INDUSTRY NEWS

Buying in a Seller’s Market
5 Savvy Steps for Purchasing Property
By Howard Mathews

What is the best way to find a property that meets the buyer’s need for size, location, desirability—and makes financial sense, too? Simply find a lodging property with problems, and add value to it! The following five steps can guide you to success:

Step One – Valuation of Prospective Property

Stop thinking about four times gross room income (or even 3, 5 or 6 times gross) as a valuation criteria. That formula is no longer a standard indication of value. Instead, look for properties that have been mismanaged, have no franchise or the wrong franchise, or are in poor condition with bad reviews.
Consider an 80-unit motel with a room income of $800,000 listed for $4.4 million, or about 5.5 times room gross. If you can answer the following question as shown below, you may have a winner!

1. Does it have a franchise? - No.


2. Is it in good condition? - No.


3. Are the rooms clean? - No.


4. Is the staff well trained and friendly? - No.


5. Is the market area strong? - Yes.

If an 80-unit property with an $800,000 room gross is managed correctly, the net operating income (NOI) should be above breakeven and maybe even cover the debt. This income would give you a RevPar (revenue per available room) of about $27.

Step Two – Evaluation of Property Condition

Making improvements in the property’s condition could move it from the bottom to the top of the local market. Gather some unbiased information on its condition and previous guests’ experiences by visiting www.tripadvisor.com and reading the reviews. We recently reviewed TripAdvisor to investigate a property purchase. Thirty-two out of 36 reviews of the reporting guests proclaimed that it was one of the worst properties they had ever stayed in. Negative information like this can be used in a positive way. A property in poor or below-average condition still showing a RevPar of $27 or an income of about $10,000 per-room per-year, could promise increased income when it’s cleaned up to above average-condition with a franchise. If TripAdvisor had only rave reviews and the property was showing the aforementioned current income, there would be no upside in purchasing, because it would already be taking its share of the market.

Step Three – Determining Room Price

When buying a property at $50,000 per room and recent comparable sales in the area show the same, there’s no room for improvement. If your investigation shows the most recent average sale in the market is $90,000 or $100,000 per room, that’s the makings of a good deal.

Consider what it would cost to build a new property in the area. If that figure is above $90,000 to $100,000 per room, you can assume that you will have an added value of $2 million (80 rooms at $25,000 per room) based on the following criteria:

1. You can buy the property at about $50,000 to $55,000 per room.
2. You can improve the property condition for about $10,000 per room ($800,000)

You would then own it at $60,000 to $65,000 per room. With an average area selling price above $90,000 per room, you’ve added value with a spread of about $25,000 per room or about $2 million (80 rooms at $25,000 per room). You have a winner!

Step Four – Contact Potential Franchisors

Contact prospective franchisors to find out if your property would be a good match for their particular system. They may be aware of the property and have a good idea of what has to be done to accommodate their company. If not, the franchise representatives are often cooperative and will do a cursory drive-by or quick walk-in to see if they are interested. If you receive positive feedback—keep going.

Step Five – Visit City or County Offices

Visit the local city or county planning and building departments to find out what new hotels are planned or under construction in the immediate area. If there’s no other major lodging property planned for the area, go ahead. If three new properties are being planned, pass on the deal.

Step Six – Purchase a STAR Report

If the above steps have positive results, a customized STAR report is probably the most important tool in deciding to purchase. STAR reports the average occupancy, ADR, and RevPar of your choice of at least four participating competitors. They require that no one property, brand or chain make up more that 35 percent of the participating rooms in your competitive set of properties. You must choose properties that are similar in size, location and market tier to your subject property. The report won’t be very useful if you choose luxury properties when you’re purchasing an economy property. For more information and to see an example of the STAR report, visit www.smithtravelresearch.com or
call (615) 824-8664.

Study this report carefully, and compare to your prospective 80-unit property, factoring in the necessary improvements and having acquired a national franchise. If the STAR report shows that the RevPar of these competitive properties is somewhere around $46-$50, you could assume an annual income of over $1.4 million on an 80-unit property and quite possibly a future value of about $7 million. With a total cost of about $5 million, you know you have a “very good buy!”

Look at all aspects of the deal before you pass or buy. It’s as important to say “no” to a deal as it is to say “yes,” but if you do your homework, you’ll find good deals where you might have previously passed them by.