Valuation of Hotels for Investors

David Harper

• Publisher: Estates Gazette
• Year: 2013
• ISBN:
  9781136147654
• Edition: 1
• Topic: Law
• Subtopic: Property Law
• Index: Law

This book provides detailed, up-to-date knowledge that will help property professionals become successful in the hotel market. The book includes a range of valuation practices and shows the reader the most effective way to read, manage and work their way through this highly competitive market.

The author focuses on current methodology and practice within the hotel market, the market trends and legalities which will change or amplify those practices, and further sets out property investment options with real examples.

1
Things to Consider When Buying a Hotel and How to Avoid Potential Pitfalls

Introduction

In simplistic terms, the value of a hotel is the price that a prospective purchaser will pay for the property if it has been effectively marketed. There are many things that determine the price that potential purchasers will pay for the property, including potential earnings from the property, the need to provide geographic coverage to maintain the integrity of a brand and potential increases in value of the asset over a period of time. A big proportion of larger hotels are purchased (and sold) with the above criteria in mind, where returns on capital employed are considered to be just as important as strategic ones.

However, the majority of hotels that are sold in Europe are smaller properties and these are not necessarily purchased for the financial returns they can generate. This chapter is not aimed at chain hoteliers or investors who will have their own specific criteria that will lead to their choice of property; instead, it is predominantly aimed at less experienced hotel purchasers who are looking to buy smaller hotels, including those considering purchasing a property as a "lifestyle purchase" (those who are looking to swap the hurly burly of urban life for the perceived "gentler paced" life of a country house hotelier).

This chapter outlines the main considerations that the purchaser should take into account when buying a hotel, types of ownership, how to find the right property and outlines the importance of professional help throughout the process, and the types of due diligence that could be needed.

It is important that the valuer understands these considerations fully and is able to take them into account. Properties that meet the needs of a larger number of potential buyers could well generate more competition leading to higher purchase prices.

Initial considerations when first thinking about buying a hotel

There are many questions that a potential hotel purchaser needs to ask themselves before starting to look into buying a hotel and it will be a useful exercise for both the potential purchaser and the valuer to go through some of these questions here.

What does the buyer want from the purchase?

This must be the most important question — what exactly is the buyer after? If the answer to this is unknown then it is highly unlikely that the buyer will be looking in the right places or at the right properties to find the perfect property to meet their requirements.

Some purchasers may want to escape the pressures of city life, some may want to move to a different location, others may want to earn a substantial income, some will be buying the hotel as a stepping stone to a better property, others may be after a "tax-free" lifestyle, others may be looking at the business as a pension fund in a few years' time, whilst yet others may be looking to start a larger hotel company.

It is probably a useful exercise for a potential purchaser to write a list of all the things that are important to them, those that are less important and those that do not matter at all. This can form the basis for drawing up a shortlist that can help you determine the type of property that will be most suitable.

Is there a specific location?

As with all property, but especially for hotels, the most important factor in determining value is location. This is also true of "lifestyle" hotels — the most desirable locations from the potential purchaser's perspective will generally be the most expensive.

The amount of trade that can be generated in a particular location, combined with the desirability of the location from an aesthetic viewpoint will ensure that any properties benefiting positively from both will be well sought after. Quieter, less sought after areas may still provide less expensive options that could still meet the majority of the buyer's requirements.

It is then important to consider which location will suit the buyer's personal requirements, ie, is it close to your friends and family or, if they have a family with small children, does the location have suitable schools.

What type of lifestyle is the buyer after?

The reasons for purchasing the property is likely to affect the type of property the buyer is looking for. If they are after a relaxing lifestyle then a smaller property in a quieter location is likely to suit them better, whereas if the goal is to earn a substantial income then they would be better off looking at a larger property in a busier area.

Other key questions may include whether they want their private accommodation to form part of the hotel, or whether separate accommodation is required, and how large that accommodation needs to be.

What support and help will the purchaser have?

Running a hotel is not as simple as some people think, as John Cleese managed to show in Fawlty Towers. Without a support network in place, it can be very difficult to run a hotel entirely on your own.

A number of people planning to move into the small hotel market may feel they can run the hotel effectively on their own, but without adequate support it will soon become a chore rather than a pleasure. However the prospective purchaser must consider whether the property will be able to generate enough profit to pay for the support staff that the purchaser requires?

What are the buyer's strengths and weaknesses?

This is one of the key tests that will influence how the buyer should consider structuring the operations of the business. What are their particular strengths; are they good with customers and staff; are they better at marketing; are they adept at the finances and the accounts? Equally important, since all facets of the business are required to work well if it is to be a success is where their weaknesses lie, and how can these weaknesses be addressed?

Once the purchaser has considered what it is they want, where they want to be and what they will need to do in terms of improving their skills (or who they need to employ), they will be well placed to look at exactly what they can afford to buy, and how to raise the finance.

Types of ownership

Another fundamental factor that can influence the price of a property is whether it is freehold or leasehold.

In simplistic terms, a freehold property means that the interest in the land is held in perpetuity at no rental cost to the owner.

A leasehold property, on the other hand, will only confer rights to the owner leaseholder for the term of the lease, and the leaseholder will have to comply with the terms of that lease which may include paying a substantial rent. As is detailed in Chapter 9, the actual terms of the lease will have an impact on the price that should be paid for such a unit.

In simple terms, there are four different categories of hotel purchases:

• Vacant possession.
• Owned but operated by a tenant.
• Owned but operated by a manager.
• Owned but operated under a franchise agreement.

Vacant possession

Most lifestyle hotels are purchased as a vacant possession. Vacant possession, in the context of hotels, is different from most other types of property, for example houses and offices. If a house is sold with vacant possession it means that the property is empty, without a tenant or occupier of any type. However hotels are sold as an ongoing business, and so to sell it empty would adversely affect the trading.

As such, vacant possession for hotels means without a tenant or manager in place, (ie, without any legal operational encumbrances) but it will still be operational at the time of purchase, and the purchaser will benefit from future bookings. This also means that the purchaser will be discussing the staffing liabilities of the property, and will take over the stock (although this will be an additional sum on top of the agreed purchase price, calculated on the day of the transfer at cost).

Owned but operated by a tenant

A growing proportion of hotel investments across Europe are subject to operational leases. The owner of the property will either accept a premium at the start of the lease to allow the tenant to run the hotel, collect rent based on the agreement struck between the parties (this will be effected by the terms of the lease — see Chapter 9), or any combination of premium and rent.

The actual structure of the deal will generally depend on the needs and intentions of the parties. The tenant will then be responsible for the operation of the property and will employ all the staff themselves, undertake whatever repairs are specified within the lease at their own expense, and will be responsible for all things that are specified within the lease as the tenant's responsibilities.

Owned but operated by a manager

An important section of the hotel investment market, especially when involving US-branded hotels, comprise hotel investments being run by a hotel operator on a management contract. In effect, the owner is paying a manager to run the hotel on their behalf; the staff, the repairs and the operational costs are all the responsibility of the owner, albeit that the manager looks after the day-to-day running of the hotel for them.

The manager will charge a fee for his services, usually a management fee (based on revenue) and an incentive fee (based on profitability).

Operated under a franchise agreement

A franchise agreement is a contract that allows a hotelier/hotel owner to use the name (and usually have access to the central reservations system) of a brand in conjunction with the hotel. Such hotels will usually have minimum standards that have to be complied with, for example rooms sizes, facilities, safety and services, and the hotel will normally pay a fee based on bookings.

In return, the hotel will be branded (hopefully with a brand that helps them to generate more revenue than they would otherwise generate), and they should benefit from central marketing and bookings.

A hotel can be owned by one party who employs a manager (paying a management fee) and is subject to a franchise agreement (also paying a franchise fee).

An independent operator will need to persuade the hotel company of their ability to comply with the requirements of the brand (as well as their general good character) before they will be able to negotiate terms for a franchise agreement.

The various types of hotels that can be purchased

In simple terms, a hotel is a property that offers letting accommodation to paying guests. The level of service, the facilities and the price will vary in each hotel, but the common theme is that a transaction occurs; the guest contracts to stay at the hotel at a certain price and contracts to receive certain things in return, whether just somewhere to lay their head or dinner, bed and breakfast.

The type of business that the buyer wants to run will, to a large extent, influence the type of property that they should look at, and different types of hotel are outlined below. This is not an exclusive list as different categories are being created almost every day, with each operator striving to provide his own specific service, and not wishing to be labelled. As such, these terms are merely to...