Hotel investments

[Kyle D.]

I was looking at the hospitality indistry today. A holiday inn express in a good vacation area makes about a $1,000,000 after debt service. Any you can get the place for $10-12 million. Is anyone involved in the hospitality indristry that can offer some insight? How does this hold up to multifamily?

[Dax Desai]

Hotels I consider as a real estate heavy business.  That being said there is fundamental value in the land, but as for the building you really have to look at income and cap rate to assess the value of the overall property.  Based on your numbers if you bought it at 10mm you're looking at a 10cap rate.  This is probably an average to better than average deal.  Cap rates of course will vary based on how strong the location is ie does this location prosper even during downtimes when other nearby areas suffer more?  Does the site have any inherent competitive advantages over other properties (ie oceanfront, proximity to convention center).   

Things to watch:

• How much time is left on the franchise agreement.  Once you become independent expect revenue to drop like a rock.  This hotel is presumably grossing around 3mm.  If it loses the Holiday Inn Express moniker expect that to drop at least by half due to lower rates and lower occupancy.
• How much PIP?  You want to assess what the PIP is (property improvement plan). Whenever there is an ownership change the franchisor (Holiday Inn Express) will require some repairs/remodeling to keep to their prevailing standard at the time of transfer. Sometimes it can be negligible. Other times it can mean a $1mm+ renovation. Furniture and fixtures quickly add up in hotels. Doing the remodel will not typically be rolled into your loan. You will either have to pay cash or find FFE financing for a shorter term typically with a higher interest rate.
• Competetive landscape Are there new competitors coming into the market?  For example if you have a 12 year old property built to the prevailing trends 12 years ago you will have an Express that is a little more country style in appearance both external and internally.  Newer Express will have a modern/Euro look with a different style of exterior, lobby, and space planning for guest interactions.  You could feasibly have another hotel open 4miles away from the same Express brand which will canabalize some of your sales.  These flagged properties do have loyal guests, but that doesn't mean they won't go to the next one if it is closer to their needs.
• AGE/QUALITY?  The age of your product will effect your operating numbers.  As the property gets older certain things will go out.  Multiple room HVAC units at $600 a pop, your pool pumps, your servers.  Things will need replacing.  Make sure you are equipped to budget for these things.  Make sure you track down the vendors you will use ahead of time so you aren't scrambling.   
• Management Encumbarances Is the property under a management contract? This is important because you want the right management company at the property. Some management companies specialize in REO properties. These type of companies are really just keeping the lights on. This is not who you'd want. You want aggressive management to put "heads in beds" as the industry refers to filling rooms.
• Market Cycle/Valuation?   Hotels have cycles. We are in the midst of a rather long upcycle. I would not suggest paying top dollar at the cusp of an upcycle on an older property. You may pay 10cap and pay $10mm, but what if a downcycle hits and your NOI drops to $600K? Now at 10cap your value would be only $6mm. In fact it would probably be less because in down cycles the cap rate typically expands so you may only get 11 or 12 cap on your property. So an exit in that scenario can be difficult if you paid top dollar. Market timing is tricky. Anyone will tell you you can't time the market. Experience helps here.

While I would not discourage you, I will say that a hotel can make much better returns than multifamily.  At the same time I will also say it is very easy to lose money in hotels as well.  This is due to the business nature of it.  It is a more active area of real estate and typically the more active/management intensive it is the higher the returns.

Please do feel free to ping me anytime.  I do have an interest in coincidentally a Holiday Inn Express and actively developing.  If you have any questions or if you need any clarification feel free to message me.