opening a new hotel is a financial journey that spans several phases, including the pre-opening, ramp-up and stabilization periods. Stabilization is a tricky phase that can make or a break a hotel project, as it is when most budgets go wrong, but with strong revenue management it can also set the foundation for success in the long term.

The following article aims to define what stabilization is, how long it lasts and why it matters, as well as analyse aspects of the pre-opening and ramp-up periods leading up to stabilization. It also looks at forecasting and pricing tactics and identifies some of the mistakes that should be avoided before the hotel reaches mature operations.

Why The Stabilization Period Matters

The stabilization period is the time it takes for newly opened hotels to reach “normalised” occupancy and RevPAR. Occupancy is often considered normalised when it stops rising sharply year over year and RevPAR when it reaches the average of direct competitors, or in other words, when a property achieves 100% RevPAR index relative to its comp set.

Having said that, investors, owners and operators may take broader or more complex approaches to determining a stabilization point. They can deem a hotel stabilized when its occupancy and revenue become largely predictable and sustainable, and when it consistently meets the targets of the feasibility study or financial projection model.

The stabilization period is important mostly as it determines how quickly the hotel starts generating steady and reliable cash flow and whether it can be profitable in the longer run. Expected investment returns, asset valuations, underwriting and financing arrangements as well as certain parts of management or franchise contracts are all based on stabilised performance, which underlines why hotels can’t afford getting stabilization wrong.

Stabilizing operations is a challenging task with a number of risks, partially as early-stage demand patterns tend to be unpredictable, ramping up daily operations comes with significant costs, and low brand awareness could make it difficult to build up occupancy. The biggest financial risk is treating a new hotel as a mature property from day one.

It must be noted here that while the terms ramp-up and stabilization are often used interchangeably, they actually refer to two different, albeit sometimes overlapping, periods after opening. Ramp-up means that operations are still volatile and dynamically growing, and stabilization that they are becoming largely stable and balanced.

Stabilization Takes Years and Can Vary

It typically takes 36-48 months for a new property to reach mature operation, although an often-cited study by Cornell University has put occupancy stabilization at just three years . Its historic data also show that market segment and location can impact stabilization speed, but the number of keys or the availability F&B outlets don’t make a difference.

Properties in emerging markets could take more time to stabilise as the destination is still developing. In an example, Saudi Arabian projects, particularly resorts or mega-hotels, might need 4-5 years to reach target occupancy, real estate consultant MMCG Invest said. It said underwriting models should calculate with a gradual rise in occupancy, which can be as low as 30-40% at remote resorts and 50-60% at new city hotels in the first year.

Hotels need 12-24 months to stabilise operations after an acquisition, or longer if they undergo renovation or repositioning, particularly if it also involves switching brands, financial models company Tilt Analytics said. It put stabilised occupancy benchmarks for underwriting purposes at 55-70% for resorts, 65-75% for select-service suburban and airport hotels, 68-78% for full-service urban and 75-85% for extended-stay properties.

Building a Realistic Pre-Opening Budget

Working with a realistic pre-opening budget can reduce issues in the stabilization period and could ultimately contribute to a successful mature operation later. Carefully built pre-opening budgets usually account for soft costs that are often overlooked, such as expenses for training or hiring additional staff when needed, as well as trial and error.

Factoring in delayed revenue from slow bookings in the first weeks or month is also imperative, as well as aligning future operations with brand standards while controlling expected cash flow. Operators are often advised to use common or shared resources in their hotel portfolio to transfer brand standards to new openings more effectively.

Pre-opening expenses related to hiring management and staff as well as marketing can surge quickly and may endanger the entire budget, but real estate companies say using market benchmark data could help pre-opening teams evaluate if they are overspending in certain areas. Hotels are also advised to draw up various budget scenarios so that they can respond to unexpected problems faster and more effectively.

Revenue Forecasting During Ramp-Up

Traditional benchmarking methods don’t work for newly opened hotels, as they are based on stabilised properties. Hotels with scarce or no historic data need other techniques, such as the combination of analysing comp set data on occupancy, ADR and RevPAR of comparable existing hotels and broader trends in competitive supply and demand.

Comp set data, normally collected from at least four other hotels under STR guidelines, can serve as the basis for ADR and occupancy estimations in gross revenue calculations until the first real booking data come in. Initial revenue assumptions should be frequently reviewed or adjusted, if necessary, and should be gradually replaced with actual data.

Setting separate forecasts with conservative, baseline and sensitivity scenarios instead of having just a single forecast is also essential when it comes to revenue plans. Different scenarios can help follow up on potential changes in occupancy, ADR and RevPAR or other variables and identify risks related to sudden changes or market volatility.

Pricing Tactics for The Stabilization Phase

Offering various promotions or opening discounts could be a natural decision for new properties to build occupancy and gain market share in the ramp-up or stabilization period. They can lift revenue in the short term, attract the attention of potential guests and help the hotel’s market entry immediately stand out in the local hospitality scene.

But buying occupancy with deep discounts in this early stage can easily cause serious problems later. Over-reliance on discounts to “fill the house” can be a big mistake during soft opening, because it can impact the hotel’s market perception, ADR positioning, distribution mix and pricing power, revenue management company Taktikon said.

Discounted rates can anchor the property at a lower perceived price level, which will be “hard to move later”, and attract price-sensitive guests as the first reviewers, which could be against long-term positioning goals, it said. Taktikon suggests value-added packages instead of rate cuts or targeting the corporate segment with special trial deals.

New hotels should take a segment-to-segment approach to pricing already in the initial stages of operation and customize rates early on to the diverse booking behaviours and price sensitivities of the leisure, corporate and group segments. Similarly, OTA channels need different pricing that takes into account commissions and slimmer margins.

Tracking KPIs and Monitoring The Budget

Monitoring and adjusting performance and budget during the stabilization period are indispensable to keep the process on track. The most important KPIs that matter early on include occupancy, ADR and RevPAR, as well as GOPPAR, which gives a picture of overall profitability, and cost per occupied room, which helps track expenses and margins.

Regularly reviewing the budget on a weekly and monthly basis by analysing actual KPIs and bookings supports decisions on whether current performance requires a revision or the hotel should stay the course. Review frequency matters more in the early stages.

Common Pitfalls to Avoid for New Hotels

The previous sections have demonstrated that the early stages of hotel operations often require testing and learning on the go, with many potential mistakes to make. These include drawing up unrealistic budgets, incorrect forecasting, getting initial pricing wrong or simply miscalculating how long ramp-up and overall stabilization actually take.

But probably one of the biggest pitfalls to avoid is underestimating working capital needs in the first six months. This cash is injected into new hotel projects to cover operating costs after opening, when revenue is often slow to ramp up and doesn’t yet cover the multitude of day-to-day expenses, such as payroll, utilities or commissions.

Running out of working capital during the ramp-up period before the hotel reaches stabilised occupancy and revenue is, in fact, the most common reason hotel projects fail after opening, according to financial models platform Finmodelbuilder. It suggests investors should have 6-12 months of operating expenses , excluding debt service, in cash reserve before opening, in addition to their development budget.

Other issues operators may face include understaffing or overstaffing. Hiring too many or too few employees compared to actual demand may signal errors in occupancy forecasts or general assumptions about ramp-up and stabilization. Needless to say, overstaffing can have the ripple effect of significantly boosting operating costs.

Newly opened hotels need to establish initial visibility, exposure and market awareness to build occupancy, which can result in high marketing costs. It is a problem if marketing spend doesn’t translate into higher booking conversions, but an even bigger issue is when new hotels ignore the gap between marketing expenses and conversion.

One way to reduce this difference is to focus marketing on direct bookings and avoid over-reliance on OTA channels. OTAs can boost visibility, but are not cost-effective in the longer run as their commissions, often reaching 15-25% , scale linearly with hotel revenue, travel tech firm The Percentage Company said. It said direct bookings, on the other hand, have the lowest acquisition costs of any channel over the medium to long term.

Conclusion

Stabilising the operations of a newly opened hotel is not a waiting game, but a strategic opportunity to lay the foundations of a profitable business. The decisions made in year one echo for years to come, which puts pressure on investors, owners and operators and simultaneously allows them to create tremendous value in the longer run.

Again, the stabilization period inevitably involves trial and error and normally comes with a number of uncertainties, but budget discipline and revenue management agility usually equal to a faster path to profitability in the equation of new hotel openings.

Reprinted from the Hotel Business Review with permission from www.HotelExecutive.com.