Factors to consider when deciding when to invest in a capital-expenditure project at your property include having an exit strategy and reacting to your competitive set.
Capital expenditures (CapEx) have a significant impact on a hotel both during and after completion of a project. With rooms out of order and guest complaints, it can be quite a challenging process. But apart from the most common considerations for timing your CapEx, such as seasonality, there are other issues that are even more important and should be considered.
In most situations, CapEx investment depends largely on your exit strategy. For an investor who plans to hold onto the property for long-term cash flow value, a seven- to 10-year CapEx cycle based on brand and property requirements is typical. But for an investor who bought the property to renovate, ramp up, stabilize and sell, timing CapEx becomes crucial.
An owner who has successfully executed the first three stages of the strategy—renovate, ramp up and stabilize—of a property that is in need of cyclical CapEx (either brand-required or general), should delay that CapEx until sale and leave it for the next owner, because any return on incremental CapEx with the existing capital stack may be minimal.
If certain CapEx items cannot be delayed, consider leasing them. While leasing out projects can be costly in the long term, it might be a better option in the short term as you negotiate a sale. Also, buyout options in a lease contract can mitigate some of those long-term concerns.
Normally when a new hotel breaks ground, it creates a panic in the competitive set and sets a ticking time bomb for the competitors. But everything else being constant, if the only differentiator between the new-build and competition is the condition of the property, investing CapEx into the competing property while the new-build is under construction can negate much of the downfall when it opens. This is especially true if the property can complete its “refresh” prior to the opening of the new-build.
Also, if the competitive property is in disrepair, and the market is looking for a renovated product and can support that increase in rate, being a first mover in the market and getting a head start on CapEx can provide significant gains in both demand and rate.
When an economy is in recession and demand is evaporating, owners spend a lot time trying to figure out a way to delay any requirement CapEx. Given that revenues and margins are retreating, causing FF&E reserves to shrink as well, allocating sufficient funds for CapEx—whether emergency, brand-required or just general replacement of FF&E—can be an impossible task. But if an owner has the ability to invest additional equity on CapEx, they could be in for significant returns once the economy rebounds.
Brands are typically lenient with a property-improvement plan given the increase in brand changes/losses during downturns. This gives an owner the ability to negotiate with brands, defer certain brand requirements and receive waivers on others. Also, suppliers are easy to negotiate with and procurement is quick.
Competition will typically start renovations once economic conditions have improved, which opens opportunity to gain penetration and share as the economy rebounds and demand increases. Also, the fear of new supply mitigating the renovation is not present, as a downturn typically stalls new supply.
A renovated and stabilized product post-recession is a highly sought-after buy for both the private and public markets as the deal market heats up. It also provides the ability to refinance post-downturn with minimal CapEx requirements and much easier terms.
Obviously all of the above depends on the financing and leverage on the property as well.
Food and beverage
Unlike hotel CapEx, F&B-related CapEx can be very different and much more complicated. It may involve planned cyclical renovations/upgrades, usually with a smaller life cycle than hotel CapEx, or a required change in concept and branding as dictated by deal economics.
At Dream Hotel Group, where F&B is a pretty significant contributor to the top and bottom line for all our properties, we are very cognizant of F&B CapEx, its impact on overall hotel product, cash flow and deal economics. Having a clear understanding of market demographics and its impact on F&B concepting and branding can avoid any unplanned CapEx down the road.
Karan Narang is the Vice President for Acquisitions and Development Analysis at Dream Hotel Group, playing an integral role in the continued growth strategy and expansion of group. Karan holds a Master of Management with specialization in Hospitality Real Estate Finance & Investments, from Cornell University; Bachelor of Science in Hotel Restaurant & Institutional Management, from the University of Delaware and a Higher Diploma in Hospitality Management, from the Swiss School of Tourism & Hospitality, Switzerland. Dream Hotel Group is a hotel brand and management company with a rich, 30-year history of managing properties in some of the world’s most highly competitive hotel environments. Home to its Dream Hotels, Time Hotels, The Chatwal and Unscripted Hotels brands, Dream Hotel Group encompasses three business lines: Proprietary Brands, Hotel Management and Dining & Nightlife.
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