Owners should follow these steps to thoroughly vet a renovation or capital-improvement project to yield maximum return on investment.
Owners are presented with opportunities to create value through additional investment, otherwise known as ROI projects.
Sometimes these are identified by the management team and others are initiated by owners or their asset managers. Over the course of a year, there might be many opportunities worthy of review, but the decision to pass or proceed is only as sound as the supporting analysis. In most instances, the management team is tasked with creating the analysis, or at least providing key assumptions.
While the concept of an ROI analysis is universal, not all analyses are equal, and missing any one key component can yield misleading results, or worse, support an investment that is not warranted.
When considering a project, owners should ensure the following critical areas are reflected in the analysis.
Maintain a ‘big-picture’ focus
Evaluate each ROI project through the lens of the overall vision or strategy for the asset. Is the goal to:
- Reposition the asset (or a part of the asset such as a restaurant)?
- Defend the hotel’s competitive position (competitors are doing something the hotel should match or exceed)?
- Create a competitive advantage?
- Stay relevant (e.g., invest in guest-facing technology)?
- Convert non-income-producing space to income-producing space (e.g., put a Starbucks in an oversized lobby, add a rooftop bar, etc.)?
- Increase the income-producing utility of real estate (e.g., converting tennis courts to more guestrooms)?
- Reduce costs (e.g., energy management, labor productivity, etc.)?
- Add capacity (rooms, meeting space, etc.)?
- Preserve long-term asset value?
There will be limitless options on where to deploy capital, so it is important to prioritize where and when you spend it. Keeping the end in mind allows ownership to focus these efforts and optimize capital deployment across the asset.
Consider the owner’s hold period
Even great ideas may be inappropriate if the time to reap the benefits exceeds the hold period or the incremental sales price.
Perform benchmarking and analysis
It is critical to understand the viability of each ROI project, and if available, there’s no better way than by studying similar projects at other comparable assets. This allows the decision-maker to stay objective and ensure the analysis utilizes realistic assumptions. Projections on a page might elicit jubilation, but it is important to do your homework before getting too carried away!
Be sure that your benchmarking is relevant and understand where it might be dissimilar as well. Ensure revenue and expense assumptions are supportable and err on the side of being conservative, as something will inevitably come up that challenges the original assumptions.
Consider all relevant incremental revenue, not just direct revenue
A rooftop bar will obviously produce direct beverage (and possible food) revenue. It might also make the hotel more attractive in general and add rooms business. The opposite is also true if the bar creates unwanted noise in rooms or security issues.
Emphasize incremental impact to NOI, not just revenue or GOP gains
Analyze all associated expenses including management, incentive management, marketing, credit card fees, the potential impact on utilities, and associated capital reserves. These expenses can easily represent another 10% of revenue and will creep up after project completion, possibly turning a potentially good project into a mediocre or bad one. If the asset is union, bear in mind any potential union wage and benefit increases, as well as implications relative to severance and work rules as a result of the project. Also, consider the project’s impact on the rest of the asset. Will it result in business disruption? If so, be sure to include the lost revenue in the ROI analysis.
Bid the project
Whenever possible, obtain three bids and ensure the bids are comparable both in scope and assumptions. The bids should include all taxes, labor, shipping, storage, warranties, ongoing maintenance contracts and other ancillary expenses. These items are often overlooked and cause issues once you are well into the project. Be sure to include project management fees for major projects. Large and/or complicated projects do not manage themselves.
Review brand standards
Confirm with the brand that the project meets their standards prior to investing too much time in analysis. It is helpful to get the brand on board with the idea to ensure collaborative dialogue on how best to make the project successful. It is possible to negotiate with the brand on standards for a given project, but be careful not to create any compliance issues that may spring up in the foreseeable future. Also, consider the brand as a potential partner in a large project to align interests, get buy-in, and enhance the probability of success.
Beware of vanity projects
Vanity projects can be owner-driven, and yes, it’s their money. They can also be driven by management, or even a naive asset manager. It’s good to be creative and have an open mind. But a healthy dose of skepticism can be a welcome reality check. Be sure to look at alternative solutions. Few things in business are as dangerous as a person with only one idea.
Determine in advance how success will be measured—and then track it
It is imperative to establish an expected return and determine how the project will be measured. Determining a solid base line with the on-site team to measure against is essential. Is the expectation an increase in average daily rate, a reduction in food cost, or perhaps lower utility consumption? Ideally, following implementation, results will be benchmarked to expected performance on a monthly or quarterly basis. Some examples of measurable metrics include guest satisfactions scores, departmental profit increases, RevPAR index growth and exit value. The project should track in line to projections and if not, use this data to question the results and determine what is not working and how to adjust. What seems like a lost cause might still be salvageable by implementing creative solutions.
As pointed out yet again in the latest ISHC/HAMA CapEx study, the capital costs of a hotel are very high. It is vitally important to make every dollar count.
Andrew Yachera is an associate of CHMWarnick, the leading provider of hotel asset management and owner advisory services. The company asset manages more than 70 hotels comprising approximately 29,000 rooms valued at roughly $15 billion, and is advising on development projects valued at over $2 billion. CHMWarnick’s hotel owner advisory services include asset management, hotel planning and development, acquisition due diligence, owner-entity accounting, management/operator selection and negotiation, capital planning and disposition strategy. CHMWarnick has none offices nationwide, including locations in Boston, New York, Los Angeles, Phoenix, Fort Lauderdale, Minneapolis, San Francisco, Washington DC and Honolulu. For more information, contact 978.522.7000 or visit www.CHMWarnick.com. For the latest company news, follow CHMWarnick on Twitter @CHMWarnick and LinkedIn.
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